In this three-part blog and video series, we are going to take a look at some year-end tax planning strategies that you will want to take advantage of as the year comes to a close. 2020 has been the strangest year ever, and it has effected almost everyone financially. Some industries actually thrived (real estate, mortgage, healthcare-related businesses, online retailers, etc.). Others suffered greatly (restaurants, entertainment, non-essential businesses, etc.).
In this article, we are going to focus on the people who unfortunately didn’t have a good year. Your business has had a tough time in the coronavirus economy. Your income has gone down. Maybe you were laid off or forced into early retirement. If your earnings have taken a major downturn, there are some year-end tax planning strategies that you can utilize. These can save you a great deal of money on your tax liabilities and maximize your returns by claiming a lower income and deducting certain losses and expenses.
Understand Your Tax Bracket—Your lower income may result in lower tax brackets. If so, take advantage of any tax savings that come along with it. Ensure you have tax projection completed so you know exactly where you stand and what levers to pull.
Take IRA or Pension Distributions—If you have been forced to dip into an IRA, make sure you properly withholding ample tax from any distribution payments. For a COVID-19 related distribution, you can realize the required income over three years to smooth out your cash flow or treat it all as taxable income this year while your income is low.
Convert Your IRA into ROTH IRA—This can be a smart move to provide more tax benefits over time and depending on your income, you may not have any taxes on the conversion.
Defer Your Deductions and Losses—If you can afford it, you may want to defer some of your deductions (don’t incur the expenses this year) to help you in future years when your income is back up.
Take Slower Depreciation—For any asset holdings, take a slower rate of depreciation on your deductions if it will work in your favor. If you need to maximize your losses this year, then you can use a more accelerated depreciation scale.
Put Off Major Purchases—Wait until 2021 for certain major purchases that don’t need to be made this year.
Take Advantage of Zero Capital Gains Tax Rates—With the capital gains tax rate being at 0%for taxable income below $80,250 for married couples, look for ways to harvest gains at this 0% tax bracket.
Benefit from Current NOL Carryback Rules—The CARES Act made three significant changes to net operating loss (NOL) rules. Understand how these changes affect you and take the time to relearn the complicated calculations of absorbing the NOL carryback in prior years.
Defer IRA Contributions—If possible, hold off on making any remaining pre-tax retirement plan contributions for the rest of 2020.
Rollover 529 Plan Funds—Use the rollover rules to put any refunded 529 plans fun back into your 529 plan for continued tax free growth.
Fund Your Health Savings Account—Use a Qualified Health Savings Account (HSA) Funding Distribution (QHFD) to fund your Health Savings Account.
Use or Defer Your HSA Funds—Pay attention to your Health Savings Account balance and make sure to use or defer any remaining funds in it before the year is through.
Reduce or Eliminate Estimated Tax Payments—If your business or investment income has taken a hit this year, you can look at reducing or eliminating your Q3 and Q4 estimated tax payments. Ensure your safe-harbor tax payments are in check.
Reduce Your Withholdings—If your wages or hours have been cut significantly enough to dramatically lower your income, consider reducing your income tax withholdings to take home more cash. Your tax liabilities now may be lower than what you projected when you set your withholdings at the beginning of the year, so tip the scale back into your pocket.
Work with a Knowledgeable Tax Advisor—Your tax preparer should be familiar with the EITC (earned income tax credit) and other special tax rules that have come from the CARES Act and any other relief efforts that may be passed by the end of the fiscal year. With the EITC, you may now qualify when you couldn’t in the past because your income was too high.
These are just a few tips you can consider however they require thoughtful planning and a clear understanding of your projected taxable income for 2020. Some of these strategies may or may not apply to you. Some may be beneficial to your specific financial situation. Others might work against you. When it comes to your taxes—especially this year if you have reduced income—it’s vital to have a plan. Take advantage of any tax breaks you are eligible for and understand all the new rules that will impact your final tax return.
For all your year-end financial planning and tax planning needs, turn to the team at Illumination Wealth. Contact us today for an introductory personal consultation with one of our top financial advisors. Be sure and stay tuned for Part 2 and Part 3 of this article, which will offer year-end tax tips to people whose income stayed roughly the same in 2020 or perhaps even went significantly higher this year.