6 Year-End Tax-Planning Strategies to Implement Now

Oct 19, 2020 / By Debra Taylor, CPA/PFS, JD, CDFA
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Reviewing your client’s tax situation is important, but making a plan and taking action is what will make the difference. With a historic year coming to an end, these tax strategies could prove to be more important than ever.

Proper year-end tax planning has always been important, but it has never been more important than now, when we could face changes with our Tax Code within the next several months.

Get started by using these six tax tips to potentially increase tax savings (and minimize the federal income tax) for your clients in 2020.

1. Evaluate 2019 IRA contributions and trust beneficiary documentation

Clients who made excess contributions to their IRA for 2019 have the option to remove it, plus the net income attributable, by October 15, 2020 and the 6% excess contribution penalty will not apply. Clients can also recharacterize any IRA or Roth IRA contribution by October 15 for any reason—even if it is an allowable contribution and not an excess. However, it is important to remember that Roth IRA conversions cannot be recharacterized.

In regard to beneficiaries, if an IRA owner or retirement plan participant named a trust as beneficiary and died in 2019, it is important that the trustee provide required documentation to either the IRA custodian or the plan administrator by October 31, 2020. This is critical because if the trustee does not submit the paperwork by the deadline, the trust will not meet the “look-through rules,” and trust beneficiaries may lose advantageous tax treatment for distributions from the trust.

2. Take advantage of coronavirus-related distributions and waived RMDs in 2020

Under the CARES Act, clients under 59½ who are “qualified individuals” can withdraw up to $100,000 of coronavirus-related distributions (CRDs) from IRAs and/or company plans if needed. The best part is that CRDs are not subject to the 10% early distribution penalty, and there is the option to spread the taxable income over a three-year period.

The CARES Act also waived 2020 RMDs. The waiver applies to RMDs from IRAs, company plans, inherited IRAs, inherited Roth IRAs, and plan beneficiaries. If RMDs were already taken, they can be repaid if they are otherwise eligible for rollover. This means any repayment must be made within 60 days and is subject to the once-per-year rollover rule (since the August 31 deadline that relieved these rules has passed).

However, if you are a “qualified individual,” then you don’t need to worry about either the August 31 deadline or the 60-day deadline as you have three years to pay back the amount (up to $100,000). For some clients, however, it may make sense to still take distributions by December 31 to take advantage of lower tax brackets and to maximize them. Any part of these brackets not used will be lost forever, so perform an analysis for these clients to decide what makes the most sense.

3. Consider a qualified charitable distribution and above-the-line charitable deduction

Before year end, it may be important to identify clients who might benefit from qualified charitable distributions, or QCDs (many people make their charitable gifts in December). QCDs remain a great tax break for charitably inclined clients as IRA owners who are at least age 70½ are eligible to transfer up to $100,000 to charity directly from their IRA. QCDs can help to offset RMDs and can still be made to lower taxable income (even though RMDs are waived for 2020). In addition, per the CARES Act, clients can benefit from the $300 above-the-line charitable deduction for the 2020 tax year.

4. Perform Roth conversions before December 31

If clients have been hesitant on converting traditional IRAs or pretax 401(k) funds to Roth accounts, this may be the perfect time to finally take the leap. Even though clients will be paying taxes on the conversion now, we are in a low tax environment and it is unlikely that taxes will ever be this low again, particularly if there is a “blue wave.” In addition, 2020 taxable income for clients could be lower than in the past as a result of lost income from the pandemic as well as waived RMD’s.

In addition, there is a one-time opportunity to convert what would have been RMD income since RMDs in a normal year cannot be converted. Remember to perform these conversions prior to December 31 so that they will count towards the 2020 tax year.

We are reviewing all clients with over $750,000 in retirement accounts to determine what Q4 actions to take. We consider their goals, age, taxable income in 2020, and size of traditional account to create a recommendation.

5. Utilize the net unrealized appreciation strategy

The net unrealized appreciation (NUA) can be a lucrative tax-planning tool for clients with highly appreciated company stock in their 401(k). NUA allows an individual to pay ordinary income tax on the cost basis of the shares (not the total value of the shares) when withdrawn. The difference between the two—the NUA—isn’t taxable until the shares are sold (and at favorable long-term capital gains rates).

Although the NUA strategy can be beneficial, it is important to remember that the participant’s entire account must essentially be emptied (with a few limited exceptions) within one calendar year. Therefore, if you plan to use this strategy, you need to ensure the lump sum distribution occurs by December 31.

6. Use estate planning strategies to reduce estate taxes

For clients subject to a federal estate tax, gifting can be less expensive because gifts are tax-exclusive, as opposed to inheritances, which are tax-inclusive. The IRS allows a $15,000 maximum for annual exclusion gifts per recipient. These gifts can be made to anyone each year and they do not reduce the gift/estate exemption. These annual exclusion gifts are always tax-free—even if the exemption is used up.

In addition, there are unlimited gifts for direct payments for tuition and medical expenses. These gifts can be made for anyone, the amounts are unlimited, and they do not reduce the lifetime gift/estate exemption. These gifts are also always tax free.

Lastly, it is important to remember the lifetime gift tax exemption is still $11,580,000 per individual lifetime in 2020. The IRS has stated that there will be no claw back if these exemptions are used now, even if the exemption is later reduced. Therefore, it is important for clients to know they must use it now or possibly lose it.

Failing to plan is a plan to fail!

Reviewing your client’s tax situation is important, but making a plan and taking action is what will make the difference. With a historic year coming to an end, these tax strategies could prove to be more important than ever. Being that this is an election year, there is also potential for major changes to the tax code as we know it. Take advantage of the low tax environment now as it is likely that tax rates will only go up from here.

Debra Taylor, CPA/PFS, JD, CDFA, is the principal and founder of Taylor Financial Group, LLC, a wealth management firm in Franklin Lakes, N.J. Debra has won many industry honors and is the author of My Journey to $1 Million: The Systems and Processes to Get You There, a book about industry best practices. She is also a co-creator of the Savvy Tax Planning program.

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