December 28, 2020

There are only a few days left to go before the year ends, but here are some actions to take before the end of the year to potentially improve your tax situation for 2020 and beyond.

Consider President-elect Biden’s proposals. As the year comes to an end, it is hard to predict what, if anything, that Mr. Biden has proposed will become law and take effect in 2021. Many believe that taxes will have to be raised after the economic effects of the pandemic are tamed, to pay for the increased federal spending caused by the pandemic. But enacting tax legislation of any sort is likely to be a slow process and could very conceivably not affect 2021 taxes.

In any case, here are some of Mr. Biden’s most noteworthy tax proposals:

Tax increase proposals

  • Raise the highest individual income tax rate to 39.6% from 37%.
  • Cap itemized deductions for the wealthiest Americans at 28%.
  • End favorable capital gains rates, including those rates on dividends, for anyone with income of more than $1 million.
  • Eliminate basis step-up at death, accompanied by taxing all appreciated investments at death.
  • Dropping the estate and gift tax exemption to its pre-Tax Cuts and Jobs Act level.

Tax decrease proposals.

  • $8,000 tax credit to help offset the costs of child care.
  • Exclusion for student loans that have been forgiven.
  • A refundable tax credit for low- and middle-income workers who contribute to IRAs and employer-provided retirement savings plans.
  • Catch-up contributions to retirement plans for caregivers of any age who leave the workforce for at least a year.
  • A $5,000 tax credit for family caregivers.

Solve underpayment of estimated tax/withheld tax issues.

Have an extra amount of withholding in order to solve an underpayment of estimated tax problem. Employees may discover that their prepayments of tax for 2020 have been too small because, for example, their estimate of income or deductions was off and they are underwithheld, or they failed to make estimated tax payments for unanticipated income, such as gains from sales of stock. Or they may have an underpayment of estimated tax because of the additional 0.9% Medicare tax and/or the 3.8% surtax on unearned income. To ward off or reduce an estimated tax underpayment penalty, employees can ask their employers to increase withholding for their last paycheck or paychecks to make up or reduce the deficiency. Employees can file a new Form W-4 or simply request that the employer withhold a flat amount of additional income tax. Increasing the final estimated tax payment for 2020 (due on Jan. 15, 2021) can cut or eliminate the penalty for a final-quarter underpayment only. It doesn’t help with underpayments for preceding quarters. By contrast, tax withheld on wages can wipe out or reduce underpayments for previous quarters because, as a general rule, an equal part of the total withholding during the year is treated as having been paid on each quarterly estimated payment date.

Take a retirement plan distribution in order to solve an underpayment of estimated tax problem. An individual can take an eligible rollover distribution from a qualified retirement plan before the end of 2020 if he or she is facing a penalty for underpayment of estimated tax and the extra withholding option described above is unavailable or won’t sufficiently address the problem. Unless the taxpayer chooses no withholding, the withholding rate for a nonperiodic distribution (a payment other than a periodic payment) that is not an eligible rollover distribution is 10% of the distribution. The taxpayer can also ask the payer to withhold an additional amount using Form W-4P. The taxpayer can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2020, but the withheld tax will be applied pro rata over the full 2020 tax year to reduce previous underpayments of estimated tax.

Charitable donations.

Use IRAs to make charitable donations. Taxpayers who have reached age 70½ by the end of 2020, own IRAs, and are thinking of making a charitable gift should consider arranging for the gift to be made by way of a qualified charitable contribution, or QCD—a direct transfer from the IRA trustee to the charitable organization. Such a transfer (not to exceed $100,000 for all such transfers for 2020) will neither be included in gross income nor allowed as a deduction on the taxpayer’s return. But, since such a distribution is not includible in gross income, it will not increase AGI for purposes of the phaseout of any deduction, exclusion, or tax credit that is limited or lost completely when AGI reaches certain specified level.

Taxpayers who have reached age 72 by Dec. 31 normally must take required minimum distributions (RMDs) from their IRAs or 401(k) plans (or other employer-sponsored retired plans) by Dec. 31. However, there is no such requirement for 2020.

Nonetheless, a QCD before Dec. 31, 2020 is still a good idea for retired taxpayers who don’t need all of their as-yet undistributed RMD for living expenses. That’s because a 2020 QCD will reduce the taxpayer’s retirement account balance and thus reduce the amount of the RMD that must be withdrawn in future tax years.

Charitable donation by non-itemzers. Non-itemizers can deduct up to $300 of cash charitable donations that they make in 2020. While the Consoidated Appropriations Act, 2021 (CAA, 2021), if signed into law, provides for an additional charitable deduction in 2021 for non-itemizers, to get the $300 deduction for 2020, the donation must be made before year-end 2020.

And, because CAA, 2021 does provide for a charitable deduction for non-itemizers for 2021, taxpayers should consider holding off in making contributions over $300 for 2020 and making those “excess contributions” in 2021.

Higher limit on charitable contributions. In response to the Coronavirus (COVID-19) pandemic, the limit on charitable contributions of cash by an individual in 2020 was increased to 100% of the individual’s contribution base. For previous years, the limit was 60% of the contribution base. The contribution base is a modification of adjusted gross income.

While this increased limit was extended to 2021 by the CAA, 2021, taxpayers should consider increasing 2020 contributions to take advantage of the increased limit.

Retirement plans.

Establish a Keogh plan. A self-employed person who wants to contribute to a Keogh plan for 2020 must establish that plan before the end of 2020. If that is done, deductible contributions for 2020 can be made as late as the taxpayer’s extended tax return due date for 2020.

Relief with respect to withdrawal from retirement plans. A distribution from a qualified retirement plan is generally subject to a 10% additional tax unless the distribution meets an exception under Code Sec. 72(t).

2020 legislation provides that the Code Sec. 72(t) 10% additional tax does not apply to any coronavirus-related distribution, up to $100,000. A coronavirus-related distribution is any distribution made on or after January 1, 2020, and before December 31, 2020, from an eligible retirement plan, made to a qualified individual.

A qualified individual is an individual

  1. Who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention (CDC),
  2. Whose spouse or dependent (as defined in Code Sec. 152) is diagnosed with such virus or disease by such a test, or
  3. Who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Secretary of the Treasury.

Other relief also applies to coronavirus-related distributions, including the ability to recognize income over a 3-tax-year period.

Other.

Make year-end gifts. A person can give any other person up to $15,000 for 2020 without incurring any gift tax. The annual exclusion amount increases to $30,000 per donee if the donor’s spouse consents to gift-splitting. Anyone who expects eventually to have estate tax liability and who can afford to make gifts to family members should do so. Besides avoiding transfer tax, annual exclusion gifts take future appreciation in the value of the gift property out of the donor’s estate, and they shift the income tax obligation on the property’s earnings to the donee who may be in a lower tax bracket (if not subject to the kiddie tax).

A gift by check to a noncharitable donee is considered to be a completed gift for gift and estate tax purposes on the earlier of:

  1. The date on which the donor has so parted with dominion and control under local law so as to leave the donor with no power to change its disposition, or
  2. The date on which the donee deposits the check (or cashes it against available funds of the donee) or presents the check for payment, if it is established that:
    • The check was paid by the drawee bank when first presented to the drawee bank for payment;
    • The donor intended to make a gift;
    • The donor was alive when the check was paid by the drawee bank;
    • Delivery of the check by the donor was unconditional; and
    • The check was deposited, cashed, or presented in the calendar year for which completed gift treatment is sought and within a reasonable time of issuance.

Thus, for example, a $15,000 gift check given to and deposited by a grandson on Dec. 31, 2020 is treated as a completed gift for 2020 even though the check doesn’t clear until 2021 (assuming the donor is still alive when the check is paid by the drawee bank).

Watch out for the use-it-or-lose-it rule. Unused cafeteria plan amounts left over at the end of a plan year must generally be forfeited (use-it-or-lose-it rule). A cafeteria plan can provide an optional grace period immediately following the end of each plan year, extending the period for incurring expenses for qualified benefits to the 15th day of the third month after the end of the plan year. Benefits or contributions not used as of the end of the grace period are forfeited. Under an exception to the use-it-or-lose-it rule, at the plan sponsor’s option and in lieu of any grace period, employees may be allowed to carry over up to $500 of unused amounts remaining at year-end in a health flexible spending account.

Taxpayers thus should make sure they understand their employer’s plan and should make last-minute purchases before year end to the extent that not doing so will result in losing benefits. In most cases, a trip to the drug store, dentist or optometrist, for goods or services that the taxpayer would otherwise have purchased in 2021, can avoid “losing it.”

Paying by credit card creates deduction on date of credit card transaction. Taxpayers should consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase their 2020 deductions even if they don’t pay their credit card bill until after the end of the year.

Renew ITINs that expire on Dec. 31. Any individual filing a U.S. tax return is required to state his or her taxpayer identification number on that return. Generally, a taxpayer identification number is the individual’s Social Security number (SSN). However, IRS issues Individual Taxpayer Identification Numbers (ITINs) to individuals who are not eligible to be issued an SSN but who still have a U.S. tax filing obligation.

Unlike SSNs, ITINs expire if not used on a return for three consecutive years or after a certain period. For example, ITINs issued in 2012 and 2013 (i.e., those with middle digits 90, 91, 92, 94, 95, 96, 97, 98 or 99) expire on December 31, 2020.

Anyone whose ITIN is expiring at the end of 2020 needs to file a complete renewal application, Form W-7, Application for IRS Individual Taxpayer Identification Number.

Increase 2020 itemized deductions via a “bunching strategy.” Many taxpayers who claimed itemized deductions in prior years will no longer be able to do so. That’s because the standard deduction has been increased and many itemized deductions have been cut back or abolished. Paying some otherwise-deductible-in-2021 itemized deductions in 2020 can decrease taxable income in 2020 and will not increase 2021 taxable income if 2021 itemized deductions would otherwise have still been less than the 2021 standard deduction. For example, a taxpayer who expects to itemize deductions in 2020 but not 2021, and usually contributes a total of $1,500 to charities each year, should consider making a total of $3,000 of charitable contributions before the end of 2020 (and skipping charitable contributions in 2021).