Investor at desk reviewing tax planning

October 28, 2020

The Individual's Tax Planning Guide

Taking the time now to make decisions involving your charitable giving and retirement distributions may enable you to lower your tax liability for years to come.

Below are five potential tax-planning strategies that may benefit both you and your family.

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Increased Deduction for Gifts to Charity

Under the coronavirus relief package known as the CARES Act, individuals may take a larger deduction against adjusted gross income when donating to public charities.

In a normal tax year, taxpayers are allowed to deduct up to 60 percent of their cash gifts to public charities against their adjusted gross income. In other words, if you gifted $100,000 in cash to a public charity last year, you would have been able to deduct $60,000 against your adjusted gross income on your 2019 tax return.

The unused portion of your charitable deduction ($40,000) would be carried forward to 2020.

Under the CARES Act during 2020, every taxpayer is entitled to take a deduction for charitable giving of up to $300 as an individual or $600 as a couple, whether or not they choose to itemize deductions, said Alan Wolberg, senior wealth planner at City National Bank.

In addition, if you choose to itemize deductions, the CARES Act allows you to deduct cash gifts made to public charities up to 100 percent of your adjusted gross income. Note that this benefit applies only to charitable gifts made in 2020. The deduction will revert back to the current 60 percent of adjusted gross income in 2021.

Taking Early Distributions from Retirement Accounts

If you have experienced a layoff, furlough or the inability to earn income due to a pandemic-related illness or caretaking responsibilities, you may qualify to take an early distribution from your retirement account under the CARES Act.

Whereas you normally would have to pay a penalty for taking a withdrawal from your IRA, 403(b) or 401(k) before you reach age 59 ½, the CARES Act allows qualifying individuals to take an early distribution of up to $100,000 from their 401(k), 403(b) or IRA, regardless of age.

You will have to pay ordinary income taxes on the amount distributed, but you can legally pay those taxes over the next three years, which would allow you to report only one-third of the income received on your 2020 return.

Also, if you repay the funds paid out to you in 2020 by contributing the amount back to your IRA, 403(B) or 401(k) within three years after you received your distribution, you'll be entitled to receive a refund on the income taxes you paid on the distributions.

But know that you will need to file an amended tax return for the years you paid taxes in order to receive a refund.

Reconsidering Distributions

Prior to the end of 2019, individuals with traditional IRAs and other qualified retirement plans usually were required to take required minimum distributions (RMD) before April 1 in the year after they turned age 70½ .

In December 2019, the federal government passed the SECURE Act, which delayed the time when individuals are required to begin taking required minimum distributions to the year they turn age 72.

As a result of the passage of the SECURE Act, if you are age 70 or 71, you are no longer required to take minimum distributions from your retirement plans. You may begin taking distributions as early as the year you reach 59½, but there is no requirement to start taking distributions from your retirement accounts until you are age 72 if you do not need the income.

Being able to defer distributions as long as possible could allow your retirement funds to continue to grow tax deferred.

But at age 72, you must take RMDs even if you don't need the income. Not taking RMDs will lead to tax penalties, which is why many wealthy individuals consider turning their RMD into a charitable contribution, which is allowed up to $100,000.

This charitable distribution exception allows individuals to satisfy their RMD requirements while not having to recognize income or pay taxes on the $100,000, since it is being distributed directly to charity, said Jeffay Chang, regional trust advisor at City National Bank.

“Charities provide an important support system and have really suffered this year due to the inability to fundraise," said Chang. “Right now, there is an opportunity to take advantage of some charitable incentives to give to charity: 100 percent charitable deduction for cash contributions to public charities this year only, and direct distributions of up to $100,000 to charities that would qualify for RMD purposes. And the direct distribution from your IRA of up to $100,000 to charity is not a one-time deal. It can be done every year."

Think about a Roth IRA conversion

If you've considered the benefits of converting assets in a traditional IRA to a Roth IRA, this year may be a good time to revisit those plans, Chang said.

“With Democrat Joe Biden as president, taxes could increase in 2021," he explained. "So it might make sense to prepay taxes by making the conversion now."

However, the right decision depends on your specific situation.

“For example, if I'm a New Yorker planning to move to Florida, which has no state income tax, there would be less of a benefit for me to convert now and pay New York state income taxes on the conversion. I could instead wait until I moved to Florida to convert," Chang said. "The decision whether to convert needs to factor in many particular issues regarding your situation"

Not sure which move is right for you? Here is a 2020 Roth IRA conversion guide to help figure it out.

Planning for Potential Policy Changes in 2021

Tax planning for this year would be incomplete without considering the outcome of the upcoming election.

“The income tax rate may go up to 39.6 percent in 2021, as Biden has proposed for individuals with taxable income of $400,000 or more," Wolberg said. “If you fall into that category, you may consider deferring the decision to take tax losses until next year - or to take extra income this year - so that you'll have higher taxable income in 2020 at the lower tax rate of 37 percent."

Taxpayers may also want to consider making adjustments to lower their income for next year, including:

  • Contributing more to 401(k)s, 403(b)s or other defined contribution plans in 2021. The maximum contribution to a 401(k) or 403(b) in 2021 will be $19,500 if you are younger than age 50, and you can contribute an additional $6,500 as a catch-up provision if you are age 50 or older, which would be $26,000 in total, Wolberg said. “These contributions are all done with before-tax dollars and therefore lower your earned income," he explained.

  • Participating in a non-qualified deferred compensation program. If your employer offers a non-qualified deferred compensation program, you may wish to inquire about the plan and defer a portion of your income to a year in the future. “Any income deferred in a given year will not be taxed in that year. It will be taxed when it is paid to you in the future," Wolberg said. "Hopefully it will not be taxed until a time when your income, or your tax rate, is lower."

  • Establishing a charitable remainder trust. This type of trust may defer income to a future year or event. Once established, you can “gift highly appreciated assets to the charitable remainder trust and sell the assets within the trust," Wolberg said. “Charitable remainder trusts are tax-exempt entities, so sales that occur within the charitable remainder trust are not taxed when they occur. Taxes are paid, depending on how the income is characterized, when the income beneficiaries of the trust receive income over time. Income may be deferred until a future date, depending on the type of charitable remainder trust created."

Next Steps

Though much changed in 2020, tax rules remained largely the same as they were in 2019.

Aside from charitable giving, “there's not much you can do to increase deductions," Chang said. “State and local income tax deductions and real property taxes are still limited to a combined $10,000."

While savvy taxpayers are known to implement various year-end strategies, such as harvesting losses, offsetting gains with capital losses and deferring income, this year's strategies may look different, explained Wolberg, based on your expectations for political change.

For instance, instead of harvesting capital losses in order to lower income this year, you may wish to consider taking gains this year and saving losses for next year, he said, if you expect taxes to be higher and that strategy fits within your overall financial plan.

“If you're thinking of selling stocks, you might consider selling this year in order to lock in potentially lower capital gains taxes," Chang added. “Biden has said he'll look to increase the capital gains tax rate to 39.6 percent for people with taxable income greater than $1 million. He is also likely to look to lower both the estate and gift tax exemption amounts in an effort to increase estate and gift tax revenue."

With Biden as president, explained Chang, there will certainly be a focus on raising tax revenue. 

"Right now we don't know which ones will be prioritized, and when any proposed legislation will be signed into law," he said.

The most important steps to take, in any year, are those that make sense for you and fit within your personal financial situation. Rather than making changes because of what you have been told might happen, make changes only if they make sense based on your specific goals and objectives, Wolberg said.

In these turbulent times, City National encourages you to discuss your wealth plan with an advisor. Wish to find one? Get in touch with a City National advisor today.

You also are invited to keep up-to-date with the latest economic perspectives and shifting global markets during the pandemic by signing up for City National Bank's newsletters here. Delivered biweekly, straight to your inbox.

This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.

City National, its managed affiliates and subsidiaries, as a matter of policy, do not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. You should consult with your other advisors on the tax, accounting and legal implications of actions you may take based on any strategies presented, taking into account your own particular circumstances.

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