With only a limited number of weeks left in the year, it is time to focus on year-end tax planning to minimize 2020 taxes and prepare for 2021. Numerous tax changes from recent laws, including the SECURE Act and the CARES Act, can affect last minute promotions. There are many tax planning options that can be implemented now that will have a positive impact on your income tax return for this year.
Typically, year-end planning is a multi-year exercise that takes into account the current tax rules, the rules for the next year, and the taxpayer’s income and expenses expected now and in the future. Due to a very modest increase in the Chained Consumer Price Index for Urban Consumers (C-CPI-U), cost of living adjustments (COLAs) to dozens of tax regulations for 2021 are modest or nonexistent (Rev. Proc. 2020-) 45). There are minor increases in tax brackets, standard withholding amounts, and minimum alternative tax exemptions for individuals. There are higher limits on qualifying business income deduction, small employer health insurance credit, and business loss surplus limit (which has been suspended for 2020 but will come into effect in 2021 unless Congress extends the suspension). There are also some increases in contributions, benefits and other amounts for qualifying retirement plans and IRAs for 2021 (Communication 2020-79).
Expiring provisions must also be taken into account when planning the year-end. There are a number of options for individuals and businesses. They could be renewed, but this promotion may not take place until after the end of the year. And there is still the potential for additional laws by Congress to introduce additional incentive measures, some of which may take the form of tax incentives.
Defer income. For individuals and cash-based businesses, deferring income shifts taxation and the tax burden by one year. Income deferral can be used for:
- Year-end bonuses if the employer offers a deferred compensation option.
- Capital gains from not updating earnings this year. Of course, this tax strategy should be applied given the market opportunities. If capital gains are realized, they can be deferred by investing in a qualifying opportunity fund (reinvestment periods have been extended due to COVID-19).
- Self-employed and cash-based businesses can delay year-end billing so payment will be received (and taxable) in 2021. This strategy should also not be used if funds are required for cash flow purposes or if there is a risk of collection due to delayed settlement.
However, income deferral may not be the best strategy if 2020 is a low tax year and 2021 is expected to be better. In this case, it can make sense to earn an income during a low tax year. Not only can this be done by avoiding postponement options, but also by:
- Conversion of a traditional IRA into a Roth IRA.
- Redemption of US savings bonds shortly before the due date.
Realize capital losses. The performance on the stock markets has resulted in paper losses for many investors. Individuals who hold securities that have declined in value may wish to realize losses for tax benefits if it makes an investment worthwhile. Loss of capital on the sale of securities can offset capital gains dollar for dollar. Capital losses in excess of capital gains can offset a decent income up to $ 3,000 ($ 1,500 for married individuals filing separately). Capital losses in excess of these limits can be carried forward indefinitely to offset gains (and limited ordinary income) in future years. However, avoid the laundromatic sale rule, which prohibits current write-offs on losses when essentially identical securities are purchased within 30 days of or after the sale date.
Make certain transfers. Giving away cash and property can save you donor taxes.
- Higher income taxpayers may wish to transfer securities to lower income individuals who do not pay taxes on long term capital gains and qualified dividends. For example, an older parent in a lower tax bracket can sell gifted securities tax-free and leave more after-tax income in the family. However, the transfer to children subject to “child tax” will not result in tax savings if their investment income exceeds a threshold ($ 2,200 in 2020).
- Donate to charity. Gifts of valued securities held for more than a year will result in a charitable contribution deduction based on their value. Any increase in value escapes capital gains tax. Cash donations can be made at the end of the year by debiting a major credit card or sending checks by December 31st. Note that higher deduction limits apply to cash donations from individuals and C-companies, as well as food inventory donations from companies. Precautions: Be sure to observe the rules of reasons (e.g. a written confirmation for gifts of 250 USD or more).
- Perform estate planning transfers. Wealthy individuals may wish to take advantage of the annual gift tax exclusion and lifetime exemption amount ($ 11,580,000 in 2020) to transfer assets to minimize future estate tax costs.
Depreciation for companies. Cash-based businesses can pay outstanding bills and replenish supplies for the coming year to make deductions now. However, as with forbearance, it might not be advisable to speed up deductions if 2020 is a low tax year but is likely to be better in 2021. Delaying deductions makes them more tax-valuable.
Buy the machinery and equipment you need so they can be up and running before the end of the year. Then when filing the 2020 return, decide on the best depreciation option for the company. This can be done immediately through expenses in the first year, bonus write-offs or a de minimis safe harbor rule. Or deductions will be distributed in the coming years through regular depreciation.
Companies that keep inventory can write off their costs if they put slow items for sale now and keep the evidence of the discounted supply. You can raise money by selling such items to a remainder or donating them to a charity for a discount (limited to the lower base value or the lower market value).
Look for reimbursement options from 2018 or 2019 net loss losses and qualifying improvement properties that were operational in 2018 or 2019. If 2020 turns out to be a bad year, prepare now to file a quick refund from a 2020 net operating loss after year-end.
Preparations for 2021
Before the end of the year:
- Opt for health insurance. Employers need to determine if they are large employers offering affordable minimum health insurance or paying a fine. ALE status for 2021 is based on payroll in 2020. Employers can choose the type of coverage offered, which may be traditional group plans. , high-deductible health plans combined with Health Savings Accounts (HSAs), or Small Business Qualified Small Employer Health Care Reimbursement Schemes (QSEHRAs) (with reimbursements for 2021 up to a maximum of $ 10,700 for family insurance and $ 5,300 for self-insurance). Employers can also set up cafeteria plans to offer flexible spending accounts (the 2021 medical FSA limit is $ 2,750) or allow workers to pay their portion of health insurance premiums before taxes. People who choose coverage for 2021 through a government marketplace must do so by December 15, 2020 (different dates may apply to government exchanges).
- Select retirement plans. A change in the SECURE Act allows employers to set up defined contribution plans until their extended due date (previously, plans other than SEPs had to be created before the end of the year). Due to the termination obligations, decisions must now be made about plans for 2021 that include wage cut elections by employees. Employees who can participate have to decide on their election contributions for the coming year. Individuals can also consider contributing to an IRA or Roth IRA for 2020 if they are eligible. The age limit for contributing to a traditional IRA no longer applies.
Withholding tax and the final installment of estimated taxes for individuals and legal entities can be adjusted to reflect tax planning measures affecting 2020 and 2021. Also, check out what Congress can do to provide additional tax breaks before the end of the year.
Sidney KessThe CPA attorney is a consultant at Kostelanetz & Fink and a senior consultant at Citrin Cooperman & Company.