By: Matt Smith, CPA | msmith@deandorton.com
Tax planning for 2020 is considerably more complicated for many taxpayers due to the following major factors:
- The impact on business profits or compensation income of the COVID-19 pandemic, including uncertainty about the ultimate tax treatment of expenses paid by PPP loan funds when the loan qualifies to be forgiven, and
- The current uncertainty about future tax law changes after the recent federal elections.
Discussions of all the “what ifs” are beyond this article’s scope, and the planning ideas that follow focus on the short-term—reducing 2020 taxes. We recommend you consult your tax advisor if you believe your situation is particularly impacted by unusual circumstances.
Maximize pre-tax deductions. Determine if you are on track to have 2020 maximum amounts withheld from your paycheck for your retirement plan contributions, HSA contributions, dependent care benefits, and other available pre-tax options. If you are not going to maximize these, consider having additional amounts withheld from year-end bonuses, if possible, and consider increasing these amounts for 2021.
Capital gains and losses. If you have realized net capital gains during 2020, consider realizing capital losses before the end of the year to offset the gains. Remember that net long-term losses can be used to offset net short-term capital gains which otherwise would be taxed as ordinary income. Also, be aware of the “wash sale” rules if you are inclined to reinvest in a security you sell at a loss.
Bonus depreciation & Section 179. Businesses should consider these tax breaks related to fixed asset acquisitions:
- Special “bonus depreciation” allowance. For 2020, 100% of the cost of qualifying property (including used assets) is deductible if the property is placed in service by year-end. This deduction can create or increase an existing business loss. Note: Because its requirements are much less restrictive, 100% bonus depreciation usually makes Section 179 not applicable.
- Section 179 depreciation deduction. In 2020, individuals and business entities can elect to deduct up to $1,040,000 of qualifying business property cost in the year the property is placed in service. The deduction is reduced dollar-for-dollar for qualifying property cost greater than $2,590,000. This deduction is available only to the extent of positive business taxable income.
Self-employed retirement plans. If you have self-employment income and don’t have a retirement plan in place to shelter any of it, you may qualify to use a Self-Employed Plan (SEP). A SEP contribution deduction is allowed for 2020, even if the SEP is created and funded at any time up to the due date, including extensions, of your 2020 income tax return in 2021. Depending on the amount of self-employment income, you could fund (and deduct) up to $57,000 for 2020.
Required minimum distributions (RMDs). The CARES Act waives required minimum distributions during 2020 for IRAs and retirement plans. Individuals with traditional IRAs and most individuals with employer-sponsored qualified retirement plan accounts must take minimum annual distributions from the account upon reaching a certain age, most recently changed to 72.
Charitable contributions. Depending on your situation, it may be beneficial to accelerate planned 2021 charitable contributions into 2020 or to defer 2020 contributions into 2021 to bunch them into the same year for greater tax savings.
Annual gifting. You may give your children and others up to $15,000 each in 2020 without any gift tax consequences. This annual exclusion is calculated on a per donee basis and no carryover is allowed for the unused exclusion. Consider making year-end gifts to fully utilize this year’s annual exclusion.
Roth IRAs. With individual tax rates at the lowest levels in recent memory, consider converting traditional IRAs to Roth IRAs. The current tax cost from a conversion done now may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings. Also consider making a backdoor Roth IRA contribution, if your current income level is too high to make a direct Roth IRA contribution. A backdoor Roth IRA contribution consists of making a nondeductible IRA contribution followed by converting the contributed funds to a Roth IRA. The rules regarding this are very particular, so please consult with your tax advisor regarding this strategy.
HSAs & FSAs. Health Savings Accounts (HSAs) and Flexible Savings Accounts (FSAs) are two separate tools to convert your dollars spent on medical expenses from post-tax into pre-tax, potentially saving you up to 42% of the cost. An HSA is a bank account set up to pay for medical expenses and must be paired with a high-deductible health plan. FSAs allow you to direct some of your wages into a pre-tax account, and your employer will reimburse you from the account for your documented medical expenses. Specific funding rules and limits apply to these accounts.
S Corporation and partnership losses. If your S Corporation will generate a tax loss this year, consider whether you have enough basis in the stock (or in loans you’ve made to the corporation) to take the full loss. If you don’t, additional investments should be considered. Similar considerations can arise in some situations with partnerships expecting tax losses.
Excess Business Loss. The Tax Cuts and Jobs Act (TCJA), passed in late 2017, introduced a limitation on business losses deductible by individuals and other non-corporate taxpayers (trusts and estates) against non-business income. Specifically, the TCJA disallowed net tax losses from active businesses over $250,000 ($500,000 for joint filers), adjusted annually for inflation. For pass-through entities, this is calculated at the owner level, as tax-paying persons combine all business activities when determining overall net business income or loss. Disallowed losses are treated as net operating loss carryforwards to the following year. Under the TCJA, the excess business loss (EBL) limitation was effective for 2018 through 2025. The CARES Act retroactively postponed implementation of the EBL limitation until 2021. This postponement and other available income tax incentives—such as 100% bonus depreciation and net operating loss carrybacks—mean 2020 could be the optimal year to accelerate deductions in your business.
This article was originally published in News & Views (Dean Dorton’s quarterly newsletter).