End-of-Year Tax Planning Checklist

I know what you’re thinking: “But I JUST filed my taxes a couple months ago!”

It’s been a bizarre year, to say the least. And with the federal government having moved this year’s tax return filing deadline from April 15 to July 15, it’s true that you may just have filed your taxes a couple months ago. Nonetheless, time — and the IRS — wait for no one. We are rapidly heading to the end of 2020 (thank goodness), and the end of the year means performing a few actions and making important financial decisions.

First, although many people may be wondering if the election will affect our tax situation, it’s unlikely that any changes will have an effect on 2020. So you should proceed with your tax planning using current tax laws.

To help you keep your priorities in order and your deadlines straight, we’ve put together this list of end-of-year tax planning tips for individuals and businesses.

Plan Your Gifts

We’re not talking about Christmas shopping here — this refers to financial gifts you may give to loved ones. Currently, the tax law allows for an annual exemption of $15,000 gift per person. A financial gift can be a straight gift of cash, or it can mean college expenses being paid directly to the institution, a deposit into a 529 college savings plan, or even forgiveness on an outstanding loan. Gifts must be given in plenty of time before January, meaning that checks must clear the bank by December 31, 2020 in order to qualify for this exemption. I have indeed heard of court cases in which recipients didn’t cash their checks until January, thereby making the gift questionable — don’t let this happen to you.

The IRS also allows for gift splitting, meaning that a married couple can qualify for the annual gift exemption even if they together give up to $30,000 to the same individual. However, if you wish to do this, you MUST file a Form 709 — U.S. Gift Tax Return — next year.

Consider Charitable Giving

Recent changes to the tax law raised the standard deduction to $12,400 per individual or $24,800 for a couple. For some, this is good news, but if you’re used to itemizing deductions for charitable donations and other expenses, this may not be favorable — you would have to give more than the standard deduction to see any benefit in your tax return. This disincentivizes giving, which has had negative impacts for a lot of organizations.

There are ways to make your donations count, however. First, you can contribute to a Donor-advised Fund (DaF). This arrangement allows you to prepay for donations for several coming years, then advise the account manager when and how much to distribute to the organizations of your choice. Prepaying allows you to surpass the standard deduction, so you can write off the donation but still provide steady levels of donations for the next few years. For example, if you wish to donate $10,000 to a charity, this doesn’t exceed the standard deduction. But if you paid for two years at a time — $20,000 — into a DaF, you could request to distribute $10,000 this year and $10,000 next year, and you can write off the entire $20,000 for the 2020 tax year.

Prepay to Itemize Deductions

Along these same lines, know that the increase in the standard deduction was designed to replace itemized deductions for donations, mortgage interest, accounting fees, DMV fees, real estate tax, and more. In some ways, this streamlines the tax preparation process. However, it limits the benefits of paying certain fees. Sometimes there is a way around this, however: prepayment.

If you prepay enough to exceed the standard deduction, you can benefit from a deduction for the 2020 tax year. For example, say you are part of a married couple who files jointly, and you’ve paid $15,000 in mortgage interest this year and donated $8,000 to charitable organizations. This totals $23,000, which still falls below the standard deduction of $24,800. If you prepaid some charitable giving, real estate taxes, or another expense for 2021 before this year is over, you could feasibly exceed the standard deduction and qualify for reduced taxable income. This provides immediate savings for you and reduces your payment burden for next year — a year when the tax laws could potentially change. Our standard advice for taxpayers is to accelerate income and delay expenses, so this approach checks both boxes.

Convert to a Roth IRA

We recommend that individuals convert their traditional retirement accounts, which defer taxes until withdrawal (at a potentially higher rate than today’s), to Roth IRAs, which contain funds that have already been taxed. This means that when you withdraw funds, you pay no additional taxes — and neither would any heirs on this account. Additionally, traditional IRAs involve required minimum distributions (RMDs). This is the first year in recent memory in which no RMD was required, and the age to begin RMDs moved from 70.5 to 72. The RMD is expected to be back in 2021. However, Roth plans have no such requirement.

But this is general advice and may not suit everyone right now. Contact us, and we can sit down with you to look at your tax rate, income situation, etc. to determine whether this is a good option for you.

Remember that if you plan to make IRA contributions (Traditional or Roth) for 2020, you may do so until April 15, 2021. If you decide to make such a contribution after your tax return has been filed, your CPA can submit an amended return.

Address Retirement Contributions

Speaking of your retirement, now is the time to review your employee contribution to a 401(k) or Simplified Employee Pension (SEP) accounts. If you’re in a position to increase your contribution before the year’s end, it could lower your taxable income, thereby lowering your tax burden. The maximum contribution for 2020 is $19,500 per person up to age 50, and for those older than 50, the maximum is $26,000. Check your paystub; if you’re not close to that and can afford to contribute more, do so.

Cash-based businesses should also plan to make all their pension contributions by the end of the year in order for them to count toward this year’s deductions.

Harvest Your Losses

If you have significant stock gains from this year, this adds to your taxable income. Talk to your financial advisor about the option for loss harvesting. In this approach, you would sell any securities that are not performing well and would result in financial losses; the losses would qualify for tax deduction. This may offset any gains you’ve realized this year, thereby potentially lowering your tax burden.

Review Your Finances Now

The end of the year is the perfect time to make an appointment with a CPA to review your financial picture. If you schedule an appointment with us, we can happily meet with you via videoconference to make recommendations for improving your tax situation, increasing your financial gains, and achieving long-term goals.

As always, remember that we’re here for any of your tax and small business needs. Happy planning!