To say that 2020 has been full of unpredicted events is certainly an understatement. I have referred several times to my 2020 calendar as an Etch A Sketch. It is as if someone took our calendars, turned them upside down and shook them, wiping the slates clean. I suspect we could apply that same analogy to our tax planning for 2020. The game has changed more than a few times since the first of the year.
We started 2020 coming off a generally strong year in the financial markets and are still digesting tax reform for many. Only a few months into 2020 did we see how quickly the landscape can change. With the effects from COVID-19, our priorities changed along with many of our assumptions and planning opportunities. Perhaps the biggest subject in the accounting and tax world this year has been the Paycheck Protection Program. While this has appropriately been a large focus, there are other changes and opportunities individuals should be familiar with.
The opportunities began with the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) in December 2019, followed by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which was passed in late March, along with subsequent legislation that continues to be issued. There are a few notable beneficial changes that create potential opportunities for tax savings.
The December 2019 SECURE Act legislation created the opportunity to continue deferring tax on individual retirement accounts (IRA) and other retirement plan funds until age 72. Individuals have always faced penalties if they took withdrawals too early or too late, or did not withdraw enough, from their retirement accounts. Too early refers to most distributions before age 59 1/2. Too late refers to the requirement to begin taking distributions. Not withdrawing enough refers to the required minimum distribution based on the life expectancy tables the IRS publishes. Several of these requirements have been changed either for 2020 or permanently. If you had not yet turned 70 1/2 as of January 1, 2020, you can postpone withdrawals from your retirement account penalty-free until you turn 72. In the first year, you can wait until the following April. If you do not need the cash flow, the tax savings of continuing to let the assets grow tax-free and postponing the tax payment can be beneficial.
There are several beneficial provisions related to retirement plans that were included in some of the stimulus packages passed by Congress in March in response to the COVID-19 situation. The CARES Act provides a one-year waiver for having to take required minimum distributions from your IRA or certain retirement plans such as a 401(k). If you do not need the cash flow, you can defer the income tax on the deferral and let the assets remain in the tax-deferred account longer to grow tax-free as the market recovers.
If you have had a negative financial effect related to COVID-19, the CARES Act also contained a provision that gives you an opportunity to access those funds without penalty. The 10 percent penalty on early distributions from retirement accounts for up to $100,000 of COVID-19-related distributions is waived in 2020. If you need the cash flow on a short-term basis, you can elect to repay the funds within three years. While these funds will be taxable to you if not repaid within that period, you have the option of paying the tax over three years. Individuals eligible to take advantage of this include those who have been diagnosed with COVID-19 or have had a spouse or dependent diagnosed. It is also available to those who have experienced a financial hardship as a result of several factors, including being unable to work due to being quarantined, furloughed or laid off, having work hours reduced, etc.
Another income tax benefit included in the CARES Act relates to charitable contributions for those who do not itemize deductions. After tax reform, many individuals now claim the standard deduction rather than itemizing. For 2020, those who claim the standard deduction can also benefit from deducting charitable contributions up to $300 in addition to the standard deduction. Another change for 2020 is the removal of the adjusted gross income limitation for deducting cash contributions to charity.
If you have business losses that create a net operating loss, the CARES Act provides the opportunity to carry those losses back five years to get a current refund of prior tax paid, as opposed to only being able to carry those losses forward against future income. This is available not only for 2020 but also retroactively to losses created in 2018 and 2019.
The current environment may create tax planning opportunities that need to be reviewed. While the stock market is making a return toward pre-COVID-19 levels, you still may find that the value of your IRA investments has temporarily declined. If you expect your taxable income to be lower than normal in 2020 or if the value of your traditional IRA is down, you could consider converting the IRA to a Roth IRA. While this triggers taxable income currently, distributions (including the future growth) at retirement can be made tax-free.
Mortgage rates are at near all-time lows. If you have a mortgage on your home, you should review your current interest rate and consider the benefit of refinancing. Depending on your situation, this could also be a good time to reduce the loan term for long-term savings of interest expense while keeping your monthly payment similar. If you have intrafamily loans, this is particularly a good time to look at refinancing with low interest rates.
While not new, one thing that warrants consideration and planning is the transfer tax. If your estate will potentially be subject to estate tax, now is an excellent time to review your overall estate plan. The lifetime exemption available to everyone for transfers either during lifetime or death has increased significantly over the years. Currently, we have a very generous lifetime exemption of more than $11 million per individual. However, this significant exemption is set to revert to approximately $5.5 million at the end of 2025. There is a great deal of speculation as to whether the exemption could be changed sooner and potentially to much lower levels. This is a use-it-or-lose-it opportunity. Now is an excellent time to review the size of your potential estate and determine if using the available exemption should be in your planning.
We have had several favorable tax changes in the last six months. Everyone’s situation is unique to them and warrants review by their tax and financial planning advisors to see what opportunities may apply.
This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult your BKD advisor or legal counsel before acting on any matter covered in this update.
Article reprinted with permission from BKD CPAs & Advisors, bkd.com. All rights reserved.