5 Smart Tax Planning Moves for 2020
The Coronavirus Crisis and the resulting CARES Act have created an unprecedented tax season. In addition to extended filing deadlines, several relief measures will directly affect your 2019 and 2020 taxes.
With a new tax deadline of July 15th, it’s not too late to save on 2019 taxes. But if you are looking for savings for 2020, here are 5 smart tax planning moves you can make right now:
- Has your income been impacted? Adjust your tax plan.
If the economic shutdown lowered your income, you might want to lower your tax withholding as well. Instead of racking up a refund on your 2020 taxes, withhold less so you can have access to that cash now.
If you have “experienced adverse financial consequences due to quarantine,” you may be able to withdraw up to $100,000 in a coronavirus-related distribution from an IRA or 401k—with significantly reduced tax penalties. If you are younger than 59 ½, you won’t have to pay the normal 10% federal tax penalty for an early withdrawal. And instead of having to withhold 20% for income taxes upon withdrawal, you can either pay those taxes over the next three years OR replace the amount you took out within the next three years and not pay income taxes on the distribution at all.
- If you still have income, maximize your retirement contributions.
401k contribution maximums went up for 2020. You can now contribute up to $19,500 if you are under 50, and those over 50 can contribute an extra $6,500.
If you expect your 2020 tax burden to be lower because of reduced income, but you still have money to contribute to a retirement fund, this might be the year to consider contributing to a Roth 401k or Roth IRA. Why? You might not need the tax deduction that pre-tax contributions would give you this year. If you invest in a Roth 401k or Roth IRA while the market is down, your original investment has the opportunity to grow as the economy recovers, and then you’ll get to withdraw that growth tax-free in the future.
- Think about converting to a Roth IRA. As Jonathan covered in his recent blog post, “10 Proactive Money Steps for These Crazy Times,” now also might be a good time to convert a portion of your traditional IRA to a Roth IRA. Yes, you will have to pay (relatively low) federal and state income tax rates on the conversion. But if you expect your taxes to be lower this year anyway, it might be worth the tradeoff for the Roth’s future tax-free withdrawal benefits. (Especially when you consider the potential growth of that relocated investment as the economy recovers.)
- You don’t have to take required minimum distributions (RMDs) in 2020. If you are over 70 ½ or have inherited a Beneficiary IRA, your RMDs are waived in 2020. If you need the cash, you can continue taking your distributions—and paying income taxes on them. If you don’t need the money right now, you can skip the distributions this year, avoid the additional income tax, and allow your IRA to recover along with the economy. If you already took out your RMD before the CARES Act was passed, you can put it back in! Don’t worry: If you are over 70 ½, you can continue to send your IRA’s required minimum distributions directly to charity (as a qualified charitable distribution), tax free.
- Consider your charitable deductions.
If you use the standard deduction, like the vast majority of Americans, you are eligible for the CARES Act’s new “above the line” charitable deduction of up to $300/taxpayer. Donate directly to charity to claim this small-but-worth-it deduction to reduce your AGI and tax bill.
If you are able to give in a significant way in 2020, this is the year to do it—the need is great! If you are itemizing your deductions in 2020, the CARES Act has made it possible to deduct gifts up to 100 percent of your adjusted gross income. Itemizers could previously deduct up to 60 percent of their AGI with donations to charities and donor-advised funds. Donations above the previous 60% cap are limited to cash contributions given directly to charity—not donor-advised funds, unless it is a fund designated for one charity only. If you have the means and the heart, 2020 is the year for “charitable chunking” and significant giving.
Tax Strategies for Charitable Deductions
Now that the standard deduction has increased to $24,000 for couples, you may be wondering where the tax advantages are in making multiple small charitable deductions.
Here’s a suggestion: Make one large donation using your appreciated securities to a donor-advised fund (DAF), which is registered as a 501(c)(3). Opening a donor-advised fund is free, but you will pay a small annual fee for the fund’s administration. You receive your tax deduction for any contributions you make to the fund and then can recommend grants from the fund to your preferred charities whenever you like.
In addition to providing a way to make many small donations and enjoy maximum tax advantage, there are several benefits of having a donor-advised fund:
- You can reduce tax liability in a windfall year by making a large contribution to your DAF and taking an immediate deduction—on gifts of appreciated assets, that deduction can be up to 30% of your adjusted gross income.
- Money in your DAF grows tax-free.
- You can reduce or, in some cases, eliminate capital gains on appreciated assets given to the fund.
- Finally, you have the luxury of knowing the funds are available to distribute as charitable grants whenever you find something you would like to support.
Pay down your debt
Lots of small business owners take on debt to finance their growth. A loan won’t be taxed in the same way as business income, but you may be taxed on interest payments. “Depending on the type of loan, as well as the legal structure of your business, you generally are able to deduct your interest payments and lower your tax burden,” writes an expert in Forbes. Speak to a CPA or accountant who can tell you whether or not you can make your loan as tax-efficient as possible.
At the same time, make sure you write off any uncollectible debts you may have accumulated through the year. Uncollectible or bad debts are those which are owed to your business by a customer that you (the business owner) or a creditor has not been able to collect. The IRS permits you to write off bad debts before the year. Run your accounts receivable aging report to see who hasn’t paid. If the results show a customer who is no longer active, then you may be able to strike this person’s balance from your total sales figure. This reduces your income, lowering your income tax. The caveat here is that unfortunately if you do write off a bad debt and the person pays you later, you must reverse the write-off.
Claim deductible expenses
Individuals are entitled to claim deductions for expenses directly related to earning taxable income. To claim a work- related deduction, individuals must have a record proving a purchase was made and must have spent the money themselves and received no reimbursement.
Donate to charity
Those who donate money as a gift may be able to receive a tax deduction. Individuals can claim tax deductions for donations given to organisations that have the status of deductible gift recipients (DGR). The gift must be money or property, and must truly be a gift i.e. a voluntary transfer where the giver receives no material benefit or advantage.
Create a mortgage offset account
A mortgage offset account allows individuals with a home loan to offset their non-deductible interest on the loan with the interest on the normal taxable earnings of money in a deposit.
It is an arrangement where individuals create a savings account with their lender. Instead of paying interest on the full home loan, individuals are charged interest on the loan minus the amount in the savings account.
Delay receiving income
Where possible, defer receiving income until after June 30 to avoid paying tax in the current financial year. This will help minimise your taxable income in this financial year.
Hold investments in a discretionary family trust
A discretionary family trust can be beneficial for high income earners who are seeking to redistribute some of their income to family members on lower tax brackets.
A properly drafted discretionary trust allows trustees to make distributions to the most appropriate members regarding their tax status i.e. distribute more income to beneficiaries on lower tax brackets or those with no other income to utilise the $18,200 tax-free threshold.
Any capital gains that are made can be distributed to beneficiaries with capital losses available or who can use of the 50 per cent discount. Franked dividends may also be paid to beneficiaries who can use the imputation credits to reduce tax on other income.
Trusts can also use the 50 per cent discount on CGT on the sale of an asset if it was held for more than 12 months.
Claim everything you are allowed to claim as a tax deduction
In general, if you have to spend money on anything that relates to “earning your income”, make sure you claim it.
Even if you purchase an item partly for work and partly for personal use, you can still claim the work-related part as a tax deduction.
Not sure whether you can claim a particular item? Keep the receipt and ask Etax support in the ‘Any other questions?’ section in your next Etax return. Remember, it is always better to keep a receipt and not be able to claim it, than to throw it out and miss a valuable tax deduction later on.
Cover: It’s important, to maximise your tax refund
If you don’t have private hospital insurance and your income is more than $90,000 for singles or more than $180,000 for families, you will pay a minimum of 1% Medicare Levy Surcharge. That’s on top of the compulsory 2.0% Medicare levy paid by most taxpayers.
A basic private health cover plan can cost less than the 1% of your gross income – less than the medicare levy that you’ll pay if you have no insurance – and that’s why private cover may be worth a look. (Plus, private health cover has some other advantages like shorter waiting times.)
Do your homework before taking out private health cover. Make sure you get cover that’s appropriate for your circumstances and your finances. Here’s more info about private health cover and your taxes.