(Hint: Make sure to read to the end for the clever charitable strategies for 2020)
December provides us with many opportunities to implement tax strategies for our clients, as all of the details come together for us to help our clients make informed decisions. We are especially focused on smart tax analysis in 2020, when we know that we have a friendly tax code, as opposed to future years which may bring higher taxes for a number of reasons. With a change of guard in Washington, we expect that discussions about possible updates to the tax code will continue. Absent an upcoming change to the tax code, there are still several provisions in the 2017 Tax Cuts and Jobs Act (TCJA) that disappear in 2025 unless there is action to extend those tax cuts. Additionally, the US deficit has grown steadily since 2015 with a historic increase in 2020 during the pandemic, eclipsing the high watermark set during the 2008-9 recession.
Tax strategy always involves questions: What do you think the tax code will look like in 10 years? 20 years? What do you think your tax bracket will be when you retire? Do you think your children will be in a higher or lower tax bracket than you when you die? Will the opportunity you are designing your assets around now still be an opportunity in the future? I imagine very few CPAs, financial advisors, or estate attorneys in 1990 ever thought the estate tax limit would go to $11.58M per person, as it is now. Accepting that the answers to these questions are assumptions and not facts, we will assume for now that we may be in a period of the lowest tax rates we are likely to see for some time.
Conventional wisdom and textbooks tell us to delay taxes as long as possible, but 2020 has not been a year for conventional wisdom. Earlier this year, I wrote about tax strategies to consider implementing in 2020, including Roth IRA conversions, donor-advised funds (DAFs), the universal charitable contribution, and other provisions under the CARES Act. What follows here is an expansion of the first recommendation that we provided in that post: if we accept that taxes are low now and likely to increase in the future, and pair that with the unique circumstances presented by the pandemic, it might make sense to consider incurring taxation under the friendly 2020 tax code. This list of 2020-21 tax brackets may be a helpful reference point as you read.
Roth IRA conversion: Conversions make sense for people who believe that paying taxes now will help them pay fewer taxes later. Some people have lower taxable income in 2020 than they expected, and will resume a normal level of income in 2021. They may want to take advantage of this one unique year to convert taxable dollars to tax-free dollars. While Roth conversions are permitted after age 72, RMDs must come out first before making any conversion. However, 2020 RMDs can be waived, providing a small window to convert qualified funds without first taking a required distribution.
These strategies should be considered by:
- Those age 72 and over who waived their Required Minimum Distribution.
- Business owners who had higher than normal expenses or lower than normal revenue.
- Taxpayers (especially those in the 24% tax bracket or lower) who believe that tax rates will be higher in the future.
- Taxpayers who have unusually low income in 2020, due to loss of a job or business.
Accelerate taxable events: We are recommending to our clients that they actually accelerate taxation into 2020, if they know taxation is coming in the near future. This is true for grandparents who may want to take a withdrawal from their IRA to gift money to grandkids, business owners with billable year-end work, and investors who have seen large gains in their portfolios this year.
These strategies should be considered by:
- Any taxpayer that knows they need to withdraw funds from their portfolio in the next two years.
- Business owners with flexibility to realize income in 2020.
- High income earners with growth-oriented portfolios.
Delay deductions: There are several opportunities to delay some deductions to next year if expectations for higher taxable income are true for 2021. December is normally the time of year that CPAs get frantic phone calls from business owner clients about how to reduce taxable income by paying for deductible expenses. We suggest keeping your taxable income high this year, and delaying deductible expenses until the new tax year. Additionally, some taxpayers have traditionally prepaid real estate taxes when possible, to reduce current year income. It might make sense to delay paying those taxes until 2021, when that deduction may be more beneficial. This is especially true for IRA owners who waived their 2020 RMD, thereby reducing their 2020 taxable income.
These strategies should be considered by:
- Business owners with flexibility to delay expenses to 2021.
- Those age 72 and over who waived their Required Minimum Distribution in 2020.
- Homeowners who anticipate high income in 2021.
Fund philanthropy: Like real estate taxes, charitable deductions can be delayed to 2021, if you anticipate higher tax rates or substantial income. However, doing so would miss out on some key provisions in the CARES Act. The biggest opportunity is that individuals who itemize can deduct up to 100% of their Adjusted Gross Income (AGI) for cash contributions made directly to a nonprofit. If you prefer to donate to a DAF, you can still deduct up to 60% of your AGI for a cash gift, or up to 30% of AGI for appreciated assets. Also, though RMDs can be waived, you can still make a qualified charitable distribution (QCD), which allows you to make a non-taxable distribution from your IRA to a nonprofit. A taxpayer with large IRA assets that does not require income may even utilize a QCD, combined with a Roth conversion, to significantly reduce Traditional IRA assets, which would reduce future RMDs.
These strategies should be considered by:
- High net worth families that want to create a philanthropic legacy.
- Individuals or families with enough liquid assets to convert Traditional IRA funds to a Roth IRA and to make a large charitable contribution in 2020.
- Those age 72 and over who waived their 2020 RMD but would like to donate IRA funds to their charity.
- Those age 72 and over with large IRA assets that intend to make charitable donations during their lifetime.
- Any individual who wants to donate to their favorite charity.
These are just a few strategies available in 2020, and each taxpayer should consider their unique circumstances with their CPA and their financial advisor to determine if these strategies are beneficial in their overall financial plan. We anticipate that 2021 may present even more opportunities for thoughtful tax design, especially in the areas of estate tax planning, charitable contributions, and in portfolio management.
As holistic investment managers and financial planners, we incorporate tax strategy into all of our portfolio recommendations. To learn more about our comprehensive investment and financial planning services, or if you have any questions, please email us at hello@bfsadvisorygroup.com.
Neither FSC Securities nor its representatives provide tax or legal advice. Individuals should consult a CPA, Tax Attorney, or similarly qualified professional of their choosing before making implementing any tax strategy.
Debra Brennan Tagg is a CERTIFIED FINANCIAL PLANNER™ Professional and the creator of the DBT360 Financial Plan, a proprietary program that helps her clients prioritize their goals, leverage their resources, and address their risks. She is the president of BFS Advisory Group and teaches the public and the financial services industry about the importance of values-based financial planning and investor education.