I don’t know about you, but I have decided to get settled into this unique moment in time. So far, hoping for a quick fix and a return to life as it was before coronavirus hasn’t changed anything, and I prefer to find opportunity in reality. I am on the constant hunt for the positive in all areas of my life and my clients’ lives, and 2020 presents some compelling reasons to spend time reviewing ways to reduce taxes, potentially turning a challenging financial environment into a boon for your financial plan.
Now that the extended July 15 tax deadline has passed, your CPA probably has more free time to discuss strategies that can be implemented before year end. Whether you are an employee or a business owner, we’ve listed below some ideas for you to consider. While we are not detailing well-known tactics like making SEP contributions for small business owners, funding 529 Plans for parents who are saving for college, and intentionally itemizing your deductions, we still encourage you to consider these and other tax opportunities and consequences with all of your asset decisions.
It’s important to remember that this year is unique (and will continue to be unique). We just need to prepare for when tax opportunities present themselves. For example, the first two strategies below were genius for about two weeks in March during the stock market correction. They may become genius again later this year if the stock market takes another dip, so you want to be prepared if that happens. Also, some of the strategies work well in years of low income, which can happen when people retire or are temporarily unemployed, which is the unfortunate reality for millions in 2020.
Incur taxation under a friendly tax code: The “textbook” recommendation when it comes to taxes is to defer them as long as possible, but that may not make sense this year. Our current tax code is very friendly to individuals, specifically regarding income tax brackets, capital gains taxes, and estates. With an election on the horizon, we are encouraging clients to take advantage of the 2020 tax code and realize some taxation now by selling appreciated assets, taking withdrawals from retirement accounts (and preserving non-IRA and Roth assets), and gifting to family.
Tax loss harvesting: This gem was more relevant in March when the stock market took a temporary plummet of more than thirty percent. The idea here is to sell an investment at a loss, and immediately reinvest the proceeds into something else that can perform well when the market rebounds. As an example, we were able to harvest losses for some of our clients by selling international assets in March and reinvested the proceeds in US assets. The tax loss was “locked in” when the international asset was sold, and can be used to offset future gains created in the portfolio.
Roth IRA conversions: Roth IRAs are a darling of tax planning strategy, but Roth conversions become very favorable under two circumstances: when the value of the asset drops significantly, or when income drops significantly. A few key strategies make Roth conversions appealing:
- The longer the post-conversion assets can stay in the Roth and experience tax-free growth, the better. For example, you will see more benefit to leave the Roth as an inheritance than to use it for living expenses in Year 6 after the conversion.
- The taxes you owe for the conversion should be paid for by another source, such as savings.
- The Roth conversion is more efficient if the money can be taxed at lower tax brackets. If you have a uniquely low-income year (due to retirement or a lay-off, for example), this may be an ideal year to convert assets.
There is another level to Roth conversions, dubbed the “mega backdoor Roth strategy” by the financial services world. If you are an employee with a 401(k) plan that allows after-tax contributions, you can contribute up to $37,500 per year (above your normal contribution) to an after-tax account and immediately convert it to a Roth. In its simplest form, all of this is done within your 401(k) plan through your HR department. If you have the cash flow available, this is worth checking out.
Donor-Advised Fund (DAF): With so many of us asking what we can do to help these days, a Donor-Advised Fund provides two opportunities. A DAF functions as a designated account for charitable donations. You receive a deduction at the time that you deposit funds into the account, but it does not yet need to be assigned to a charity. Maybe you know you want to fund food banks now, but are also looking for programs that have long-term goals to address racial equity and economic opportunities. You can realize a tax deduction in 2020, but send the money to the charity of your choosing when the time is right. And for those of you who were clever enough to buy into the market dip earlier this year, you can donate that appreciated stock to a DAF (or any charity) and avoid paying the taxes on the gains.
Universal Charitable Contribution: Team member Sergio Garcia, who is both a CFP and an Enrolled Agent, provides another strategy for 2020. For charitably inclined taxpayers who are not itemizing and might not otherwise be able to deduct their charitable donations, they can now make up to $300 of charitable contributions to be deducted as an above the line deduction in 2020. This ‘universal’ deduction is allowed for cash contributions to charity, but not stock or other assets.
Coronavirus-Related Distributions: Part of the CARES Act, this provision allows those affected by the coronavirus to take up to $100,000 from their retirement account. To qualify, you, your spouse, or dependent must have a health or financial impact from the virus. For those under 59 ½.there is no 10% penalty, and anyone who takes advantage of this can pay the taxes over three years, or repay the funds over three years. This blog describes the provision in detail, with specific examples.
Taxable transactions don’t happen in a vacuum, and should be considered in the larger context of your financial plan, long-term goals, and asset structure. We work with our clients’ tax and estate advisors to thoroughly vet tax strategies before executing them. If you would like to learn more about how we incorporate tax strategies into our client portfolios and financial plans, send us an email at email@example.com.
You can also explore our website for further tax resources.
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.
Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. This material is intended for informational purposes only and should not be construed or acted upon as individualized tax, legal or investment advice. Federal tax laws are complex and subject to change. Neither FSC Securities Corporation, nor its registered representatives, offer tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.