COVID-19’s impact is being felt across the financial spectrum, from lower interest rates, slashed dividends and reduced incomes to unpredictable stock market swings. At such a volatile time, it’s important to be aware of some potential strategies for reducing your income tax liability before the end of the year.
Give to charity
Charitable giving is a tried-and-true year-end tax planning strategy. And it might be particularly valuable this year.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily raises the ceiling on charitable deductions for cash contributions to public charities. For 2020, you can deduct as much as 100% of your adjusted gross income (AGI), up from the usual 60%. (Note that certain contributions, such as those to donor-advised funds and private foundations, don’t qualify for the 100% limit.) The increase provides the opportunity, with some savvy planning, to slash — or even completely offset — your taxable income for the year.
And you don’t need to limit your gifts to cash donations to fully benefit; you can “stack” cash donations with gifts of property subject to unchanged limits. Gifts of appreciated marketable securities, for example, are subject to limits of 20% or 30% of AGI, depending on various factors.
So, you could donate appreciated marketable securities you’ve held for more than a year (long-term capital gains property) to public charities in the amount of 30% of your AGI (thereby avoiding any capital gains taxes), and also donate 70% of your AGI in cash to public charities.
Or you could donate long-term capital property to a private foundation in the amount of 20% of your AGI and donate 80% of your AGI in cash to public charities. Under either scenario, you’re offsetting your entire taxable income.
But you’ll also want to keep in mind your prospects. If you accelerate donations you otherwise would have made in the future but, because of COVID-19 effects or for other reasons, your income this year is taxed at lower brackets than you expect in coming years, you may forfeit tax savings. Your CPA can help you determine the best charitable giving strategy for your situation.
Execute a Roth conversion
This is a good time to consider converting pretax traditional IRAs to after-tax Roth IRAs. The usual advantages of Roth IRAs — that you can extend tax-free growth because Roth IRAs don’t have required minimum distributions (RMDs), and that distributions generally will be tax-free — may be augmented by other advantages triggered by current circumstances.
When a traditional IRA is converted, you must pay income tax on the fair market value of its assets on the date of transfer. If your IRA holds stocks that have fallen in value due to the fluctuating markets, or if you’re in a lower tax bracket for 2020, you’ll pay less in taxes now. In addition, subsequent recoveries in value will be tax-free.
There are no AGI limits on Roth IRA conversions — but note, though, that the maximum amount you can contribute to a Roth IRA each year is subject to phaseouts based on AGI. So, depending on your income, you might not be able to make annual contributions to the Roth IRA.
Harvest your losses
Market swings also may allow you to harvest losses that you can then apply to offset any taxable gains. By selling underperforming investments before the end of the year, you neutralize realized gains on a dollar-for-dollar basis. And, if you realize more losses than gains, you generally can apply up to $3,000 of the excess to reduce your ordinary income, with any remaining losses carried forward to future tax years.
You can compound the benefit by donating the proceeds from the sale of a depreciated investment to charity. You apply the loss to offset gains and, if you itemize, claim the charitable contribution deduction for the cash donation. If you don’t itemize, you can deduct up to $300 of contributions above the line this year thanks to a temporary provision in the CARES Act.
Timing is key in making the most of these opportunities. But you also need to consider, for example, the chance that your tax bracket will change in the future, whether due to income shifts or tax law changes under a new administration. Also keep an eye out for any additional legislation that might be signed into law providing more tax breaks for 2020. Your CPA can help you plot the best course to minimize your tax liabilities this year — and beyond.
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.