2020 Year-End Tax Planning for Individuals
As the end of 2020 approaches, we can all agree that this year is unlike any other. The coronavirus pandemic and natural disasters have had a significant impact on the tax situation for many taxpayers. In response to the health and economic impact of the coronavirus pandemic, Congress passed two major pieces of legislation – the Families First Coronavirus Response Act and the Coronavirus Aid, Relief, and Economic Security (CARES) Act. More relief may be forthcoming. In addition, we might expect future tax law changes following the election. As such, each individual taxpayer should consider the unique challenges and opportunities that this year presents.
Economic Impact Payment
If an individual missed the extension for non-filers, the credit may be taken on the 2020 Form 1040 for the full amount to which they are entitled. Taxpayers who received more than the amount to which they are entitled do not have to repay it unless they were not eligible to receive it in the first place, e.g. deceased individuals or non-resident aliens. A person claimed as a dependent in 2018 or 2019 may also be entitled to the refundable credit if they are not claimed as a dependent in 2020 even though their parent received the $500 credit for the earlier year.
The CARES Act allows penalty free distributions made during the 2020 calendar year of up to $100,000 for COVID-related expenses. Any income attributable to an early withdrawal is subject to tax over a three-year period, and taxpayers may recontribute the withdrawn amounts to a qualified retirement plan without regard to annual caps on contributions if made within three years.
The maximum loan amount from a retirement account is increased from the lesser of $50,000 or 50% of vested balance to the lesser of $100,000 or 100% of vested balance for qualified individuals. This increase applies to loans made between March 27, 2020 and December 31, 2020. In addition, qualified individuals may delay loan payments due after March 27, 2020 and before December 31, 2020 for one year. A qualified individual is an individual (or the spouse of an individual) diagnosed with COVID-19 with a CDC-approved test, or who experiences adverse financial consequences as a result of quarantine, business closure, layoff, or reduced hours due to the virus.
There is a temporary waiver of required minimum distributions for the 2020 calendar year. However, because of recent changes to retirement accounts, such as the increased age to begin RMDs, the end to the 70 ½ age limit for contributions to an IRA, and the shortened distribution period for non-spouse inherited IRAs, taxpayers are encouraged to review strategies for continuing to make IRA contributions and to reevaluate their beneficiary designations.
For 85% of taxpayers who do not itemize, a $300 above-the-line deduction for cash contributions is available for 2020. However, the law is unclear if the $300 amount applies for both individual and joint returns or whether it is available beyond 2020.
For 2020 only, the limit for itemized charitable deductions is increased from 60% to 100% of adjusted gross income.
Although the CARES Act eliminated the required minimum distribution for 2020, taxpayers over age 70 ½ may still make a direct contribution to a charity from their IRA of up to $100,000 in 2020 and thereby reduce their adjusted gross income.
For payments made before January 1, 2021, employers may reimburse employees for principal and interest on student loans of up to $5,250 as part of an education reimbursement program.
Changes under the Tax Cuts and Jobs Act (TCJA), that were meant to simplify the application of the kiddie tax, had the unintended consequence of increasing the tax on the unearned income, such as military death benefits, of children in low-income families. As a result, the kiddie tax reverts to rules prior to TCJA, using the parents’ tax rate for tax years after 2019. However, a taxpayer may elect to apply the parent’s tax rate to 2018 and 2019 thereby providing an opportunity to amend a prior year’s return.
Several tax law provisions may help taxpayers recover financially from the impact of a disaster, especially when the federal government declares their location to be a major disaster area. Depending on the circumstances, the IRS may grant additional time to file returns and pay taxes. Both individuals and businesses can elect to claim casualty losses related to a disaster on the tax return for the previous year and thereby receive needed funds more quickly. Although the Covid-19 pandemic is a federally declared disaster and qualifies for a casualty loss deduction in 2020 (or the prior year, if elected) the IRS must provide further clarification on what losses qualify and for what time period.
Taxpayers might consider taking advantage of these tax benefits in 2020 before they expire. In some cases, these benefits were retroactively applied. In which case, it might be useful to amend prior year’s returns if the savings are significant enough.
- Exclusion from income for the forgiveness of debt on a principal residence. The exclusion now applies to discharges of qualified principal residence indebtedness occurring before January 1, 2021, or discharges that are subject to an arrangement that is entered into and evidenced in writing before January 1, 2021.
- Mortgage insurance premium deduction. Premiums paid or accrued after January 1, 2018, for qualified mortgage insurance in connection with acquisition indebtedness are deductible as home mortgage interest (qualified residence interest). The deduction is subject to the taxpayers adjusted gross income (AGI) limits.
- Above-the-line deduction for tuition and fees. The tuition and fees deduction may be claimed for qualified tuition and related expenses paid for the enrollment or attendance at an eligible education institution. The student may be the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent.
- Nonbusiness energy property credit. The nonrefundable nonbusiness energy property credit is available for qualified energy efficient improvements or property placed in service before January 1, 2021. Qualified energy efficiency improvements include energy-efficient exterior windows, doors and skylights; roofs (metal and asphalt) and roof products; and insulation. Residential energy property includes energy-efficient heating and air conditioning systems; water heaters (natural gas, propane or oil); and biomass stoves.
- Reduced 7.5 percent threshold for medical expense. If it is possible and the expenses are significant, accelerate the payment of medical expenses into 2020. The threshold rises to 10% of adjusted gross income in 2021.
- Health coverage tax credit (HCTC). Eligible individuals can receive a tax credit to offset the cost of their monthly health insurance premiums for 2020 if they have qualified health coverage for the HCTC.
In addition to the individual mandate tax penalty, the Affordable Care Act introduced the 3.8 percent net investment income tax and the .09 percent Medicare tax. If the Supreme Court determines the ACA to be unconstitutional, there is a potential for a refund for taxpayers subject to these taxes. Taxpayers should consider filing a protective claim for any open tax years.
2020 Year-End Tax Planning for Businesses
We can all agree that 2020 is unlike any other year. As we consider tax-planning strategies for the year end, major uncertainty continues concerning the severity of the pandemic and length of the economic recovery. Although Congress passed two major pieces of legislation in response to the health and economic impact of the coronavirus pandemic, it remains unclear if additional relief is forthcoming. In addition, some regularly expiring tax provisions are due to expire again at the end of 2020. In the meantime, the IRS continues to release significant guidance on provisions of the Tax Cuts and Jobs Act. As such, each business should consider the unique challenges and possible opportunities that this year presents.
In addition to providing resources to the health community to help contain and combat the virus, the Families First Coronavirus Response Act offered employees and self-employed individuals affected by the pandemic with guaranteed paid sick leave. Provisions of the Coronavirus Aid, Relief and Economic Security (CARES) Act also included numerous tax benefits for businesses. Here are highlights for tax planning consideration at 2020 year-end.
- The Paycheck Protection Program (PPP). Under the Cares Act, a recipient of a covered loan can receive forgiveness of indebtedness on a PPP loan in an amount equal to the sum of payments made for qualified expenses. According to IRS guidance, the business expenses related to forgivable PPP loans are not deductible. However, lawmakers state that this was not their intent. Congress will need to address the deductibility of these expenses in future legislation to clearly make these expenses deductible.
- Employee Retention Credits. The employee retention credit is designed to encourage businesses to keep employees on their payroll and is available for qualified wages paid through the end of 2020. This credit is very similar to the paid leave credits granted to employers under the Families First Coronavirus Response Act with some changes to the requirements. Most significantly, neither the employee nor the employer has to be directly impacted by the infection. Employers can reduce their required deposits of payroll taxes withheld from employees’ wages by the amount of the credit or request an advance of the employee retention credit. Eligible employers may use the employee retention credit with other relief such as payroll tax deferral which may affect deposits and advances.
- Deferred Payroll Tax Payments. Payroll taxes due from the period beginning on March 27, 2020 and ending on December 31, 2020, can be deferred. The total payroll taxes incurred by employers, and 50 percent of payroll taxes incurred by self-employed persons qualify for the deferral. Half of the deferred payroll taxes are due on December 31, 2021, with the remainder due on December 31, 2022.
- Executive Memorandum on Withholding. President Trump has authorized employers to defer the withholding of the employee’s share of Social Security taxes through the end of 2020. However, unless Congress forgives the repayment of these taxes, they will have to be repaid in the first quarter of 2021. It is unclear as to how the deferred tax would be collected from individuals who are no longer employed when the taxes come due. Employers that are concerned with the administration and collection of the deferred taxes continue to withhold the taxes from their employees.
Tax Cuts and Jobs Act modified under the CARES Act
Several tax provisions under the Tax Cuts and Jobs Act were modified by the CARES Act for 2020 and earlier years providing opportunities to amend prior year returns. A 15-year recovery period is retroactively assigned to qualified improvement property placed in service after December 31, 2017 allowing the property to be depreciated over 15 years or, alternatively to qualify for 100 percent bonus depreciation. Net operating losses (NOLs) arising in tax years beginning in 2018, 2019, and 2020 now have a five-year carryback period with an unlimited carryforward period and are not limited to 80 percent of taxable income. The business interest deduction limit increased from 30 to 50 percent of the taxpayer’s adjusted taxable income for the 2019 and 2020 tax years with special rules for partners and partnerships. The limitation on the deduction of excess business losses for noncorporate taxpayers does not apply for tax years beginning in 2018, 2019, and 2020. Corporations can accelerate the recovery of refundable AMT credits which allows corporations to claim a refund immediately and obtain additional cash flow during the COVID-19 emergency.
Taxpayers might consider taking advantage of the following tax benefits in 2020 before they expire. In some cases, these benefits were retroactively applied. In which case, it may be useful to amend prior year’s returns if the savings are significant enough.
- The Work Opportunity Credit terminates for wages paid to workers that begin work for an employer after December 31, 2020.
- A deduction is allowed for all or part of the cost of energy efficient commercial building property (i.e., certain major energy-savings improvements made to domestic commercial buildings) placed in service after December 31, 2017 and before January 1, 2020.
- A three-year extension of the energy-efficient homes credit is available to eligible contractors for new homes manufactured after December 31, 2017 through December 31, 2020.
Because of the retroactive changes to tax rules, the possibility of more changes after the election and with the continuing challenge of the pandemic, there is no one size fits all for tax planning and any strategy may have unintended consequences if the taxpayer’s situation is not evaluated holistically considering the changing landscape. Please call our office to schedule an appointment to discuss your year-end strategy.