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Year-End Tax Planning Tips Thumbnail

Year-End Tax Planning Tips

This year has been rough for everyone.  Hopefully, you and your family have made it through okay and everyone stays healthy.   Now that we’re nearing the final weeks of 2020, it’s time to wrap things up and get ready to dive into 2021.  Part of that involves making sure your tax plan is optimized for this and the coming years.

Following is the first of two tax planning notes that we are sending this year.  Look for the second this Friday, December 11th.

Why Do End of Year Tax Planning?

As we so often say, “It’s not what you make, it’s what you keep that counts.” Building your wealth is just the first step; the second, and arguably more important, is keeping it after settling up with the tax man.  

This is where our planning strategies come into play.  Not only can they help you reduce your current year’s tax liability, they can help you optimize your future cash flow by structuring your income and expenses to pay the least amount of taxes in the long term.  Many accountants and advisors who offer tax planning only focus on the current year. When they do that, they can deliver valuable short-term benefits. However, American tax law is a complicated beast, and many of the actions taken to drive down your taxes this year can lead to higher taxes in the future, ultimately leaving you worse off in the long run.  By keeping the whole picture in mind, we strive for the solution that leaves you best off in the long term, empowering you to pursue your financial dreams.

How is Tax Planning Done?

While the tax law can get messy and changes often, the overarching goal of tax planning is simply to exercise the control you have over the timing of your income and deductions to minimize your total tax burden over a period of years. This can mean moving income or deductions forward or backward in time, shifting income among people, and investing or spending in such a way that taxes are deferred to a future time when your tax bracket might be lower.  It can also entail converting one type of income into another that is subject to lower tax rates, such as tax-free interest (Roth or HSA distributions), qualified dividends, or long-term capital gains.  This could involve moving from accounts that are taxable to those that provide non-taxable benefits or tax-free cash flow.

What can I do before January 1st?

Lots of things!  Obviously, this isn’t a comprehensive list, and everyone’s situation is different, so before you dive in on any of this, it’d be best if you reach out to your financial advisor or CPA.  Also, our note on Friday will contain more actionable ideas.

  • Pre-pay 2021 bills now: if you’re planning to itemize deductions on your 2020 tax return, this may be a good time to pay deductible expenses, such as your January mortgage payment due at the beginning of next year and state/local taxes (subject to the $10,000 SALT limits). If you think you will be in a comparable or lower tax bracket next year, shifting these payments forward in time, may enable you to enjoy a larger tax deduction sooner, leading to an improved outlook for your pocketbook.
  • Charitable deduction for non-itemizers: in most tax years, to receive a benefit from charitable gifts, you need to itemize your deductions, and only 10% of taxpayers itemize. This year, however, non-itemizers may deduct up to $300.00 of cash gifts to qualifying organizations and still claim the full standard deduction.    
  • Accelerate charitable contributions: if you will be itemizing your deductions, the CARES Act, passed earlier this year, has something for you. The Act increased the maximum deduction available for cash contributions to eligible charities to 100% of adjusted gross income.  Theoretically, you could donate all of this year’s income and have no tax obligation for 2020.  While it’s unlikely anyone will do that, if you are a philanthropic person, and your circumstances are right, this could be a good time to increase donations and receive a hefty tax deduction for your effort.
  • Pay for Education in Advance: if you’re paying college tuition for yourself, your spouse, or a dependent, here’s a chance to lower your 2020 tax bill.  The American Opportunity Tax Credit, available for undergraduate students in their first four years of college, can give you up to $2500 per student off your taxes.  A single filer can receive the full credit if their modified adjusted gross income (MAGI) is under $80,000, while they can receive a partial credit if their income is below $90,000.  For joint filers, a full credit is available for those with a MAGI under $160,000, and a partial credit is available to those with MAGI below $180,000. Prepaying next year’s tuition in December can shift this credit onto your 2020 taxes.
  • 529 Plans: If you’re saving up for someone who’s headed to college in the future, making an additional contribution to a 529 plan can be a smart move.   Although it won’t reduce your federal taxes, it can help with your state tax burden.  Ohioans can deduct their 529 plan contributions from their Ohio taxable income, up to $4,000 per year, per beneficiary, with unlimited carry forward.  An unlimited carry forward on a $4,000 deduction can be a great thing to help save for a rainy day (or tax year, as it were).  If you’re not in Ohio, check out savingforcollege.com to learn the tax implications of a 529 plan contribution in your state.  
  • Superfunding: for those who would like to get a head start on funding education, 529 plans offer a great way to get started.  The law allows you to make a lump-sum contribution to a 529 plan of up to $75,000 (five times the annual gift exclusion) by electing to spread the gift evenly over five years, while completely avoiding the federal gift tax (provided no other gifts are made to the same individual during the five year planning window).  This allows more money to get started growing tax free.
  • Take Advantage of Low Interest Rates and Exemptions: Interest rates being as low as they are present a number of unique estate planning opportunities.  When you factor in the lifetime gift and estate tax exemptions that may be reduced under the new administration, the time to act is now.  This is an excellent time to gift assets, especially assets with depressed values and those with great appreciation potential.
  • Tax Loss (or Gain) Harvesting:  As we said at the outsettax planning is most often about managing the amount and character of the income that you choose to recognize in any particular year.  This is most often accomplished through strategically selling investment assets at losses (or gains) in the short or long-term as you may need to reach your income goals for any particular year.  Remember though, that net capital losses can only be deducted from other types of income up to $3,000. 
  • Claim CARES Stimulus Money You’re Owed: While not exactly a year-end tax planning tactic, a famous aspect of the CARES act passed earlier this year was the distribution of stimulus checks up to $1,200 per taxpayer with $500 per qualified child dependent.  These payments were based on previous tax returns but were actually an advance of 2020 tax credits.  The credits phased out for higher-income taxpayers, which means that if you made less in 2020 than you did in 2019 or 2018 (depending on which tax return the government used to base your stimulus check amount), you may be owed additional CARES money.  Note that if your situation is reversed (your 2020 tax return indicates that you should have received less stimulus than you got), there is no clawback.  

It can be challenging, in addition to everything else that you need to do by the end of the year, to include tax planning on your Christmas list.  But, in most cases it is very much worth it.  By planning, you can likely improve your tax situation for years to come. Since properly managing your tax burden is an important part of your Wealth Plan, this can help you put yourself in a better situation to realize your financial dreams and live a life of financial freedom and independence. 

Questions?  Reach out to an Advisor today!

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