Wealth Planning
U.S. taxes: It’s time to act
Make the most of your 2020 year-end planning. Here’s how.
We’ve heard a lot of tax angst this fall.
Although the anticipated blue wave did not materialize, control of the Senate will come down to runoff elections in January. If successful, Democrats may look to increase federal taxes for individuals earning more than $400K. At the same time, the pandemic’s impact on businesses has state budgets searching for revenue. Higher state taxes seem likely to follow.
J.P. Morgan clients, naturally thinking their federal and state taxes might increase, have been asking us whether they should do anything about it now.
Our answer: Rather than look ahead, focus on the present to maximize your 2020 returns under the current tax system.
So here are the four questions to ask yourself this autumn, and the associated actions you may want to discuss with your tax advisor and your J.P. Morgan team.
Can you reduce your 2020 tax liability?
The stock market has generated significant profits for some. It’s usually wise to ask your tax advisor to prepare a “pro-forma” tax return—an unofficial sketch of what your tax situation is likely to be if you take no further actions for the year. It can help you decide whether to try to reduce your tax liability through tax-loss harvesting or charitable deductions.
Tax-loss harvesting is a classic strategy that may reduce your tax liability for capital gains or ordinary income.
To do it, you sell an investment that has an unrealized loss. Then you use that realized loss to offset either already realized gains or embedded gains in your portfolio that you plan to realize now or or in the future.
If you still like the asset, you can buy it back. But be careful not to violate what’s known as the “wash sale rule.” This rule prevents you from taking a tax deduction for a realized loss if you buy a security that is substantially identical within 30 days before or after the trade.
If you do not want to be out of the position for an entire month, you might “double up” on your position, then wait 30 days before selling the original loss position. November 30 is the last day to do so and still be able to recognize the loss in this tax year.
Key dates for year-end tax planning
This year there are two additional benefits for gifts of cash to public charities. In addition to the standard deduction, there is now:
- A $300 “above-the-line” deduction for taxpayers who do not itemize and make cash gifts to public charities.
- For taxpayers who itemize, gifts of cash to certain public charities can be deducted up to 100% of the adjusted gross income (AGI), as opposed to the usual 60% of AGI.
If you’re unsure which charity or cause you want to support but need the deduction before year-end, you might consider giving to a donor-advised fund (DAF). Tax deductions for gifts to DAFs are immediate, but the payout from the DAF to a qualified recipient does not have to be. But note, this year’s two additional benefits for gifts of cash to public charities do not apply to donations to DAFs.
Rules on income tax deductibility
Are you making the most of income tax deferrals?
If you have the opportunity to contribute to a retirement account, we recommend doing so—up to the full amount permissible. The maximum amounts you can contribute to retirement accounts in 2020 before year-end are:
- IRAs—The contribution limit is $6K a year. However, if you are 50 or older, it’s $7K.
- 401(k)s/403(b)s—People under 50 years old can save up to $19.5K a year. If you’re 50 or older, you can contribute up to $26K annually.
If you think your future income tax rates may be higher, consider converting your traditional IRAs to Roth IRAs before this year-end.
The age at which you have to start taking required minimum distributions (RMDs) from retirement accounts was raised from 70 ½ to 72 years by the SECURE Act. But no one has to take any RMDs in 2020, thanks to the CARES Act. So if you have taken a distribution, you may want to speak with your tax advisor.
If your employer allows you to defer your compensation, you must elect to defer your 2021 salary and bonuses by December 31, 2020. (Many employers set an earlier administrative deadline for making the election, so be sure to check your employer’s specific policy.)
Deferral means irrevocably selecting how and when you will receive the compensation. There is no income tax liability on either the compensation or its growth until you receive it. Then, the payment will be taxed at your ordinary income rate in effect when you receive the funds.
Key numbers for high income earners
Do you want to give to your children?
Do you have a taxable estate and the capacity to gift? Have you yet to use your lifetime gift and estate tax exclusion? Then you may want to do so now. The exclusion amount is currently at an all-time high. An individual can now transfer, tax-free, $11.58 million, and married couples can transfer double that amount.
This exclusion amount is set to drop to $5 million (inflation adjusted) after 2025. However, if Democrats have the opportunity to rewrite tax laws, that number may be reduced sooner; also, transfer tax rates may go up from their current 40%.
Every year, most U.S. taxpayers also have the opportunity to give, without any gift taxes due, an “annual gift tax exclusion” amount. This year it’s $15K; for married couples, it is $30K. This amount can be given to as many people as you like. Also, your beneficiaries can use the money for whatever purpose they like.
Parents and grandparents often use their annual gift tax exclusions to fund 529 accounts, where the funds can grow free of federal taxes. As long as the money is used for the account beneficiary’s qualified education expenses, no federal tax will be due when the funds are distributed.
Key dates for year-end tax planning
Are you getting the help you need?
These are just a few examples of the many opportunities you may have right now to strengthen your financial health. Speak with your tax advisor about which actions be right for you. Consult with your J.P. Morgan team about how any potential action might align with your financial goals.
The sooner you have these discussions, the more benefit you may be able to reap from your year-end planning.
1 Please consult your tax advisor to see whether tax loss harvesting is available with your accounts.
2 Keep in mind that short- and long-term losses are first netted against short- and long-term gains, respectively.
3 Before acting, please be sure to discuss your potential buy backs with your tax advisor.
4 Tax should not be the only factor to drive an investment decision.
5 The CARES Act – which was signed into law in late March to ameliorate some of the most severe economic impacts of COVID-19 – enacted two provisions this year.
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