Due to the coronavirus pandemic and the enactment of legislation to offset the economic burden wrought by COVID-19, as well as legislation passed at the end of 2019, there is a lot to consider when reviewing year-end tax planning options that may be available to reduce your 2020 tax liability.
In December of 2019, the SECURE Act was signed into law. This legislation extended several expiring deductions and tax credits and provided some taxpayer-friendly changes to retirement-related rules. In 2020, the first piece of COVID-19 tax-related legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, four types of tax credits for employers and self-employed individuals. The Families First Act was followed by the biggest piece of legislation for the year – the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act, as well as subsequent coronavirus-related legislation, will most likely impact your tax return in some way. The following are some of the considerations we should explore when discussing the tax breaks from which you may benefit, as well as the strategies we can employ to help minimize your taxable income and resulting federal tax liability.
Effect of the CARES Act Rebate on Your 2020 Tax Return
Under the CARES Act, individuals with income under a certain level are entitled to a recovery rebate tax credit. These are direct payments or stimulus checks to individuals by the government. Most, but no all, of these stimulus checks have already been sent out to eligible individuals.
The CARES Act excludes from income certain student loan debt repaid by an individual’s employer. Thus, if an employer repaid some or all your student loan debt after March 27, 2020, and before 2021, that repayment, which would otherwise be taxable income to you, is not includible in your income.
The Tax Cuts and Jobs Act of 2017 (TCJA) substantially increased the standard deduction amounts, thus making itemized deductions less attractive for some individuals. For 2020, the standard deduction amounts are: $12,400 for single; $18,650 for head of household; $24,800 for married filing jointly; and $12,400 for married filing separately. If the total of your itemized deductions in 2020 will be close to your standard deduction amount, we should evaluate whether alternation between bunching itemized deductions into 2020 and taking the standard deduction in 2021 could provide a net tax benefit over the two year period. For example, you might consider doubling up this year on your charitable contributions rather than spreading the contributions over a two-year period. If these contributions, along with your mortgage interest, medical expenses and property taxes (limited to $10,000) exceed your standard deduction, then itemizing such expenses this year and taking the standard deduction next year may be appropriate.
For 2020, your medical expenses are deductible as an itemized deduction to the extent they exceed 7.5% of your adjusted gross income. To be deductible, medical expenses must be primarily to alleviate or prevent a physical or mental illness. Several CARES Act provisions affect health care related rules. Under the CARES Act a high deductible health plan temporarily can cover telehealth and other remote care services without a deductible. Also, under the CARES Act, over-the-counter products and medications that were in the prior act were denied deductions, are now deductible without a prescription. Consider setting up a Health Savings Account (HSA) or a Flexible Spending Account, FSA, if you qualify. Contributions to the HSA are above-the-line deductions for those with high deductible medial plans and FSA contributions are pre-tax dollars.
The CARES Act modified the charitable contribution rules for 2020 by allowing an above-the-line charitable contribution up to $300 even thought the taxpayer does not itemize. This is only available for those contributions made in 2020. Contributions of non-cash property, such as securities, are not qualified contributions.
In addition, if you are itemizing your deductions and have substantial charitable contributions, the CARES Act modified the percentage limitation rules that could otherwise limit your charitable contribution deduction. Under the provision, for charitable contributions made during 2020, any qualified contribution is allowed as a deduction to the extent that the aggregate of such contributions does not exceed the excess of your charitable contribution base over the amount of all other charitable contributions. Excess contributions are eligible for a five-year carryover.
As in prior years, you can reap a larger tax benefit by donating appreciated assets, such as stock, to charity. Generally, the higher the appreciated value of the asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles you to a charitable contribution deduction at fair market value but also helps you avoid the capital gains tax that would otherwise be due if you sold your stock.
Expenses Incurred While Working from Home. Although more people have been working from home this year due to the pandemic, related expenses are not deductible if you are an employee. TCJA eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was available before 2018. However, if you are self employed and worked from home as an independent contractor, a portion of your home related expenses will be deductible as a business expense.
If you sold your principal residence during the year and acquired a new home, the deduction for any interest on your acquisition indebtedness could be limited. The mortgage interest deduction on mortgages of more than $750,000 obtained after December 14, 2017, is limited to the portion of the interest allocated to the $750,000. If you have a mortgage on a principle residence acquired before December 15, 2017, the limitation applies to mortgages of $1,000,000 or less. However, if you operate a business from your home, an allocable portion of your mortgage interest is not subject to these limitations.
Interest on Home Equity indebtedness can be deducted if you used the debt to buy, build, or substantially improve your home, however, if the same loan is used for personal expenses, such as credit card debt, it is not deductible.
If your mortgage company discharged some of your qualified principal residence indebtedness in 2020, it is not includible in gross income for 2020 only.
Qualified Business Income Passthrough Tax Break. Under the qualified business income tax break, a 20 percent deduction is allowed for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and nonitemizers, it is taken on your individual income tax return as a reduction to taxable income. This tax break is subject to some complicated restrictions and computations.
Certain education-related tax deductions, credits, and exclusions from income may apply for 2020. Tax-free distributions from a qualified tuition program, also referred to as a Section 529 plan, of up to $10,000 are allowed for qualified higher education expenses. Qualified education expenses for this purpose include tuition expenses of a designated beneficiary’s enrollment in an elementary or secondary public, private or religious school. A special rule applies to a sibling of a designated beneficiary as well, therefore, covering expenses of the sibling without changing the account.
Under the Families First Act, if you are considered an eligible self-employed individual, you may be eligible for an income tax credit for a qualified sick leave equivalent amount. A complicated equation, your average daily self-employment income under this provision is an amount equal to the net earnings from self-employment for the year divided by 260 and may not generally exceed 10 days of sick leave.
Another income tax credit that may be available to you under the Families First Act is a credit for a qualified family leave equivalent amount. The qualified family leave equivalent amount is an amount equal to the number of days (up to 50) during the year that you could not perform services for which you would be entitled. If you were employed by an employer, to paid leave under the Emergency Family and Medical Leave Expansion Act, which was added by the Families First Act, multiplied by the lesser of two amounts: (1) 67 percent of your average daily self-employment income for the tax year, or (2) $200.
RETIREMENT PLANNING
Several taxpayer-favorable changes were made in the CARES Act and the SECURE Act with respect to retirement plans and distributions from those plans including the following:
(1) The required minimum distribution rules for 2020 are waived so no one is required to take such a distribution and include it in taxable income in 2020.
(2) The age limit for making contributions to a traditional IRA, previously 70-1/2, was repealed in 2020. Thus, anyone who is otherwise eligible may contribute to a traditional IRA.
(3) A new type of retirement plan distribution was added to the list of early distributions that are excepted for the 10% penalty for early withdrawals. You can now receive a distribution from an applicable eligible retirement plan of up to $5,000 without penalty if the distribution is either a qualified birth or adoption distribution.
(4) Taxpayers impacted by the coronavirus can withdraw up to $100,000 from a retirement plan without penalty and is generally includible in income over a three-year period and, to the extent the distribution is eligible for tax-free rollover treatment and is contributed to an eligible retirement plan within a 3-year period, is not includible in income.
(5) The required beginning date for required minimum distributions has been increased to 72 years from 70-1/2. The former rules apply to employees and IRA owners who attained age 70-1/2 prior to January 1, 2020. The new provision is effective for distributions required to be made after December 31, 2019.
Life events can have a significant impact on your tax liability. Let me know if you have been impacted by a life event, such as a birth or death in the family, the loss of a job or a change in jobs, or a retirement during the year. All of these can affect your tax situation.
Because it is unclear what, if any, tax legislation may be coming next year, we will need to base our year-end planning on existing law.
I hope that this finds all of you healthy and safe!! An unforgettable and complicated year….I hope you all are doing well, and I will look forward to connecting with you all in 2021!!!
Be Well and Take care!!!