Don’t let the holidays distract you from last-minute opportunities to reduce your 2020 tax bill.
Some tactics are only in play for 2020, thanks to the federal CARES Act, so this is the only chance you’ll have to capitalize on them.
Here are a few tips for your 2020 year end:
Give generously
In the midst of a global crisis, charitable giving will be a major focus at the end of the year. The CARES Act for COVID-19 relief provides a $300 deduction from income for charitable giving on the 2020 income tax return, regardless of whether you take the standard deduction or itemize.
If you plan to give more generously than that, the CARES Act, also gives donors an incentive to give away more cash. Taxpayers who take itemized deductions on their tax return can deduct up to 100% of their adjusted gross income for cash donations to public charities.
Certain entities are excluded from this deal, which means you can’t collect a 100% deduction for donating cash to your donor-advised fund.
This is for 2020 only. In any other case, you could claim up to 60% of your AGI for charitable donations.
Sell loser investments to offset gains
A key year-end strategy is called “loss harvesting” — selling investments such as stocks and mutual funds to realize losses. You can then use those losses to offset any taxable gains you have realized during the year. Losses offset gains dollar for dollar.
And if your losses are more than your gains, you can use up to $3,000 of excess loss to wipe out other income.
If you have more than $3,000 in excess loss, it can be carried over to the next year. You can use it then to offset any 2020 gains, plus up to $3,000 of other income. You can carry over losses year after year for as long as you live.
Contribute the maximum to retirement accounts
There may be no better investment than tax-deferred retirement accounts. They can grow to a substantial sum because they compound over time free of taxes.
Company-sponsored 401(k) plans may be the best deal because employers often match contributions.
Try to increase your 401(k) contribution so that you are putting in the maximum amount of money allowed ($19,500 for 2020, $26,000 if you are age 50 or over). If you cannot afford that much, try to at least contribute the amount that will be matched by employer contributions.
Also consider contributing to an IRA.
- You usually have until the April 15 filing deadline to make IRA contributions, but the sooner you get your money into the account, the sooner it has the potential to start to grow tax-deferred.
- Making deductible contributions also reduces your taxable income for the year.
- You can contribute a maximum of $6,000 to an IRA for 2020, plus an extra $1,000 if you are 50 or older.
- If you are self-employed, a good retirement plan might be a Keogh plan. These plans must be established by December 31 but contributions may still be made until the tax filing deadline (including extensions) for your 2020 return. The amount you can contribute depends on the type of Keogh plan you choose.
Watch your flexible spending accounts
Flexible spending accounts, also called flex plans, are fringe benefits that many companies offer. Flex plans allow employees to steer part of their pay into a special account, which can then be tapped to pay child care or medical bills.
The advantage is that money that goes into the account avoids both income and Social Security taxes. However, there is the notorious “use it or lose it” rule. You have to decide at the beginning of the year how much to contribute to the plan and, if you don’t use it all by the end of the year, you forfeit the excess.
With year-end approaching, check to see if your employer has adopted a grace period permitted by the IRS, allowing employees to spend 2020 set-aside money as late as March 15, 2021. If not, you can do what employees have always done and make a last-minute trip to the drug store, dentist or optometrist to use up the funds in your account.
Avoid the kiddie tax
Congress created the “kiddie tax” rules to prevent families from shifting the tax bill on investment income from Mom and Dad’s high tax bracket to junior’s low bracket.
- For 2020, the “kiddie tax” imposes taxes on a child’s investment income above $2,200 at the same rates as trusts and estates, which are typically higher than the rates for individuals.
- If the child is a full-time student who provides less than half of his or her support, the tax usually applies until the year the child turns age 24.
So be careful if you plan to give a child stock to sell to pay college expenses. If the gain is too large and the child’s unearned income exceeds $2,200, you could end up paying taxes at the same rates as trusts and estates.
Sources:
- “Top 8 Year-End Tax Tips.” TurboTax Tax Tips; Videos, turbotax.intuit.com/tax-tips/tax-planning-and-checklists/top-8-year-end-tax-tips/L5szeuFnE#:~:text=So%20be%20careful%20if%20you,rates%20as%20trusts%20and%20estates.
- Mercado, Darla. “5 Year-End Strategies to Save on Your 2020 Taxes.” CNBC, CNBC, 22 Nov. 2020, www.cnbc.com/2020/11/22/5-year-end-strategies-to-save-on-your-2020-taxes.html.