2020 is winding down, and what a year it has been! Now is an ideal time to inventory where you are so you can take action before time runs out. There are many financial strategies that must be reviewed prior to December 31 so that you can fully receive all tax benefits associated with these accounts.
Even though 2020 brought us a global pandemic, market volatility and social unrest, individuals are exhibiting extraordinary levels of generosity. That being said, many charities are still struggling due to the lack of in-person events that often drive fundraising efforts. To apply your contributions towards your 2020 tax return, you should be cognizant of the Dec. 31 deadline. Charitable donations of both property and money – cash, check or credit card funding – need to be received by your charity of choice by Dec. 31. If you choose to wait until the last minute, a postmark or a credit card transaction placed on Dec. 31 will still apply for the 2020 tax season (even if the charity does not process the transaction until January 2021). Charities will issue a receipt for donations of $250 or greater, but personal record keeping is important to verify details, such as a postmarked date.
One often overlooked donation is appreciated stock. If you have a taxable account and have positions that contain large gains, you may donate that stock, ETF, or mutual fund directly to a charitable organization without having to pay capital gains. There is a lot of nuance to this, such as how donating the stock impacts your asset allocation and financial planning goals, so it is best to work with a professional that understands both the taxation side and financial planning.
Another way to give to charities is directly from your IRA. Even though the CARES Act eliminated the penalty against not taking a Required Minimum Distribution (RMD) from your account, you are still able to donate directly from your IRA to a charity via a Qualified Charitable Distribution. This transaction allows you to give to the charity of your choice and avoid taxation. The custodian of your IRA will make the check directly out to the charity of your choice and helps with record-keeping for your taxes.
The increased standard deduction has been a point of contention with people who previously itemized deductions on a Schedule A. One way to increase the likelihood of being able to itemize is to double up on charitable contributions. By making both your 2020 and 2021 donation in the same year (2020), you increase the likelihood of surpassing your standard deduction and having the ability to itemize on your taxes. This will then allow you to deduct items you were previously accustomed to on your Schedule A, such as primary residence mortgage interest and property taxes.
Review Your Account Gains and Losses
The end of the year is also a good time to consider harvesting gains and losses from your nonqualified (taxable brokerage account) holdings. If you hold a stock that has done particularly well over the last year, now may be the time to sell it. If you are in a lower tax bracket (10% or 12%), your capital gains rate may be zero. If you desire to have the same holdings, you can always re-purchase the stock after the “wash sale” period, which would reset your basis to zero. You can also do this by selling a good performing fund or ETF and purchasing something similar but not exactly the same, i.e. selling an S&P 500 fund and buying an equal-weighted, large-cap ETF.
You may also want to consider selling poor performers in your portfolio by loss harvesting. Loss harvesting is a way to offset any gains you may have to recognize. Generally, a fundamental rule of investing is that we have a long time horizon and employ a “buy and hold” strategy (and therefore, do not advise on selling a security at a low point). However, if you are experiencing a year with a high amount of realized gains, it may be a good strategy to sell off a poor performer in your portfolio. Capital losses can offset (erase) capital gains dollar-for-dollar. In the event that your losses are more than your gains, you can take up to $3,000 in losses each year (with the excess carried over to subsequent years) to offset ordinary income as well. Furthermore, any losses that exceed $3,000 can be carried forward to future years to offset gains.
Flexible Spending Accounts (FSA)
Flexible Spending Accounts, commonly known as “flex benefits” or “dependent care benefits,” are a great way to defer part of your pay for medical and daycare costs. You may choose to defer a portion of your pay into these accounts income tax-free. However, in many cases, these funds have a “use it or lose it” by year-end provision related to their benefit aside from a fairly nominal amount you may carry over into the next year if your plan allows. By reviewing your remaining balance, you can plan ahead and spend down the account so you do not lose any dollars allotted to this. This year, in particular, this type of account may have higher balances remaining due to potentially reduced daycare expenses due to COVID-19 shutdowns and the reduced number of medical procedures performed over the 2020 tax year.
Health Savings Account (HSA) Contributions
If you hold an HSA because you participate in a high-deductible health plan, now is a good time to take inventory of your year-to-date contributions. For a single participant, the contribution limit for 2020 is $3,550 and for a family participant, the limit is $7,100, not including a catch-up provision of $1,000 for age 55 and older. Unlike Flexible Spending Accounts, HSA contributions can be carried forward from one year to another. This type of account can serve as a great tool to pay medical expenses both now and into retirement, as you do not have to be in a high deductible plan when the funds are spent on medical expenses. Funds from an HSA account can be used to pay for medical expenses (but not insurance premiums) if you choose to take early retirement. Furthermore, the leftover balance can be used to pay for Medicare premiums in retirement, so there are many uses for these tax-favored plans well into retirement.
Roth IRA Conversions
For many people, COVID-19 has impacted income negatively. Despite this, it may provide a unique opportunity to convert IRA or 401k assets into Roth IRAs. The purpose of this is to move assets from a pre-tax bucket into a tax-free one. This will add income in the amount of the conversion, so you will want to plan out how to pay for the taxes. All conversions must be done by Dec. 31. This is where it is extremely important that you do a year-end tax review, since there may be a lot of components to your income such as capital gains, dividend income, and interest income on top of your salary that will impact whether or not a Roth conversion is right for you.
Required Minimum Distributions
The CARES Act eliminated the requirement for taking regular Required Minimum Distributions (RMDs) from accounts for 2020. However, with current tax rates being at what may be considered an all-time low, it still may be advantageous to take a distribution from your IRAs and recognize the taxation. You may wonder why you would want to take a withdrawal from your account if you are not required to do so, but a review of your tax bracket can help determine if you are now in an advantageous position to take a withdrawal from your account.
Each year, the IRS allows gifting of up to an annual exclusion ($15,000 in 2020). This means that you are able to give up to $15,000 to each person, not just $15,000 total. If you are married, the combined amount you can give is $30,000 to one recipient. If you are looking to pass assets on or just help a family member or child affected by the changes in the economy, this is a tax-free way to do so. Keeping accurate records of your gift and notifying your tax preparer of all gifts given can help determine if a Form 709 is required to be included with your return.
How We Can Help
This year has been one riddled with uncertainty and changes. By taking advantage of our tax review services, you can have a personalized analysis done by our firm. This unique level of experience will help assure that you are making the right choices both in taxes and financial planning. Contact us today for a no-cost, no-obligation initial meeting to assess whether we are a good fit for tax services and to receive a personalized quote.