When you begin gathering information you need to file your income taxes, there 2020 tax-planning strategies you should know. And, you definitely want to make the most of how the CARES Act impacts your tax planning and potential liability. This article covers a few of those strategies, but your income tax professional can help you determine additional provisions that may apply to you in determining and alleviating your income tax burden.
Follow the Rules for Coronavirus-Related Distributions from Retirement Plans
The Coronavirus Aid, Relief, and Economic Security (CARES) Act allowed for penalty-free distributions of up to $100,000 from your retirement plan for those 59 ½ and older, as long as you qualified for this benefit by meeting specific coronavirus related-distribution (CRD) criteria. If you meet the qualifications, you have the ability to borrow up to the limit from your plan between January 1, 2020 and December 30, 2020.
The IRS gave you the ability to either span the taxable income over three years or repay the borrowed amount within three years. You can repay some or all of it, depending on your situation and income tax goals. This can be a big help for those in need. But, if you took/take advantage of this CRD, make sure you have a plan in place to repay it or pay the taxes by the deadline.
Take Advantage of Special Required Minimum Distribution (RMD) Provision for 2020
Another perk of the CARES Act involves RMD rules. If you’re 72 and over, you supposed to take annual RMDs from your retirement plan. But you don’t have to take it thanks to this one-time waiver that applies for 2020 RMDs. This will help relieve your income tax burden. If you had already taken your RMD before the act came along, you may have a few options to return it to your account. You could follow the 60-day rule that allows you to return the money to your plan or roll it over into another plan. But, if you meet the criteria of being directly impacted by COVID-19, you can return your RMD back into your account any time this year.
It’s important to understand that when RMDs resume in 2021, the amount of your required distribution will change a bit—to an age-based dollar amount that is determined by your retirement plan balance as of December 31, 2020. While there is speculation that due to the ongoing pandemic RMD waivers may continue in 2021, this is yet to be decided.
Max Out Your IRA Contribution Limits
If you plan to max out your 2020 contribution limits in your IRA, pat yourself on the back! The more you save, the better financially prepared you’ll be when you retire. For 2020, Roth and traditional IRA annual contribution limits cap out at $6000 (or $7000 if you’re 50 and older). And, you have until you file your taxes on or before April 15, 2021, to make contributions to your IRAs.
Make Sure You Didn’t Contribute Too Much to Your IRA
If you find that your contributions exceeded the annual limits—that’s not a good thing. If you pay more into your IRA than allowed, the IRS will hit you with a 6 percent penalty for doing so unless you make moves to rectify this oversight. The good news is that you do have time to rectify excess IRA contributions and avoid that penalty.
If your contributions for the 2020 tax year exceed the annual limits above, you have until October 15, 2022, to withdraw that overpayment amount. You must withdraw the net income the excess contribution generated from your IRA, as well.
Another strategy is to recharacterize that overage. You can actually recharacterize any contribution to your traditional or Roth IRA even if it’s not an excess amount, as long as you do so by the aforementioned October 15 deadline. By withdrawing your overpayment or recharacterizing it appropriately, you can avoid the penalty attributed to excess contributions.
It’s important to remind you that Roth conversions are not able to be recharacterized as they were in years past. Keep that in mind if you plan on converting your retirement plan to a Roth IRA.
Consider Performing a Roth IRA Conversion by December 31
Any time you perform a conversion to a Roth IRA, you have to pay income tax on the converted funds. If you’ve been waiting to make this move, now may be a good time for Roth conversion since taxes are relatively low. Additionally, if your tax bracket is expected to be lower because of lost income due to COVID or because you didn’t take your RMD—you might find a Roth conversion especially prudent. Talk to your tax professional about the ability in 2020 to perform a conversion with your RMD, too. Either of these maneuvers can help your tax burden and also benefit your retirement savings plan. Keep in mind, the deadline for Roth conversions is December 31.
Follow Rules for Trusts that are Beneficiaries of IRAs and/or Plan Participants
Often, a retirement plan participant or IRA owner designates a trust as its beneficiary. If the owner of the account passes away in 2020, the trustee of the beneficiary trust has an October 31, 2021 deadline to give documentation to the plan administrator or custodian. Why is this important? Because trusts have special “look through” rules, allowing tax-advantaged distributions out of the trust. If proper documentation isn’t in place, that advantage may be lost.
Check to See if You’d Benefit from a Charitable Distribution
The IRS allows people who are 70 ½ and older to make qualified charitable distributions (QRDs) of up to $100,000 from their IRAs. This strategy impacts your RMD amount (in case you decided to take one in 2020) and also offsets your income tax liability.
The CARES Act came through in this area, as well, allowing a $300 above-the-line charitable contribution. This 2020 deduction applies to everyone, whether you itemize your income tax deductions or not.
Use the Net Unrealized Appreciation (NUA) Strategy for Company Stock in Your 401(k)
This applies to company stock in your 401(k) that has a high appreciation value. Net unrealized appreciation is the difference between the cost basis of those shares versus the total value of the shares. When you withdraw the stock, this strategy allows you to pay ordinary income tax on the cost of the shares instead of their total value. The NUA isn’t taxed until you sell the shares.
Remember These Tips to Avoid Federal Estate Tax
You can gift up to $15,000 each year to any of your loved ones, which lets them avoid inheritance tax, and it doesn’t reduce the gift/estate tax exemption.
You can give unlimited gift amounts by directly paying for tuition and medical costs. Again, these gifts are tax free and don’t reduce the gift/estate tax exemption.
Per the IRS, the lifetime gift tax exemption per individual in 2020 is $11,580,000. However, understand that there’s no claw back for using the exemptions now and even if it’s reduced at a later date. So, use it now, if you can, or risk losing this ability later.
The information above hopefully provides you enough information to understand how to begin making strategic moves to impact your income tax liability. Your tax professional can assist you in determining which strategies are best for you and can ensure you take appropriate advantages of CARES Act provisions that apply to you.
This article is for informational purposes only and should not be used as tax, investment, or legal advice. Please consult the appropriate professional when preparing your taxes or making other financial decisions.