Let’s face it, there is a lot of uncertainty as to what our tax code will look like in 2021. With control of the Senate to be decided within weeks, we could be looking at a full-scale rollout of Biden’s tax plan in 2021. Or, we could see only a few bipartisan tax changes if Republicans retain control of the Senate. You can listen to our Podcast (Taxes Made Simple) episode on Biden’s tax plan for a more in-depth discussion. There are many tax planning strategies you can make, however, that will hedge your bets for the myriad directions the tax code could go.
With all of the uncertainty, what is one to do? As a general rule, 2021 and forward will not be as favorable from a tax standpoint. We just don’t yet know to what extent that rule will be true. In 2020, we have all of the TCJA in place with some favorable enhancement due to various COVID-related relief measures. So, you would usually be best advised to push forward income into 2020 and defer expenses to 2021. This is the opposite of traditional tax planning mantra but for many taxpayers, this strategy will make sense. The reasoning is that you’d rather pay tax now at a lower rate as opposed to deferring it and paying a higher rate in future years. Keep in mind, however, that if you are lucky enough to have much higher taxable income in 2020 than normal, you may not want to push forward income due to how high your marginal tax rate currently is. Just because taxes will increase in future years doesn’t mean that your personal effective tax rate will increase if your income decreases. With that in mind, we present the following strategies to you.
UNDERSTAND THE BENEFITS PROVIDED UNDER THE NEW STIMULUS PACKAGE THAT WAS JUST PASSED BY CONGRESS. There are many items that impact your taxes in the new stimulus bill and you’d be wise to watch our video explaining them here.
Take Bonuses or Other Performance Compensation in 2020. If you have the ability to push bonuses or other performance-related compensation to 2020, it may be a viable tax planning strategy if you are a high-earner. Also, you’d want to consider exercising your stock Nonqualified Stock Options and ESPPs in 2020, as well as making any 83(b) elections that could push forward your taxable wages to 2020. Why? Biden’s tax plan calls for reinstating Social Security taxes on incomes above $400K. This represents a 6.2% increase to your effective taxes on all income above $400K on top of the increased top tax rate at that income level which could add another 2.6% for a total of 8.8%. So, if you take this compensation in future years, you may be not happy you waited. Plus, in the case of stock compensation, you’ll be starting your holding period now which will increase your likelihood of ultimately achieving long-term capital gains tax rates.
Push forward income into 2020 and defer paying expenses until 2021. If you have net operating loss carryforwards from previous years, you may want to increase your taxable income to a point to utilize the loss. Or, you may want to save the loss for future tax years where the benefit will be greater (since taxes will be increasing). Which tax planning strategy you choose will depend on what you envision the next couple of years looking like from a taxable income standpoint.
Defer income to 2021 and accelerate expenses into 2020. Exactly the opposite as above, but this strategy can pay off for those who had substantial tax bills in previous years. Thanks to the CARES Act, you can carryback any Net Operating Losses generated in 2020 back to previous tax years (all the way back to 2015). This would allow you to realize a refund for that tax year, although you may have to subsequently roll it to a tax year that is open (available to generate a refund).
Consider recognizing long-term capital gains in 2020. With Biden’s tax plan, long-term capital gains would be taxed as ordinary income for those with incomes over $1M. Thus, if you’re in that realm (or would be via the sale of certain stock), a viable tax planning strategy might be selling stock this year to lock-in the current (lower) long-term capital gains rates. This is especially true if you have capital loss carryforwards from previous tax year. Or, you’ll just need to be willing to potentially hold the stock for a long time until such point that current long-term capital gains rates are restored.
Consider selling stock that currently has unrealized losses. If you have stock that you’ve lost money on but are still holding on to, consider selling the stock if you have substantial realized capital gains in 2020 (especially if those gains are short-term). Just make sure to not buy the stock back within 30 days of the sale or else the loss will disallowed due to the wash sale rules.
Consider rolling capital gains into a Qualified Opportunity Fund (QOF). If you don’t want to pay long-term capital gains taxes at the current rates or future rates at this moment in time, a tax planning strategy to consider is to defer your gains by investing them into a QOF. You just need to make sure to do this within 180 days of the disposition that created the gains. You’ll end up paying the tax years from now, which will allow you to shore up the cash for the taxes in the meantime and if you hold the investments in the QOF for over 10 years, any subsequent gains will be entirely tax free.
Make your donations in 2020. Thanks to the CARES Act, a taxpayer can deduct charitable donations to the extent of 100% of their AGI. In other words, you could offset all of your taxable income with charitable donations in 2020. In future years, this will return to the 60% limitation, and if Biden’s tax plan is implemented, there would be two additional limitations on overall itemized deductions that further reduce the tax benefit of these charitable donations. These limitations are the reintroduction of the Pease Limitation and capping the benefit of itemized deductions to 28%, regardless of the tax bracket the taxpayer is in. Further discussion on this here. For this same reason, you’d want to consider pushing forward any itemized deduction to 2020 (mortgage interest, property taxes, SALT taxes, medical and dental expenses, etc.). If you’re unsure about which charities to direct your donations to, you could always contribute to a Donor Advised Fund, which will provide the deduction in the year of funding and then allow you to make the donations later on as you see fit. Also, if you don’t itemize deductions, for 2020 only, you can deduct up to $300 of charitable donations.
Max Out Retirement Contributions in 2020. Especially if you are increasing your taxable income via some of the aforementioned strategies, you will want to consider contributing to retirement accounts now as opposed to waiting until future years to fund them. Under Biden’s tax plan, the tax benefit would not be a deduction at your marginal tax bracket, but rather a 26% tax credit for all contributions, regardless of your tax bracket. So, anyone in a tax bracket greater than 26% would likely see a reduced benefit from contributions to retirement accounts. This tax planning strategy might be paired with contributing to Roth retirement accounts in the future, as a 26% credit may not be worth having after-tax funds available in retirement.
Wait to buy that first time home. Under Biden’s tax plan, the new first-time homebuyer tax credit would be up to $15,000. In 2020, there is currently no such tax credit.
Make a COVID-related retirement distribution. Because of how lenient the qualifications are, many taxpayers could distribute up to $100,000 in 2020 without incurring the 10% penalty on early withdrawals. This is true even if the distribution occurred in 2020 but prior to March 27th. What’s more is that the income tax from the distribution can be paid in equal installments over 3 years (2020 – 2022). And, if you wanted to repay the distribution, you could do so by the end of 2022 and avoid paying the aforementioned income tax.
Don’t make retirement account distributions. The CARES Act suspended the need to take Required Minimum Distributions (RMDs) in 2020. If you don’t need the money and wouldn’t prefer to pay the tax this year, don’t distribute any monies.
Withhold additional amounts through payroll. If you are underwithheld, and you don’t meet the safe harbor (of 90% of current year tax or 110% of prior year tax), withhold additional taxes through payroll to avoid underpayment penalties and interest. Because of the way W-2 withholdings function, you won’t end up paying interest on the amount that should have been withheld earlier in the year.
There are many other moves that can be made other than those above, but are often too nuanced or taxpayer-specific to merit discussion herein. We’re here to help you make the tax saving moves that make the most sense for you.
About Dark Horse CPAs
Dark Horse CPAs provides integrated tax, accounting, and CFO services to small businesses and individuals across the U.S. The firm was founded to save small businesses (and their owners) from subpar accounting and tax services and subpar client experiences. These small businesses are Dark Horses among their larger and more well-known competition. Being a Dark Horse CPA means advocating for small businesses by bringing them the tax strategies and accounting insights previously reserved for big business. Get a quote today.