By: Susan Powers, CFA, CPA, CFP®, CPFA
COVID-19 brought financial changes and challenges to many this year and Congress responded with relief packages for both businesses and individuals which may have an impact on your 2020 taxes. As a result, tax planning is critically important this year.
- Review your investments: market volatility may have impacted how your assets are now allocated. While you may have been concerned about losses earlier this year, many have seen their investments rebound with the recent strong market performance. Rebalancing helps you to re-align your asset allocation to balance return and risk with your personal goals. For some, tax loss harvesting may be an appropriate strategy in order to realize a loss on some investments to offset other realized capital gains and income.
- Required Minimum Distribution (RMD) by December 31st.? If you are over 70, you may be planning on taking your RMD by year-end in order to avoid large penalties. Like many other things in 2020, the rules are different this year due to RMD waivers provided by the CARES Act.
- Stimulus payments: Under the 2020 tax rules, you may be able to claim an additional refund on top of any stimulus payments received.
Review and Rebalance Investments
Rebalancing means selling investments that have increased in value and buying other investments that have gone down in order to realign your asset allocation to the desired percentages. Rebalancing in your tax-deferred or tax-free accounts such as 401k and IRAs can be done without impact to your taxable income. Rebalancing in taxable accounts can have tax consequences as gains or losses are realized.
Tax loss harvesting means selling some investments that lost value in order to realize a capital loss and use the loss to offset realized capital gains and income. Watch out for the "wash sale rule" though. The IRS won't allow you to sell an investment at a loss and then immediately repurchase it (known as a "wash sale") and still claim the loss.
Unlike rebalancing, tax loss harvesting only applies to taxable accounts, not tax advantaged accounts such as 401k/403b accounts and IRAs where income and gains are deferred or tax-free.
IRA Required Minimum Distributions
This past March, in response to COVID-19, Congress passed The Coronavirus Aid, Relief, and Economic Security Act (CARES Act). One provision of this act was waiving Required Minimum Distributions (RMDs) for 2020. If you usually take your RMD at year-end, don’t forget to pause that distribution to avoid paying taxes this year if you don’t need that money for current living expenses.
There may be reasons you would still want to take your RMD. Tax rates are at historically low levels. If you are concerned about higher tax rates in the future, taking funds from your tax-deferred IRA and paying taxes now versus later at higher rates may be a smart move. Qualified Charitable Distributions (QCDs) are the most tax-efficient way to make charitable gifts because they reduce tax-deferred IRA balances without paying taxes on the amount distributed. Many individuals take their RMD and give it to charity via QCD. See Kate Hennessy’s article this month for more detail on QCDs.
The CARES Act also created stimulus payments of up to $1,200 per taxpayer and $500 per qualified dependent child. The payments were paid based on 2018 or 2019 return information, but they are technically pre-paid 2020 tax credits. As a result, your 2020 tax return will calculate the credit due based on your income level, and there’s nothing but good news here. If your 2020 return shows you should receive an additional credit, you can claim it on your return. But if your return shows a credit less than a stimulus check you’ve already received, there is no required repayment.
Keep Your Eyes Open
In addition to existing planning opportunities, keep in mind that we might not be done with developments for the 2020 tax year. There could be additional legislation that affects this tax year during the Congressional lame duck session this month.
For optimal results, we believe tax planning is not an event but an exercise that should be done throughout the year. Combining your investment strategy with a tax-efficient overlay requires careful, ongoing consideration. Please let us know how we can help with your planning and investing needs.