Year-end planning for 2020 takes place against the backdrop of a global pandemic that has impacted so many individuals. The following is a brief overview of some of the many year-end tax saving strategies, incorporating the implications of the pandemic and how they will affect individuals.
Individual income tax rates
Your so-called “ordinary” oncome (e.g., compensation, interest income, most retirement income, and net short-term capital gains) is taxed at increasing tax rates that apply to different ranges of income. In 2020, there are seven ordinary income tax brackets as follows: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Although all tax brackets have been retained, the income limits for each have been adjusted for inflation. Determining the overall tax impact on a particular individual or family in 2020 will be similar to 2019 in many ways due to the changes that were put in place by the New Law such as: an increase in the standard deduction, loss of personal and dependency exemptions, the elimination of limitation of certain itemized deductions, increases in the child tax credit, higher income phase-outs for the child credit, a new credit for certain qualifying dependents, and others. Additional tax implications will be present for the 2020 filling season in connection with the CARES Act and related stimulus payments.
Minimize Tax on Capital Gains
Generally, when you sell stock or mutual fund shares, the shares you purchased first are considered sold first. That’s usually good news since it’s often beneficial to qualify for the lower long-term capital gain rate by selling shares that have been held for more than one year. However, there may be situations where you’re better off selling shares other than those that have been held the longest. For example, the newer shares may have a higher cost-basis (because you paid a higher price for them) which would then result in a smaller taxable gain or even a loss that can be netted against the gain. When you want to sell shares other than those you purchased first, you must properly notify your broker as to the specific shares you want sold.
Realize Losses on Stock
You can take losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, and then buy back the same securities at least 31 days later. Or, if you own a fund (such as an index fund), you can sell it, and buy a similar fund right away while still claiming the loss. This works great with index funds, because as long as you buy a fund in the same index, it contains all the same securities.
Maximize Certain “Above the Line” Deductions
“Above-the-line” deductions reduce both your “adjusted gross income” (AGI) and your modified adjusted gross income (MAGI), while “itemized” deductions (i.e., below-the-line deductions) do not reduce either AGI or MAGI. Deductions that reduce your AGI (or MAGI) can potentially generate multiple tax benefits, for example by:
1. Reducing your taxable income and allowing you to be taxed in a lower tax bracket;
2. Freeing up deductions (and tax credits) that phase out as your AGI (or MAGI) increases (e.g., child credit, certain IRA contributions; certain education credits; adoption credits, etc); and
3. Reducing your MAGI below the income threshold for the 3.8% Net Investment Income Tax (i.e., 3.8% NIIT only applies if MAGI exceeds $250,000 if single).
Many of the popular “above-the-line” deductions were retained under the New Law, such as deductions for IRA and Health Savings Account (HAS) contributions, health insurance premiums for self-employed individuals, qualified student loan interest, and business expenses for a self-employed individual.
For more year-end individual tax saving strategies, visit our white paper here. Or review our 2020 Individual Year-End Tax Planning Tips Continued.
Tax planning in 2020 is complex and made even more so with the pandemic. Avoid any surprises next April 15th and be proactive in your tax strategizing. Davis & Hodgdon Associates CPAs has been assisting individuals and businesses throughout Vermont and New England for more than 30 years so please reach out to us in Williston 802-308-4310) or Rutland (802.775.7132) to schedule a strategy session today! You can also email us at [email protected].