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Here Are 5 Tax Moves to Consider for an Unusual Year

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David M. Brenner, ChFC®, CLU®

D. M. Brenner, Inc.
Phone : (858) 345-1001
Schedule a Meeting

Year-end tax planning isn’t as straightforward as usual in 2020. Uncertainty about whether President-elect Joe Biden can enact tax hikes next year is a complicating factor, and some folks can’t predict their 2021 income after earning less this year due to Covid-related job losses, shortened work hours, or forgoing a required retirement account distribution as allowed under the Cares Act.

“With these unknowns, some planning is about hedging your bets,” says Gretchen Hollstein, a senior advisor at Litman Gregory in San Francisco. “We’ve landed on a number of moves taxpayers should think about.”


As you plan, keep four aspects of Biden’s tax proposals in mind, advisors say: an increase in income-tax rates for people earning more than $400,000 to 39.6% from 37%; capped deductions for top earners; a rate hike on capital gains of more than $1 million to 39.6% from 20%; and a decrease in the estate-tax exemption from $11.58 million per person to around $3.5 million.

Consider the following moves:

Accelerate income. If you expect 2020 to be a low-tax year—either because you’ve earned less or tax laws will change—consider accelerating taxable income.

For example, this may be a prime time to convert your regular individual retirement account to a Roth IRA because income taxes are owed on converted assets.

“We’ve been helping people who are in a relatively low tax bracket with conversions,” Hollstein says. “The key is how much to convert—we suggest partial conversions, just enough to keep people in their income-tax bracket.”

Why trouble with a Roth? Assets can be left growing intact for a lifetime and are tax-free upon withdrawal. In contrast, investors in regular IRAs must take required minimum distributions after turning age 72, even if they don’t need them, and payouts are subject to income taxes.

Also consider timing compensation. Certain types can be flexible. If you’re due a bonus, an employer may pay it in 2020 rather than early in 2021. Or if you recently received stock options, you may be able to trigger taxes this year. Normally options are recognized as taxable income when they vest, but if they were awarded within 30 days prior, you can recognize income early with a so-called Section 83B election, says Tim Speiss, a personal wealth advisor at EisnerAmper.

There’s a potential downside to accelerating compensation: If your rate doesn’t go up next year, you will have paid taxes earlier than needed and lost the time value of the cash used, so be sure to crunch the numbers under different scenarios.

Fatten deductions. Any time you accelerate income, accelerating deductions to offset it makes sense—and even more so if you believe Biden will succeed in limiting the value of deductions next year.

For taxpayers earning more than $400,000, Biden aims to cap the value of itemized deductions at 28% and reinstate the Pease Limitation, which reduces deductions on every dollar by three cents.

To inflate 2020 deductions, consider condensing several years of charitable gifts this year, and take advantage of a rule under the Cares Act that raised the deductibility of cash contributions this year from 60% to 100% of adjusted gross income.

The generous deductibility of cash this year may turn some conventional planning on its head: Normally, investors are advised to donate appreciated stock to charity rather than cash—this avoids a future capital-gains tax hit. But deductions for stock gifts are limited to 30% of AGI, so if your goal is to plump deductions, cash gifts may be best.

In some cases, it may even make sense to sell a stock, pay capital-gains taxes, then make a cash donation with what’s left and claim a deduction valued at 100% of your adjusted gross income, says Bill Smith, managing director of CBIZ MHM. “The smaller the appreciation you have in the stock, the better,” Smith says, adding that the aim is to minimize capital-gains taxes. “You can get more benefit if you use the strategy to make the next, say, five years’ worth of charitable contributions in the current year. You get the full cash deduction this year.”

Manage your IRA required distribution. Under the Cares Act, investors can waive 2020 required minimum distributions from retirement plans—good news for folks who don’t need the money, because income taxes are owed on distributions.

But there’s a downside to leaving assets in the IRA: Next year’s distribution—and therefore, tax bill—may be significantly bigger. “To address this, we’re helping clients use IRAs for charitable giving this year,” Hollstein says.

A so-called qualified charitable distribution rule allows gifts to be made directly from IRAs to a charity without tax consequence. “It doesn’t end up as an itemized deduction, but it reduces their IRA balance,” Hollstein says.

Harvest tax losses. Year end is always a good time for tax-loss harvesting, and this year there is an added motivation for wealthy investors to realize gains and lock in a higher cost basis: Biden is intent on raising taxes on capital gains of more than $1 million.

Realized losses can be used to offset realized capital gains, and excess losses can offset up to $3,000 of income. Unused losses can be rolled into future years.

A bifurcated stock market is a prime landscape to pair losses with gains. While the S&P 500 is up almost 15% over the past 12 months, performance by sector varies wildly. Information technology stocks are up 39%, for example, while energy stocks are down by 38%.

Take advantage of the high estate-tax exemption. If you want to transfer money out of your estate and into your heirs’ names during your lifetime and take advantage of the $11.58 million per person estate-tax exemption, aim to do this by year end.

Even advisors who think it’s unlikely that the estate-tax exemption will be lowered effective 2021 say they don’t want to take any chances.

“The only thing we know right now is that in 2020, the exemption is $11.58 million per person,” says Speiss, who adds that he has been setting up a number of irrevocable trusts for clients lately. “Anyone who hasn’t implemented a plan to take advantage of this risks not having that exemption available later.”

This Barron's article was legally licensed by AdvisorStream.

David M. Brenner profile photo

David M. Brenner, ChFC®, CLU®

D. M. Brenner, Inc.
Phone : (858) 345-1001
Schedule a Meeting