It seems hard to believe, but the end of the tax year will soon be here and with that, comes tax issues to be aware of. Now is a great time to review year-end tax issues that might reduce your tax bite for 2020. Other options may provide long-term tax benefits, especially in light of the financial havoc created by COVID-19 this year.
Tax Issues to be aware of regarding Deductions and Contributions
Take Full Advantage of Your Deductions
Individuals can itemize their deductions or take the standard deduction. The standard deduction is $12,400 for singles and married couples filing separate returns; $24,800 for married couples filing jointly; and $18,650 for those filing as heads of household. Because of the COVID-19 pandemic, some people have seen substantial reductions in their income. Tax issues to be aware of include checking to determine if your income is less than your deductions. If so, this means you would not be taking full advantage of the deductions.
If you fall into that category, review your resources to determine if you have opportunities to increase your 2020 income. That way you can take full advantage of your deductions and cash in some income tax-free states. For example, you might be able to sell profitable stocks or withdraw funds from taxable retirement accounts*. You could even exercise a stock option.
Traditional IRA Contributions at Any Age
The SECURE Act passed by Congress removed the age restriction on making traditional IRA contributions beginning in 2020. Thus, taxpayers who are 70½ or older and still working are no longer prohibited from contributing to a traditional IRA. However, the contribution is still limited to earned income (income from working). Traditional IRAs are tax deductible. So consider whether you would gain any benefit from making a contribution for 2020. Plus you have time to figure it out! You can defer your decision until April 15, 2021 and still qualify for a 2020 tax deduction.
Tax Issues to be Aware of Regarding Charitable Contributions
Make Charitable Contributions with IRA Funds
If you are age 70½ or over and have an IRA, you can have your IRA trustee transfer funds directly to a charity of your choosing. Although the donation will not be tax deductible, the distribution will not be taxable either. This gives you an opportunity to help your favorite charity or charities with untaxed funds in this time of need. But tax issues to be aware of include making sure there is a direct transfer of the donation from the IRA to the charity. That is, it cannot pass through your hands or it will be taxable.
Larger-Than-Normal Charitable Contributions Are Possible
For those of substantial means, be aware that the income (AGI) limit on cash charitable contributions has been increased. The normal amount was 60% and it is now 100%. The change was a way to stimulate more contributions in light of the needs brought about by COVID. Donations of property (used furniture and clothing, for example) are not eligible for this enhanced deduction.
Deducting Charitable Contributions Without Itemizing
Charitable contributions are allowed as a tax deduction if you itemize your deductions. However, for 2020 only, taxpayers can deduct up to $300 of cash charitable contributions. Even when taxpayers are claiming the standard deduction.
Charities and Documentation
If you usually claim the standard deduction, you may not be familiar with the documentation rules for charitable contributions. So here’s a brief rundown.
Donations to qualified organizations need to be made by December 31 to be deductible on your 2020 return. For cash contributions you cannot claim a tax deduction, regardless of the amount, unless you have a bank record. Cash contributions include any gifts paid by cash, check, electronic funds transfer, or credit card. Bank records could include a canceled check, bank or credit union statement, or a credit card statement. The bank record needs to show the name of the qualified organization, the contribution date, and the amount given. A receipt from the organization showing the name of the organization, date of the contribution, and the amount can be substituted for a bank record.
To claim a deduction for a contribution of $250 or more, you must have a written acknowledgment of the contribution from the qualified organization that includes the following details:
- The amount of cash contributed;
- Whether the qualified organization gave you goods or services as a result of the contribution. Also, a description and good-faith estimate of the value of any goods or services that were provided. (Other than intangible religious benefits); and
- A statement that the only benefit received was an intangible religious benefit, if that was the case.
Personal tax issues to be aware of
Marital Status
Be mindful that filing status for the entire year is determined on the last day of the tax year. This means if you get married during the year, you will be considered married for the entire year for tax purposes. Even if you got married December 31. In addition, if a spouse is changing names, the Social Security Administration should be notified. And inform the IRS if there is any address change by either or both spouses.
Options when Divorcing
If you are in the process of divorcing but the divorce isn’t final by December 31, you have two options.
- You and your spouse file jointly
- You each submit a return using the married filing separate status. There is an exception to this rule if 1) a couple has been separated for all of the last 6 months of the year and 2) one spouse has paid more than half the cost of maintaining a household for a qualified child. In that situation, that spouse can use the more favorable head of household filing status.
If each spouse meets the criteria for that exception, they can both file using the head of household status; otherwise, the spouse who doesn’t qualify will need to use the status of married filing separately.
Filing a joint return often results in less tax overall than filing two married separate returns. However when a joint return is filed, each spouse assumes liability for the full amount of the tax. These are just a few of the tax issues to be aware of when determining the filing status of a married couple. Especially when a divorce is in process or being contemplated.
If your divorce has been finalized and you haven’t remarried, your filing status will be single. Or if you meet the requirements, your filing status will be head of household.
Maximize 2020 Education Tax Credits
Both the lifetime learning education credit and the American opportunity credit allow qualified taxpayers to prepay 2021 college tuition bills. This prepayment is for an academic period that begins by the end of March 2021. That means that if you are eligible to take the credit, you can bump up your 2020 credits by paying for 2021 now. This may not apply to you if you’ve been paying tuition expenses for the entire 2020 tax year. However, if your child just started college this fall, it will probably provide you with some additional tax credit for 2020.
If you are a grandparent, you may be paying all or part of the tuition for a grandchild. And if the child’s parents are claiming the child as a dependent, then the parents would receive the education credit. If the payment is made directly to the college, there are no gift tax issues. So, the grandparent makes two gifts—tuition for the student and the tax credit to the student’s parents.
Convert Your Traditional IRA into a Roth IRA
By converting a traditional IRA into a Roth IRA, taxpayers whose incomes have been very low in 2020 may be able to move the assets currently in their traditional IRA into a Roth IRA at a much lower tax rate. Any amount can be converted, and with a little planning, the conversion tax can be low or even zero. To take advantage of this opportunity, the conversion must be made before year end, and it is irrevocable.
Remember the Annual Gift Tax Exemption
One of the best ways to reduce your taxes while giving to those you love is to take advantage of the annual gift tax exemption. Though the gifts are not tax deductible, for tax year 2020 you are able to give $15,000 each to as many people as you want without having to pay any gift tax. If you want to do this, make sure that you do so by the end of the year. This is because you are not able to carry the $15,000 over into 2021.
If you itemize your deductions, specific tax issues to be aware of include:
Medical Expenses
If you itemize your deductions, you are able to deduct unreimbursed medical expenses in excess of 7½ percent of your income (AGI). Reached that threshold or are close? It may make more financial sense for you to pay off medical bills that are still outstanding, rather than paying them over time.
Also, consider looking at what your expenses will be for the next year. Then move those that you can into 2020 to increase the deduction. These expenses could include dental work or eyeglasses. Beware – if you pay for those expenses using a credit card make sure that you’re not paying more in interest than you’re saving with the increased deduction. This can easily happen if you’re not going to pay the balance immediately. Medical expenses charged to a credit card are counted toward your medical deduction for the year the expense is charged to the card. Not as the balance on the card is paid off.
Property Taxes
Certain taxes are included as deductions on your federal return if you itemize your deductions. It used to make sense to maximize your tax deduction by prepaying part of your real property taxes for the subsequent year. But now the total itemized deductions for state and local taxes in a year are limited to $10,000. That limit includes state income tax, if your state has an income tax, or if not, then state sales tax. So, depending on the amount of state income or sales tax you’ve already paid during the year, it may not be beneficial to prepay property taxes.
Manage Your Stock Portfolio
Normally, if you have stocks that have declined in value, you may want to sell them before December 31. Then you can use the loss to offset other capital gains for the year or to produce a deductible loss. The net capital loss on a tax return that can be used to offset other types of income is limited to $3,000 for the year. However any excess loss carries over to future years. You can repurchase the stocks you sold at a loss after 30 days have passed and avoid the wash sale rules that prohibit a loss from being claimed when you repurchase the same or similar stock right away. However, for 2020 you may find yourself in a lower-than-normal tax bracket, and it actually may be beneficial to take stock gains rather than losses. (Of course, this is depending on your overall situation).
Also, be aware of the 0% income tax rate on long-term capital gains. Yes, you could pay zero tax on long-term capital gains if your taxable income is $40,000 or less. The upper limit for a married couple filing a joint return is $80,000. While the limit is $53,600 for those filing as head of household.
Every taxpayer’s situation is unique. And the suggestions offered here may not apply to you. The best way to ensure that you are positioning yourself in the best way regarding taxes is to give us a call at 360-778-2901.
*But only after age 59½ to avoid a penalty.
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