In a year marked by much uncertainty, it can be tempting to defer financial decisions. The pandemic and political landscape continue to generate change that affects families and businesses alike. A sound year-end tax plan can help mitigate this ambiguity and create a clear, well-informed path into 2021 and beyond.

This year, we have divided our year-end recommendations into two different guides. Below we will cover strategies specifically tailored towards individuals and families. You can learn more about year-end business tax planning strategies by reading our 2020 Year-End Tax Planning Guide for Businesses.

The concepts discussed in these guides are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with your Aldrich Advisor.

In response to the pandemic, Congress authorized economic stimulus payments and favorable business loans as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act also features key changes relating to income and payroll taxes. This new law follows the massive Tax Cuts and Jobs Act (TCJA) of 2017. The TCJA revised whole sections of the tax code and included notable provisions for both individuals and businesses.

Retirement Accounts + Planning

Almost a year ago now, the “Setting Every Community Up for Retirement Enhancement” (SECURE) Act of 2019 was signed into law. The SECURE Act provided the most drastic changes to retirement plan law for over a decade. Some of the Act’s updates were then modified by the CARES Act to provide pandemic relief, including waiving required minimum distributions (RMDs), plan loans, rollovers, and early withdrawals.

Waived Required Minimum Distributions

The CARES Act waived RMDs for the 2020 calendar year. As a general rule, you must receive RMDs from qualified retirement plans and IRAs after reaching age 72 (70½ for taxpayers affected prior to 2020). The amount of the RMD is based on IRS life expectancy tables and your account balance at the end of last year.

We recommend individuals take RMDs, to the extent needed, in 2020 if that is their regular cash flow source in retirement. Otherwise, skip them this year. There is no requirement to demonstrate any hardship relating to the pandemic. Additionally, the Act allowed those with RMD requirement to return funds to their accounts if desired by August 31. If you did not return the money to a qualified plan or IRA by August 31, the distribution is generally taxable in 2020.

Typically, retirees wait until late in the year to arrange RMDs. If you still intend to take any of your RMDs in 2020, make sure you complete the arrangements in time to have this accommodated by the financial institution.

As a note, distributions from retirement accounts are not treated as net investment income for purposes of the 3.8 percent tax Net Investment Income Tax (NIIT). Nevertheless, a distribution may still increase your modified adjusted gross income (MAGI) used in the NIIT calculation and, as a result, may cause your other income sources to be subject to the NIIT.

Hardship Distributions + IRA Rollovers

Based on the retirement relief in the CARES Act, individuals may withdraw up to $100,000 from retirement accounts in 2020 without the 10 percent early distribution penalty as long as it qualifies as a coronavirus-related distribution. This withdrawal also avoids the 20 percent federal tax withholding normally required with distributions. Individuals who withdrew a hardship distribution due to COVID-19, or COVID Related Distribution (CRD), may repay the amount into a retirement account over the next three years. Those payments will be treated as rollover contributions and are not subject to contribution limits.

To qualify for this tax break, you (or your spouse, if you are married) must have been diagnosed with COVID-19 or experienced adverse financial consequences due to the virus (e.g., being laid off, having work hours reduced, or being quarantined or furloughed). If you do not replace the funds, the resulting tax is spread evenly over three years.

We recommend individuals take their time redepositing the funds if it qualifies as a COVID-19 related distribution. The CARES Act gives you three years from the date of distribution, instead of the usual 60 days, to redeposit up to $100,000 of funds in a plan or IRA without owing any tax. Depending on the repayment timing, you may need to file an amended tax return to have any previously paid income tax refunded.

If you receive a distribution from a qualified retirement plan or IRA, it is generally subject to tax unless you roll it over into another qualified plan or IRA within 60 days. In addition, you may owe a 10 percent tax penalty on taxable distributions received before age 59½.

Additionally, this may be a good time to consider converting a traditional IRA to a Roth IRA. Future payouts are generally exempt from tax with a Roth, but you must pay current tax on the converted amount.

Metro Income Tax

In May, greater Portland area voters passed the Metro ballot Measure 26-210 to raise money for housing services for individuals and families experiencing or at risk of experiencing homelessness. The tax affects income earned after January 1, 2021, with the first payment due April 15, 2021.

Individuals who earn income within the metro area over $125,000 for single filers or $200,000 married filing jointly will be subject to the 1 percent tax, regardless if they live outside of the Portland metro. We recommend keeping a close eye on where you are actually working and earning income starting in January 2021.

Multnomah County Income Tax

Multnomah County residents voted this month and passed a county preschool initiative, referred to as Preschool For All (PFA) or MULTCOINIT-08. The tax rate will range from 1.5 to 3 percent based on income levels for individuals living in the county.

Those with income over $125,000 single and $200,000 married filing jointly would be subject to a 1.5 percent tax on income over those thresholds. This rate would increase to 2.3 percent in 2026. Taxpayers with income over $250,000 single and $400,000 married filing jointly would be subject to a higher tax rate of 3 percent on income over those amounts. For county residents, this tax will be in addition to the Metro income tax mentioned earlier.

Many individuals suffered property loss or destruction with historic wildfires and high wind events along the west coast. If you own property damaged in a federal disaster area in 2020, you may qualify for quick casualty loss relief by filing an amended 2019 return. The TCJA suspended the deduction for casualty losses for 2018 through 2025 but retained a current deduction for disaster-area losses.

In today’s world, working from home or another location is more common for many employees. This could be the perfect time to consider realizing your dream of moving to a warmer (or colder) place. There are a few key questions to consider prior to packing up:

• Will your employer allow you to live in a different state (employer rules can be drastically different in some states)?
• Would just moving further away in a given state be more acceptable for your employer?
• Does your employer have a work from home or remote policy?
• Can you do your job effectively from a distance?

Frequently, investors time sales of assets like securities at year-end to produce optimal tax results. For starters, capital gains and losses offset each other. If you show an excess loss for the year, it offsets up to $3,000 of ordinary income before being carried over to the next year. Long-term capital gains from securities sales owned longer than one year are taxed at a maximum rate of 15 percent or 20 percent for certain high-income investors. Conversely, short-term capital gains are taxed at ordinary income rates, reaching up to 37 percent in 2020.

Depending on your situation, you may harvest capital losses to offset gains realized earlier in the year or cherry-pick capital gains that will be partially or wholly absorbed by prior losses.

Certain long-term capital gains may have increased favorable tax treatments, including a 0 percent rate for taxpayers below certain income levels, like a young child. Furthermore, some taxpayers who ultimately pay ordinary income tax at higher rates due to investments may qualify for the 0 percent tax rate on a portion of the long-term capital gains.

That being said, if you sell securities at a loss and reacquire substantially identical securities within 30 days of the sale, the tax loss is disallowed. We recommend avoiding this result by waiting at least 31 days to reacquire substantially identical securities

Also, this rate structure for long-term capital gains applies to qualified dividends received in 2020. These are dividends paid by U.S. companies or qualified foreign companies.

In addition to capital gains tax, a special 3.8 percent tax applies to the lesser of your NII or the amount by which your MAGI for the year exceeds $200,000 for single filers or $250,000 for joint filers.

NII’s definition includes interest, dividends, capital gains, and income from passive activities, but not Social Security benefits, tax-exempt interest, and distributions from qualified retirement plans and IRAs.

We recommend closely assessing your NII and your MAGI at the end of the year to reduce your NII tax liability in 2020 or avoid it altogether. For example, you might add municipal bonds (munis) to your portfolio. Interest income generated by munis does not count as NII, nor is it included in the MAGI calculation.

Similarly, if you turn a passive activity into an active business, the resulting income may be exempt from the NII tax. As a note, adding the NII tax to your regular tax, plus applicable state income tax, the overall rate may approach, or even exceed, 50 percent.

Additionally, some states, counties, and cities do not tax municipal interest income sourced to their locality or certain non-taxable federal jurisdictions, like Washington D.C. Rules vary depending on the state. However, municipal bond funds can be a way to reduce taxable income while maintaining a strong, tax-adjusted rate of return on the investment.

As Biden becomes the next president, those with income over $400,000 will potentially have higher tax rates. It is unclear if these changes will occur, but it is a substantial part of Biden’s platform. To pass any tax plan, both the Senate and the House would have to approve such bills. Large changes to such plan are unexpected with the Senate remaining in Republican control and the House only being minorly controlled by Democrats.

The estate tax exemption is currently set to decrease in 2026. Although not mentioned explicitly in Biden’s platform, it could be adjusted as part of a tax plan. Biden’s proposed tax plan includes altering estate tax law by removing ‘step-up’ in basis at the time of death and returning lifetime and death exemption thresholds to pre-TCJA levels. Without knowing the full impact of the change, individuals with more than $3.5 million in assets should consider taking a fresh look at their estate planning documents and consider a fresh plan to minimize possible estate tax liability.

Congress updated the tax code to allow for more options for individuals to claim a tax deduction for the 2020 tax year. Since the standard deduction increased to $24,800 for married taxpayers filing jointly, we recommend strategically itemizing philanthropic donations, including any stocks or non-cash gifts. For 2020, those who claim a standard deduction can deduct some charitable contributions as an above the line donation. An additional change this year, taxpayers may donate up to 100 percent of their adjusted gross income as opposed to the usual 60 percent.

For those looking to maximize tax savings over several years, a strategy called bunching could provide the necessary longevity for tax savings. Intentionally making several large donations in one year is an excellent way for donors to maximize tax savings. There are also vehicles to make the tax donation in one tax year and spread out the charitable gifts over multiple tax years.

Using Retirement Funds to Fund Charitable Goals

For taxpayers over the age of 70½, consider using your qualified retirement accounts to fund your charitable gift, up to $100,000. A qualified charitable distribution (QCD) is an excellent way to support meaningful causes while saving on federal income taxes, including the 3.8 percent NIIT.

Family members do not always have the cash flow to save for retirement despite being employed. As such, you may want to make a gift to a family member to help them fund an IRA or a company retirement plan (401k) contribution. If the family member’s adjusted gross income is below $32,500 ($65,000 if filing jointly), they can qualify for a savers credit for making the retirement contribution. The maximum credit is $1,000, $2,000 if filing jointly. The credit is determined by the contribution amount multiplied by a percentage based on the adjusted gross income.

Even if the family member does not qualify for the savers credit, starting to save for retirement as early as possible takes advantage of the power of compounding interest and is a long-term strategy for a healthy financial future. If the contribution is made to a Roth IRA account, the contribution can be treated as an emergency fund. The contribution can always be distributed tax-free at any time (but the earnings would be taxed if distributed before age 59 1/2). We recommend reviewing the IRA qualifications to determine if an individual can make an IRA contribution and the gifting rules to see if your gift exceeds the annual gift exclusion amount.

For pre-high school children and grandchildren, look to front-load their 529 plan account in one tax year. In 2018, the TCJA expanded the use of 529 plans for tuition payments of up to $10,000 a year for a child’s kindergarten, elementary, or secondary school education.

With a 529 plan, you can establish an account for a child’s college education that will grow without current tax erosion. Any distributions used for qualified expenses are tax-exempt. Note that at this time, not all states conformed to the federal definition of qualifying education expenses.

By election, you can contribute five years’ worth of gifts to a 529 plan under the annual exclusion amount ($15k per year) without paying gift taxes or using any of your lifetime gift exemption. This election does require a gift tax return in the same year of the gift.

Depending on your state of residence, there may also be state-level tax advantages for 529 plan contributions. Oregon residents are eligible for a state tax credit for Oregon 529 plan contributions, subject to limitation on the amount of the credit depending on their adjusted gross income and the contribution amount.

For kids and grandchildren currently in secondary education, you could also consider paying their tuition costs directly to the school. Payments to qualifying institutions for education expenses are not considered taxable gifts for gift tax purposes.

Kiddie Tax Considerations

Unearned income above $2,200 received in 2020 by a child younger than 19, or a full-time student younger than 24, is taxed at the child’s parents’ top marginal tax rate. This is typically referred to as the kiddie tax and could affect family income-splitting strategies at the end of the year.

In the last few years, the kiddie tax has experienced a boomerang policy shift. If there is a danger that the kiddie tax could be triggered in 2020, some of the same income deferral strategies available to adults may be used for dependent children. For example, you may arrange for a child to postpone a large capital gain from a securities sale to 2021 or realize a capital loss at year-end to offset previous capital gains.

Because this tax strategy can become especially complex, we recommend speaking directly with your advisor. If it makes sense for your circumstances, parents should elect to report income on their tax return and file fewer returns.

Higher Education Expenses

The tax law provides tax breaks to parents of children in college. This often includes a choice between one of two higher education credits and a tuition-and-fees deduction.

We recommend paying qualified expenses for next semester by the end of this year. The costs will be eligible for a credit or deduction in 2020, even if the semester does not begin until 2021.

If you have already paid enough to use the credit for 2020 fully, we recommend deferring payments until next year. For example, if you have already paid $4,000 or $10,000, depending on the type of tax credit, in expenses in the 2020 tax year, it may be better to pay expenses next year to maximize the credit. This is often seen in a student’s final year in school before graduation.

Medical + Dental Expenses

Previously, taxpayers could only deduct unreimbursed medical and dental expenses above 10 percent of their AGI. But the TCJA temporarily lowered the threshold to 7.5 percent of AGI for 2017 and 2018. Subsequent legislation extended this tax break through 2020.

To qualify for a deduction, the expense must be for the diagnosis, cure, mitigation, treatment, prevention of disease, or payments for treatments affecting any structure or function of the body. But any costs for your general health or well-being are nondeductible.

We recommend allocating non-emergency expenses into this year to benefit from the lower threshold. If you expect to itemize deductions and have already surpassed the 7.5 percent-of-AGI threshold this year, or you expect to soon, accelerate elective expenses into 2020. Of course, the 7.5 percent-of-AGI threshold may be extended again, but you should plan to maximize the tax deduction when you can.

Additionally, unreimbursed medical and dental expenses for your immediate family members, as well as other tax dependents, count toward this deduction. These extra expenses can push you over the 7.5 percent-of-AGI mark for the year or boost an existing deduction.

Suppose you are supporting friends, family, or strangers in the community by their paying medical bills. In that case, we recommend paying the medical facility directly as these payments will not be considered gifts by the IRS and be subject to gift taxes.

Divorce + Separation

Individuals pursuing divorce or separation should be aware of related tax impacts. The TCJA repealed the deduction for alimony expenses for payers and the corresponding inclusion in income for recipients, for divorce and separation agreements executed after 2018. Deductions may still be available for pre-2019 agreements that are modified after 2018. Amounts paid for child support or property settlement are the same as alimony; neither payment will generate a tax deduction under either set of tax rules.

Student Loans

Under the CARES Act, payment on federal student loans was suspended tax-free until December 31, 2020. Barring any further developments, you must resume required payments in 2021. The max deduction is $2,500 for paid interest, subject to income limitations. It may be worth expediting or delaying payment to maximize tax savings due to income phase-outs. Generally, payments are applied to interest before reducing the principal of a loan.

For those managing financial hardships, declaring bankruptcy will not result in student loan forgiveness.

The IRS is increasing its scrutiny into cryptocurrency transactions. In 2019, the IRS began asking taxpayers to affirm if they received, sold, gifted, exchanged, or otherwise acquired a financial interest in any virtual currency. For 2020, the question has been relocated to the front page of Form 1040 and will need to be answered by all taxpayers (for 2019, this was on Form 1040, Schedule 1, and was not required with every tax return).

The IRS sees each transaction as a sale of an asset and not as traditional currency. Therefore, the number of reported transactions can grow rapidly depending on how active you are with your cryptocurrency. Additionally, most wallets are hosted outside of the U.S. and may be considered a foreign asset and subject to the Report of Foreign Bank and Financial Accounts (FBAR) reporting rules.

If you have any foreign accounts, this should be noted on your tax return. If the account balance was greater than $10,000 at any point during the calendar year, there are other reporting requirements and additional account disclosures. Additionally, interest or dividends generated by these accounts must be included on your tax return. Foreign reporting can become incredibly complicated quickly, and the penalties for non-compliance can increase just as quickly. Penalties begin at $10,000 per unreported account per year.

As a reminder, Aldrich Advisors recommends keeping all relevant tax documents on hand for a minimum of seven years. You can find a detailed chart with record retention best practices here.

This year-end tax-planning guide is based on the prevailing federal tax laws, rules, and regulations. It is subject to change, especially if Congress enacts additional tax legislation before the end of the year. Your personal circumstances will likely require careful examination. Your Aldrich Advisor is here to provide support and answer your questions. Reach out today to schedule a meeting to discuss your 2020 tax plan.