If you thought 2020 was bad...
What a year we have been through (and at this writing it is not yet over). I will not list out what has happened because I do not want to depress you any further.
We have 2021 starting shortly. There are jokes around such as “If you thought 2020 was bad, just wait until it turns 21 and is able to drink” or “I refuse to go into 2021 until I get promises that it will not be anything like its predecessor.” The list goes on and they are all along the same theme.
There are tax changes that are in effect for this year only resulting primarily from the CARES Act. And at this point in time, no one knows what will happen with tax laws. No politics implied but currently, there are 50 Republicans and 48 Democrats.
If Republicans maintain control of the Senate, most likely there will not be any substantive tax changes. Which does leave the question of the very significant debt to be addressed later.
If the Democrats win the two seats up for grabs in Georgia, we can expect there will be a substantial tax law change with higher tax rates and many other changes. But based on what Biden has been promising, it will not affect you if your income is less than $400k. Unfortunately, that means I won’t pay more tax (I’d much rather have that amount of income even if it meant I paid more in taxes).
There are other proposed changes but they are not law so why discuss what may or may not happen at this point. However, the possibility of changes in tax rates may affect what you do right now.
Accordingly, here is a lengthy Top 10 list of things I believe you should know about as the year draws to a close.
1. Conventional tax planning is to accelerate expenses and defer income at year end, to reduce the current year’s taxable income. But what if the law does change and the rates do increase (and affect you)? Then, the wisdom is different.
If you believe the tax rates will change and affect you, you want to have your 2020 taxable income higher than 2021 (when your potential rates might be higher). So, don’t accelerate expenses and defer income if you think the rates will change and you will be affected. (Yes, I know I wrote the same thing basically, but I want to be sure you understand what might potentially happen.)
2. Medical expenses for 2020 are deductible at 7.5% of Adjusted Gross Income (AGI). For 2021 (barring any changes), that will increase to 10%. So, if you are considering any sort of elective surgery, now is the time to do it. Tell your doctor they want to accelerate their income into 2020. 😉 But if you buy and must pay for any medical supplies or prescriptions, pre-purchase some of those supplies now for the beginning of 2021. BUT REMEMBER … you can only deduct medical expenses if you do itemize deductions. With the increase in the standard deduction, limitation of state and local taxes (SALT), and no longer being able to deduct miscellaneous itemized deductions, fewer people have been able to itemize.
3. Continuing on the immediately preceding statement, if you are not itemizing deductions, you may still be able to deduct (currently) up to $300 in cash charitable contributions on page 1 of your tax return. The requirement for receipts for those charitable contributions is still in effect. And again, noncash charitable contributions do not count for this.
4. Did you have to take out money from an IRA or any other retirement plan in 2020 BECAUSE OF SOMETHING RELATED TO COVID (key terms)? If so, there are many options available to you (but again, you will need to prove it was COVID related).
- If under age 59 ½, the 10% early distribution penalty will not apply.
- It will be taxed over 3 years unless you choose to have it taxed in full for 2020.
- But bear in mind the possible change in tax rates mentioned above
- Those tax rate changes may not apply to you
- You can also elect to pay back the distribution within 3 years thus avoiding the tax completely
This could be an interest free loan if you took the money out and then pay it back. But in every case, remember that you MUST have had a COVID related event happen to you, or a spouse or dependent.
5. If you have been required to take Required Minimum Distributions (RMD) from a retirement plan, that requirement is suspended for 2020. So, if you have not taken it yet, you are not required to. If you had taken it previously, as mentioned in my August 2020 letter, you had until August 31, 2020 to repay the distribution to avoid taxation. You still can rollover funds from one account to another within a 60-day (not two months) time frame so if you took out funds i.e., November 5, you could roll them over to a new IRA by January 4, 2021 and avoid taxation.
Oh, and by the way, if you turned age 70½ during 2020, you are not required to take an RMD until you turn 72. If you fall in between those ages, it means that as of December 31, 2019 or earlier you were required to take an RMD and you do not get that 18-month extension.
6. Say you’re still working (like me) and want to take advantage of making a deductible IRA contribution, but you were over age 70½. Previously, you could not. The SECURE Act (because every tax law must have an acronym – I think it is in the Declaration of Independence – that relates to the law) passed late in 2019 and not effective until after 2019 opens the possibility of making those contributions.
7. Did you receive unemployment during 2020? Regardless of whether it included the Federal bonus unemployment benefits or not, remember that all unemployment is in fact taxable income. You can thank President Reagan for that (1982). If you did not have taxes withheld from it, you may owe taxes come April 15. Start planning as soon as you receive your 1099-G.
8. Those darned stimulus payments (EIP) are not taxable. BUT you do have to report how much you received. “Why?” you ask. To make certain you received the right amount. They will compare your receipt against what you were entitled to. Let’s say you had a new child in 2020. Since your EIP was based on your 2018 or 2019 return and the child was not born until 2020, you did not receive any money for him/her/them(!). But when you file your 2020 return, you will square up with the Treasury. Or let’s say your 2018 return disqualified you and your 2019 return was filed late, on extension, or whatever, and you otherwise would have qualified. By reporting no receipt of the EIP, you will receive it during 2021.
If Congress goes ahead and passes an additional EIP as is being discussed today, how things will be reported may again change. Don’t shoot me, I’m only the messenger.
9. Were you one of those “few” people that wound up working from home? Well, if you were and think you can now take a home office deduction, you’d be thinking wrong. The Home office deduction is only available to businesses and the self-employed. Even then, it was only available if your employer required it (which was most likely the case) and you had no other space in which to work. But home office deductions for employees were part of Employee Business Deductions and were part of Miscellaneous Itemized deductions. Those were eliminated in the 2017 tax act, so it is not available. And, with itemized deductions not being taken by so many because of the increased standard deductions, you may not have had enough to claim those any way. They are not available, you cannot take it, so just put that thought out of your head (again, unless you are a business and self-employed). I won’t even get into the various state tax filing issues that working from home has caused.
10. I do not often give advice about when or if to convert funds from a traditional IRA to a Roth IRA because it does matter in each situation based on taxable income levels, age, etc. But with the tax rates still being low (and again, not knowing when or if they will change), it might be a good time to take advantage of the low tax rates and convert your IRAs to Roth IRAs.