3 Year-End Tax Planning Tips

The year 2020 has been a tumultuous one, and an unusual one for taxpayers. As the year draws to a close, year-end tax planning may be more important than ever before. Here are three strategies to consider. One or more may fit into your tax plan.

1. Make substantial gifts to your family

Gifts to family members can help them through difficult financial times while allowing you to make the most of the record-high gift and estate tax exemption amount. The Tax Cuts and Jobs Act of 2017 temporarily doubled the exemption from $5 million to $10 million, indexed for inflation, through 2025. This year, it stands at $11.58 million — or an effective exemption of $23.16 million for married couples.

Now may be the time to take advantage of the current exemption amount by transferring substantial amounts of wealth tax-free and shielding those gifts from future gift or estate taxes. Even if your net worth is well within the exemption, this may be a wise strategy because there’s no guarantee that a future administration or legislature won’t slash the exemption amount, possibly before 2025. For example, in recent years lawmakers have proposed reducing the exemption to $3.5 million or even as low as $1 million.

2. Donate to charity

The CARES Act sweetened the tax benefits of philanthropy for certain gifts made by the end of 2020. For this year only, cash gifts to public charities are deductible up to 100% (up from 60%) of adjusted gross income (AGI). Keep in mind that these deductions may be reduced by other types of donations, such as gifts of property other than cash or gifts to donor-advised funds or private foundations. So, plan carefully to achieve your charitable goals at the lowest possible tax cost.

The act also established a new “above-the-line” charitable deduction (in other words, a deduction from gross income in calculating AGI) of up to $300 for nonitemizers. This benefit also is limited to cash gifts to public charities.

3. Do a Roth conversion

Have you been thinking about converting a traditional IRA, 401(k) or other eligible retirement account into a Roth account? If so, now may be the ideal time to pull the trigger. Roth accounts offer several attractive benefits, such as tax-free withdrawals of both contributions and earnings and no minimum distribution requirements during the owner’s lifetime.

When you do a Roth conversion, the amount you convert is fully or partially taxable, so you’ll need to be prepared for a larger tax bill this year. But if the value of your account is depressed as a result of recent market volatility, or a decline in income has pushed you into a lower tax bracket, there may be no better time to make the switch.

If a Roth conversion isn’t right for you, perhaps a contribution to a Roth IRA is appropriate. Though not technically a year-end decision (because you have until April 15, 2021, to make a contribution for 2020), it’s worth considering. Be aware that, unlike contributions to traditional retirement accounts, contributions to a Roth account aren’t tax-deductible.

To determine whether a Roth is right for you, you’ll need to weigh the benefits of tax-free withdrawals in the future against the benefits of deductible contributions now. There are other factors that come into play but, as a general rule, people who expect their tax rates to be higher when they withdraw retirement funds are better off with a Roth. Consult one of our tax professionals at (973) 298-8500 about your particular situation.

© 2020