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Wealth & Well-Being

2020 Year End Tax Planning Tips

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Many of the smart tax moves for 2020 are familiar ones—such as contributing to tax-advantaged retirement plans and increasing or "bunching deductions." However, the recently enacted CARES and Secure Acts have provided us with some additional year end tax reduction strategies you may wish to take advantage of. 

Consider a ROTH IRA Conversion

A Roth conversion refers to the transfer of an Individual Retirement Account (IRA), either traditional, SIMPLE, or SEP-IRA, into a Roth IRA. Roth IRAs are attractive investment vehicles because they offer tax-free growth and withdrawals. Because taxes are paid on the money upon contribution, it is not taxed when taken out in retirement. This is especially beneficial for individuals who believe they will be in a higher income tax bracket in the future when they begin making withdrawals.

Unlike traditional IRA accounts, Roth IRAs do not require individuals to take Required Minimum Distributions (RMDs) during their lifetime.  The account continues to enjoy tax-deferred growth and ultimately, tax-free distributions.  This allows for strategic tax planning (and saving) in retirement, but can also be a wonderful legacy gift for heirs to receive if the funds aren't used during the account owners' lifetime. 

Contribute to Charity

Contributing to charitable causes before the end of the year is a tried-and-true tax-reduction strategy. But, remember to get a receipt for every contribution you make, not just those over $250. 

If you want to be even more strategic, you could open a donor-advised fund, which offers several advantages for managing your charitable-giving activity. You could, for example, contribute a lump sum to the fund before December 31, take the entire deduction on your 2020 tax return, and then instruct the fund to use the money to make next year’s gifts.

One strategy that offers two tax benefits is donating appreciated securities, such as stocks or bonds, to charity. The tax code allows you to use the current market value of the asset as a deduction without having to pay tax on the capital appreciation, so you get the charitable contribution deduction and avoid capital gains tax. 

Donate Your IRA Required Minimum Distribution to Charity

IRA Owners must be age 72 or older to make a tax-free charitable contribution. Those who meetthe age requirement can transfer up to $100,000 per year directly from an IRA to an eligible charity without paying income tax on the transaction. If you file a joint tax return, your spouse can also make a charitable contribution of up to $100,000, meaning couples can exclude up to $200,000 of their retirement savings from income tax if they donate it to charity. However, if you donate more than the maximum allowable amount, it is considered income and could be subject to income tax. Qualified charitable contributions must be made by December 31st each year in order to exclude that amount from taxable income.

Keep in mind that charitable contributions can only be made from IRAs, not 401(k)s or similar types of retirement accounts. So you might need to roll funds over from a 401(k) to an IRA if you want to make tax-free charitable contributions part of your retirement plan. You won't need to itemize your taxes in order to make an IRA charitable distribution, but you cannot additionally claim a charitable contribution tax deduction on a charitable distribution from your IRA. An IRA charitable contribution also satisfies the annual minimum distribution requirement for your IRA, so you don’t have to take both.

Leverage Retirement Account Tax Savings

It isn’t too late to increase contributions to a retirement account. Traditional retirement accounts like 401(k)s or IRAs still offer some of the best tax savings. Contributions reduce taxable income in the year they are made, and you don’t pay taxes on the funds until you take the money out in retirement. Contributions to your 401(k) or 403(b) must be made by December 31, 2020, to impact your 2020 taxes, so you need to act quickly to increase your deferral. The 2020 401(k) contribution limit is $19,500 ($26,000 for people age 50 or older). With an IRA, you have until April 15, 2021 to make a 2020 tax-deductible contribution of up to $6,000 ($7,000 if you’re age 50 or older).

Use your Annual Gift Tax Exemptions

Every year, you can give up to a certain amount to anyone you want without having to deal with the gift tax at all. For 2020, that amount is $15,000.

With the annual exclusion provision, you're allowed to make multiple $15,000 gifts to as many different people as you want. For example, if you have three children and you want to max out your giving, then you could give a total of $45,000 without any gift tax consequences.

What if I go over $15,000? 

The logical question to ask is what the consequences are if you end up giving somebody more than the annual exclusion amount. In that event, you'll end up having to file a gift tax return with the IRS. Form 709 is the form on which you'll report the amount of the taxable gift. So, for instance, if you gave someone $20,000, you'd report that amount, subtract out the $15,000 annual exclusion amount, and then have $5,000 left over.

However, that still doesn't mean that you'll actually have to pay any tax. The reason is that on top of the annual exclusion amount, there's also a lifetime exemption from gift and estate tax that you're allowed to use. For 2020, the exemption is $11.58 million. Unlike the annual exclusion amount, the lifetime exemption applies to all the gifts you make, rather than on a per-person basis.

Taking the example above, say that you gave $20,000 in gifts to someone just after New Year's. You'd have a taxable gift of $5,000, and that would use up a small piece of your $11.58 million exemption. However, you'd still have $11.395 million left for future gifts during your lifetime or for money that you transferred to your heirs after your death.

The only time you actually pay any gift tax out of pocket is if you use up your entire lifetime exemption. That's very rare, and only a small fraction of Americans ever have to pay any gift tax.

If you are interested in taking advantage of one or more of these strategies, but have questions, we are here to help. Schedule a complimentary Discovery Call with one of our advisors today to have your questions answered and learn more about our comprehensive wealth management services. We look forward to meeting you.

Written by Kristina George in collaboration with Lexicon Content Development

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