Year-end Tax Planning and the Pandemic

Tax Planning and the Pandemic

We face a challenging time for planning:  The election resulted in a new President while the rate of Covid-19 infections (and deaths) continues to rise.  This has affected the economy, resulted in some tax law changes and may yield more stimulus to restore the economy.  Also, there may be more changes in 2021.  This post is intended to help you make the best tax-efficient moves before 2021 begins.  

2020 year-end tax planning – update on using the tax laws to save you money

In 2018, we provided a three-part series explaining the impact of the new tax law.  In our first part, we discussed the impact of the new law on personal taxes and in our second part, we discussed planning for small businesses.  This update replaces the third part from December 2018, as updated December in 2019 – it is our guide for year-end moves to reduce total taxes between 2020 and 2021.  But, before getting to the planning steps, we address the uncertainty caused by possible tax changes in 2021 and review some recent changes from earlier this year. 

Possible Tax Law Changes under Biden

President-Elect Biden campaigned on raising taxes for corporations and for individuals making over $400,000 of income.  However, even if the Senate seats in Georgia go to Democrats in January, the lack of a “Blue Wave,” a sweeping Democratic mandate, means that the tax hikes are unlikely to pass.  Furthermore, the President-Elect has made clear that controlling Covid-19 and economic recovery are the top priorities of his new administration. 

What did President-Elect Biden propose?  He would restore the 39.6% bracket for couples making $622,050 or more ($518,400 for singles), add a 12.4% social security tax for income over $400,000, place a 28% limit on itemized deductions for high income taxpayers, restore the 20% long-term capital gains rate for high income returns (and even apply ordinary rates on gains of taxpayers over $1 million), and limit the Qualified Business Income Deduction and opportunity zone credits.  For estate taxes, he would reduce the current $11.58 million exemption to a lower amount, perhaps $5 million or even $3.5 million, and eliminate the step-up in basis at death. 

While none of these changes are likely, there may be narrow tax hikes to fund infrastructure building and small tax breaks for lower earners (child/dependent care and elderly long-term care credits).  There may also be more stimulus action, such as more Paycheck Protection Program loans and business tax breaks for worker safety measures, as well as retirement savings incentives, tax extenders for items expiring this year, and tax breaks to encourage US manufacturing.  We will monitor activity on these matters for comment in future posts. 

Changes from the SECURE and CARES Acts for 2020

We wrote about the CARES act earlier this year, which waived the 10% penalty for coronavirus-related distributions from qualified plans of up to $100,000, with three years to pay the taxes due or redeposit as a roll-over, and suspension of required minimum distributions (“RMDs”). The act also allows larger plan loans.

The Secure Act delayed RMDs to age 72 and allowed individuals to contribute to IRAs after age 70 ½ if still working.   But the Act also limited the distribution of IRAs to a 10-year maximum for beneficiaries other than spouses and certain others, thus eliminating the “stretch IRA.” 

The Families First Act created credits for people unable to work due to Covid-19 illness and due to caring for others.  If you are affected, check to see if you are eligible for any of these tax credits. 

A reminder on the mortgage interest deductions

As you may recall, mortgage interest on new home purchases is deductible only for loans of up to $750,000 used to purchase your primary and secondary residences.  Interest on home equity loans is not deductible, except when the home equity indebtedness is used to purchase or improve your primary or secondary residence.

Check taxes already paid

Make sure your total paid to the IRS and state via withholdings and estimates meets the safe harbor rules.  If not, you could owe interest for under-withholding. 

Now to the planning:  Can you act at all?   

Each year, we advise that you be practical, focusing on where you can actually make moves.  For many, the $24,800 standard deduction for married couples (more for over 65 taxpayers, and $12,400 for single taxpayers) means you will not itemize (i.e., your total for itemized deductions is less than the standard amount so you take the higher standard deduction).  And, if you are not itemizing, you have fewer ways in which to affect change in the taxes due in either year (but you can also stop collecting receipts for those deductions). 

There is one exception from the CARES Act, which provides a $300 above the line charitable deduction for cash contributions.  You get this regardless of itemizing. 

Some possible deduction strategies

One technique for getting around the limit on deductions is to bunch certain deductions from two or more years into one year.  However, the only deduction that you can easily move is for charitable donations, because your state, local and real estate taxes are limited to a $10,000 maximum and you cannot accelerate, or delay, significant amounts of mortgage interest. 

If you do not want any one charity to receive the full amount in one year, you can still use this bunching strategy to donate to a donor advised fund, from which you may be able to designate donations to particular charities in future years.

The tax planning steps

What can you move?  If you are able to itemize, determine what income and deductions you can move from 2020 to 2021 or vice versa.  You want to minimize total taxes for both years.  Make sure your planning includes the 3.8% Medicare tax on high income and a review Roth conversion.  Roth distributions are not taxed, so converting a traditional or roll-over IRA to a Roth could be beneficial, as long as the tax cost now is not too great – see more at Roth or not to Roth?  With the waiver of the 10% penalty for early withdrawals, a Roth conversion may be more attractive.  Business owners will want to review our post on planning under 199A for QBID

What is the effect of moving?  Next, review the impact of moving income and expense to see what happens if you shift any of these amounts from one year to the other year.

The AMT – Finally, watch for the Alternative Minimum Tax (“AMT”).  The AMT affects fewer people, but it is still wise to review so you avoid it. 

Retirement contributions

If you have not maxed-out your 401(k) plan, IRA, Health Savings Account or flex plan account, consider doing so before the end of the year.  The contributions reduce your tax able income while adding to savings.  But check out our post on paying debts vs. investing.

If you are 70½ or older, you have the option of distributing up to $100,000 from your IRA or other qualified plan to an IRS-approved charity and having none of the distribution taxed.  The provision was great when you had an RMD to satisfy, but that was suspended for 2020.  That should not stop you if you still have the charitable intent. 

Business expenses

The deduction of unreimbursed business expenses was terminated by the new tax law.  That hurts many who are working from home this year, as they cannot deduct associated costs. 

We wrote about forming an LLC or S Corp. to report business expenses or taking expenses on Schedule C in our 2018 Part III post, but that applies to expenses for that business and we stressed that you will need a valid business purpose to form the LLC or S Corp. or use Schedule C for self-employment and take expenses.  Be sure to consult with an attorney before trying any of these ideas. 

Capital gains

Review your unrealized losses to see if you can “harvest” those losses to offset or “shelter” realized gains, reducing your total taxable income.  If you have more losses than gains, you can take up to $3,000 of capital losses against other income. 

If you sell an asset that you would prefer to retain, in order to shelter gains in 2020, make sure you do not run afoul of the wash-sale rule (any loss on an asset that you repurchase in 30 days will be disallowed, so you have to either wait 30 days or purchase a similar asset that fits your portfolio while not counting against the wash sale rule).  N.B. – when buying mutual funds late in the year, check for distribution dates so you do not purchase just before dividend and capital gains distributions, as you will owe taxes on those distributions. 

If you have significant unrealized gains, consider using appreciated stock for charitable donations – that way you avoid the tax on the gain while still getting the full fair market value for your charitable donation.  That is very effective tax leverage!

Estate plan review

While you review your taxes, review your estate plan as well.  The federal exemption is over $11 million in 2020, so fewer people will owe any federal estate tax.  However, that may change in 2021; also, many states still impose estate taxes on smaller estates. 

The individual gift and estate tax exemption is due to return to $5 million, adjusted for inflation, in 2026 and could be lowered sooner, as noted above.  That tax rate could also go up. 

If you have “excess wealth” and want to reduce your taxable estate by gifting assets to children or others, you can give $15,000 per person, per year now.  If your spouse joins you, that is $30,000 per person.  This includes funding a 529 plan for education cost – expanded to provide for more than just college – or an ABLE account for disabled dependents.  Note, however, that holding appreciated assets for the step up in basis at death may be better than gifting, but this could be eliminated as noted above. 

If you do review your estate plan documents, also review beneficiary designations to make sure everything is current.  And review your medical directive and durable power of attorney.  

Summary

Carefully review any income and deductions that you can still shift to see if moving will lessen the total taxes you pay for 2020 and 2021. 

Good luck and best wishes for happy and healthy holidays!

CARES Act, Stimulus checks, and other tax law updates

Keeping in touch during these challenging times …

2019 due dates (tax season is not quite over yet)

The IRS extended all of the following deadlines to July 15th:

  • 2019 return or extension filing;
  • Payment of 2019 taxes due;
  • Q1 2020 estimate payment; and
  • Q2 2020 estimate payment.

Most states have followed the same delayed dates (but not all).  Let me know if you have a question on payment and filing. 

So “tax season” will be over soon, yea!

Stimulus checks and other changes

Many people are asking about their stimulus checks and expanded unemployment benefits under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.  The Act also has other provisions including tax credits for self-employed affected by Covid-19, student loan payment delays, and relief on mortgage payments and rent.

Of the many posts regarding the stimulus checks and benefits, student loans and 401(k) distributions, here is a good summary from the NY Times

If you want to check on the status of your stimulus check, here is the IRS website to find the status or apply for your stimulus check.  If you expect a check that has not arrived, check out the links in this Huffington Post article

And if you received a check for a deceased relative (over 1 million were sent!), you need to return it to the Treasury, sorry. 

Small businesses

CARES Act includes benefits for small businesses: Payroll Protection Program loans; payroll deposit delays; and tax credits.  The SBA funds for the PPP ran out initially, but Congress added more funding. 

The key is to file so that the loan is forgiven, so that the funds become a grant.  The forgiven loan is not treated as income.  

If you need more information on these programs, let me know. 

2020 tax law changes

The required minimum distributions or RMDs are suspended for 2020.  This way, you do not need to sell funds at a low to withdraw and may even be able to redeposit funds that you already withdrew. 

The CARES Act waives the 10% penalty for early withdrawals from qualified plans for up to $100,000 for coronavirus-related circumstances. The distribution is taxed over three years. And, if the funds withdrawn are repaid to the plan within 3 years, that is treated as a tax-free roll over.  The act also allows loan from the plan up to the lesser of the vested balance and $100,000. 

For 2020, there is an above-the-line charitable donation deduction up to $300.  This should help charities that are responding to those impacted helping them raise money now.

More Scams and Hackers

Be wary of messages asking for personal information because scams are on the rise.  And be careful working from home, as there are more hacker attempts to gain access via the home connections to companies. 

If you want help dealing with any, let me know.

Personal impact

Being cooped up is challenging, even if it is the best way to stay healthy.  Make sure you practice self-care so you can handle this! 

I hope you and your loved ones are all managing this as well as you can.

If you want to just talk, I would be glad to set up a time, just let me know! 

Thank you, and be well

Steven

Robo-Advisors may be just what we need!

Should you really fear Robo-Advisors?

Reading financial news, you see many posts warning of robo-advisors, telling you how you really need a human advisor, how you can robo-proof your investment business, or how robo-advisors are merely a fad and will die off when everyone realizes how evil they are.

All these posts have it backwards. They are apologists for entrenched firms attempting to protect their turf when individuals need help.

Shift from pensions to 401(k) plans hurt individuals

Last century, many large employers provided pensions as a benefit. These were large portfolios that could hire good advisors and thus performed well. However, by the end of last century, retirement funds had shifted to 401(k) and similar plans, where individuals managed their own portfolios.

Institutional portfolios hire great managers so many are able to beat their various market indices. In contrast, individual investors historically achieve less than half the returns of their related indices.

Poor performance by individuals managing their own retirement funds is a key factor in the current crisis facing Boomers who are under-funded for retirement. (Note to Millennials: don’t just speak to your parents, do your own planning so this doesn’t happen to you!)

Why do individuals invest poorly?

Individual investors are seen as a contrary indicator:

  • If they are buying, then the market is near its peak and it is time to sell; and
  • If they are selling, the market has reached its bottom and it is time to buy.

Here is a case in point:

We saw the regret and pride response in action beginning in March 2000, the largest purchase of mutual funds in the history of the stock market. Fast forward to 2008, just before the “Great Recession” market downturn, and stock prices were falling, but investors refused to sell at a loss. As the market continued to fall, investors held off until they simply couldn’t take it any longer. Many sold their stock near the bottom and missed the following upswing that began March 2009. Forbes – Why average investors returns are so low.

To summarize, individual investors perform poorly due to these factors:

  1. Lack of access to good investment advice; and
  2. Investment psychology. For more on the psychological factors to which individuals fall prey, see Seven deadly sins of investing to avoid.

There is a third factor: High expenses in form of commissions and other fees.

Robo-advisors address all three factors. 

  • First, automating advice permits good advisors to offer services to small investors. Betterment with automated rebalancing and tax-loss harvesting is a good example.
  • Second, automation lowers costs, so fees charged can be reduced. Combine that with use of ETFs and you have dramatically reduced expenses.
  • Last, robo-advisors are immune to greed and fear so their performance will not suffer the way performance of individuals may. No robo-advisor would wait until the market hit bottom to sell, as in the case of 2008 summarized above.  

Bring on the Robos!

What is my conclusion? Not only are robo-advisors here to stay, they may be just what individual investors need so they can retire well!

“Simplify your finances? No; “Gain control, understand your finances?” Yes

After reading a recent article in Kiplinger’s Finance Magazine  on simplifying your finances, I wondered if your personal finances can really be made simple.  While many of us may hope so, I am not sure that “simple” is best.

However, gaining control of your finances and gaining a better understanding do make sense.

clutter-286975_1920 Okay, that does need to be simplified!

Here are some ways that help you gain control that may also “simplify” your life:

Cash management and Debt management

Set up automatic payments with vendors so they use your bank or credit card, or set up payments using your bank website.

  • If the payments are regular, and of similar amounts, you save time and can plan on the withdrawals.
  • However, if you change banks, sorting and resetting auto-pay at the new bank can be a major headache. Similarly, if you change credit cards, you need to update information with all vendors.

You can also automate tracking of your spending by using websites like Mint or Personalcapital.  Or, you can use Quicken or QuickBooks software from Intuit to track your bank and credit card accounts.  You can download from your bank and credit card websites into the program and then review to analyze your cash flow and spending.

Setting up direct deposit for payroll into your checking is great.  You can also split part so it goes to savings or even have some go to your investment accounts.  You will then need to follow up to invest the cash that accumulates, but having money set aside saves it from being spent, and adds to your investments

Investing

Kiplinger’s recommended consolidating retirement accounts to avoid low balance fees.  It also makes updating beneficiary designations easier.

While avoiding fees makes sense, am not sure that putting all investments into a single retirement account does.  You cannot do this if you have Roth and pre-tax accounts like a 401(k) plan, and you probably should not do it if you have contributory IRA and 401(k) accounts that are subject to different tax rules.

Kiplinger’s also recommended using one broker for your taxable accounts.  This makes more sense, in that you have a higher balance which should mean lower fees and more attention from the broker.  However, I prefer using exchange traded funds, or ETFs, and avoiding most broker fees, which means essentially no attention from a broker.

One article said that your investment plan should be to “sign up and forget it.”  While avoiding investment pitfalls like second-guessing yourself out of panic when a fund goes down is good, I do think you need to review and rebalance your investments once a year.

Another article recommended using an “all in one” fund for investing.  Now, this really troubles me.  If your sole goal is retirement, then an age-targeted fund could make sense.  But, if you are saving for goals with different time horizons, this is a bad idea.

If you use an age-targeted fund, do your homework on the funds.  For example, if the fund plans to suddenly shift to bonds when you retire, that will not serve you well because you are likely to have several decades for which you will need the growth from stocks.

Protecting your information

Having a master password for access to all your other passwords reminds me of the joke about the student who repeatedly distilled his notes down, first to an outline, then to note cards, and finally to one word.  How did he do on the day of the exam?  He forgot the word.

Nonetheless, having passwords is clearly important so having a way to manage them is as well.  Check out this recent review of apps for managing your passwords PC Magazine Best Password Managers for 2015.  You can manage the passwords yourself by creating a document that you save as a PDF and then encrypt.  But don’t forget the password you used for the PDF!

Store files in one place

We did a post on using cloud storage when you do not need originals.  Here is another site to check out:  Shoeboxed

Credit cards

In addition to downloading transactions as noted above, you can track your credit score and credit history by using sites like Credit Karma

Estate planning

For insurance purposes, and for your estate plan, having a record of possessions, you can list all your property using sites like Know your stuff home inventory.

Conclusion?

There are ways to gain better understanding of your finances that also make your finances simpler.  But setting simplification as your primary goal risks distorting your finances – too simple may be a bad result.

P.S. Our sister website, www.wokemoney.com, encourages you to gain a better understanding of your finances so you can handle your own planning.  Let me know what you think.

Okay then, what is a financial plan?

You may hear some argue that robo-planners will not replace individual, human planners. I call them the “There’s no app for that” group.

We do believe that “There is an app for that.”
workshop-1280264_1920

Well, that is not what I had in mind.

But exactly what is “a financial plan”? Finding a good, workable definition is a challenge.

Wikipedia says:

Textbooks used in colleges offering financial planning-related courses also generally do not define the term “financial plan.” For example, Sid Mittra, Anandi P. Sahu, and Robert A Crane, authors of Practicing Financial Planning for Professionals[8] do not define what a financial plan is, but merely defer to the Certified Financial Planner Board of Standards’ definition of ‘financial planning’.

Can’t we define “financial plan”?

Yes. Investopedia offers this broad definition:

While there is no specific template for a financial plan, most licensed professionals will include knowledge and considerations of the client’s future life goals, future wealth transfer plans and future expense levels. Extrapolated asset values will determine whether the client has sufficient funds to meet future needs.

And Wikipedia gives more detail:

In general usage, a financial plan is a comprehensive evaluation of an individual’s current pay and future financial state by using current known variables to predict future income, asset values and withdrawal plans. This often includes a budget which organizes an individual’s finances and sometimes includes a series of steps or specific goals for spending and saving in the future.

So you need to project where your assets can take you to be sure you meet your future in good shape. Makes sense

And what is my definition?

A to do list or “action plan” that tells you what you need to change now so you optimize the use of all your resources to achieve your major, long term goals in the future.         

So what does a financial plan look like?

If you paid to have a financial plan prepared, and have a complicated situation, you may get a glossy, bound book filled with projections, charts and graphs, plus text. While much of it may be boilerplate, it will tell you where you are going from now until you die, how your money will follow if you invest according to the plan, and what you need to change on taxes, insurance, and your estate plan.

At the other extreme, you can glean the essential steps and write them all on a PostIt note, which you then place in a spot you see often enough to remind you what to do:

  • Maximize my 401(k) contributions,
  • Set up and contribute to a Roth IRA,
  • Review my investment allocation, use ETFs,
  • Steer clear of any major credit card debt,
  • Review my beneficiary designations,
  • Sign an medical directive, and
  • Save enough for a fun (not too expensive) vacation next summer!

In the end, it doesn’t matter how many pages or what the plan looks like; what matters is that you learn from reviewing your finances and change how you manage your resources so that improve your finances.

So, yes, a simple to do list could be enough, if you follow it!