Do you have a “simple” 1040? Do you receive a W-2 and have straightforward investments? It probably seems like there is not a lot of fancy planning you need to do. You might be right, though that doesn’t mean you shouldn’t consider some proactive steps before the end of the year. Let’s check a few areas where you might be able to save on your tax bill.
Charitable Giving - Clients who itemize are well aware of the tax benefits related to charitable giving. New for the 2020 tax year, there is an opportunity for individuals who don’t itemize to get a benefit. The IRS has allowed for a charitable deduction up to $300 even if you don’t itemize.
Employer Benefits - If your employer offers a complete benefit package, do a quick check to see which benefits you are utilizing effectively.
Childcare - Flexible spending arrangement (FSA), if offered by your employer, can almost always save in your daycare costs. Up to $5,000 can be put into the FSA to help reduce income and FICA taxes for the taxpayer.
401(k) - If you are fortunate enough to increase your savings in 2020, consider utilizing your 401(k). You’ll save on tax and may have the additional benefit of employer matching opportunities. If cash flow is an issue, the tax savings from utilizing the 401(k) might not be worth the overall decrease to your cash flow.
Health savings accounts (HSA)- Check with your employer if they have an program to help with employee HSA’s. These can be a good way for employees to save for emergency medical bills and keep what they save out of their taxable income. Some employers even help fund a portion of the HSA.
RMD’s - The SECURE act raised the required minimum distribution (RMD) age from 70 1/2 to 72. Better yet, in 2020 RMD’s aren’t required at all per the CARES Act. If you took a 2020 RMD, you had until August 31st to put the money back into the individual retirement account.
Roth Conversions - If your income is lower in 2020, this may be a good year to consider converting your IRA (pre-tax) to a Roth IRA (after-tax). You’ll pay more tax now, but then you won’t pay tax in the future when you withdraw.
There are some things to be aware of here. If the taxpayer withdraws from the Roth within 5 years of conversion, then they may be subject to the 10% early withdrawal penalty. Talk to your financial advisor to see if this is a good fit with your overall retirement planning strategy.
Sometimes your income is high enough that you can’t benefit from deductible contributions to traditional IRAs. In that case, speak to your financial advisor about a Backdoor Roth. In this situation, you put non-deductible contributions into a traditional IRA, then you convert the traditional IRA to a Roth. The conversion of the amount you contributed isn’t taxable, because the original contribution was non-deductible. The earnings in the conversion are taxable. There are some nuances to these strategies so be sure to talk to your advisor prior to either of these types of conversion.
One final tip isn’t actually a way to save on taxes, but it is a way to increase your 2020 cash flow. The CARES act may provide the opportunity to access retirement account funds penalty free for COVID-19 related withdrawals up to $100,000. Remember, this is penalty free not income tax free. If you do make a withdrawal be sure to plan for the increased tax bill when April comes around. There may be options to spread the taxes from the withdrawal over your 2020, 2021, and 2022 tax returns. You can also pay back the withdrawal over 2020, 2021, and 2022 and avoid the tax altogether, if the entire withdrawal is repaid.
Eligible plans may include IRAs and employer plans, such as 401(k)’s. COVID-19 related withdrawals includes a taxpayer, spouse, or dependent diagnosed with COVID-19. Adverse financial consequences as a result of being quarantined, furloughed or laid off, or having work hours reduced due to COVID-19. If lack of childcare due to COVID-19 means that you are unable to work, then that would also qualify.
I hope you enjoyed these ideas. Good luck with your 2020 tax planning.