Tax Strategy: More than the usual year-end tax planning
Year-end tax planning for 2020 involves several new wrinkles, in addition to the usual strategies. The Treasury Department and the Internal Revenue Service continued a significant flow of guidance with respect to the Tax Cuts and Jobs Act in 2020. Most of the new tax legislation was related to COVID-19 relief, and frequently expires at the end of 2020. Those pesky regularly expiring provisions are also expiring once again at the end of 2020.
Add to this that the COVID relief often involves the ability to amend prior years’ tax returns for even greater and more immediate relief, and you have much to think about for year-end planning. The year 2020 is also an election year, which could affect the tax law in various ways in future years.
A significant portion of COVID relief enacted by Congress this year was in the form of direct payments and not directly tax-related. However, both the Family First Coronavirus Relief Act and the CARES Act include a number of tax provisions. The Paycheck Protection Program was not directly tax-related, although a tax issue has come up during the course of the year. The IRS has taken the position that expenses covered by the PPP, where those loans are forgiven, are not deductible. Many in Congress have said that this was not their intent, but Congress has not yet been able to enact a provision to clearly make those expenses deductible.
Many people have received Economic Impact Payments this year. The IRS has recently extended the deadline for non-filers to apply for EIPs to Nov. 21, 2020, by going to the Non-Filers Enter Payment Tool on the IRS website. The EIPs will be taken into account as a credit on the 2020 Form 1040. It appears on Draft Form Line 30 as the Recovery Rebate Credit. The refundable credit gives taxpayers an additional chance to claim the EIP if they have not received the full amount to which they are entitled already. If the taxpayer has received more than the amount to which they are entitled, they do not have to repay it unless the IRS determines that they were not eligible to receive the EIP in the first place, e.g., deceased persons or non-resident aliens. If a taxpayer received a $500 EIP for a child claimed as a dependent on a 2018 or 2019 tax return, the child may be entitled to their own $500 recovery rebate credit if they are not claimed as a dependent on the 2020 tax return.
For 2020 only, the adjusted gross income limit for itemized charitable deductions has been raised from 50 percent to 100 percent for any qualified charitable contributions. The contributions need not be COVID-related. For non-itemizers, there is a new above-the-line deduction of $300 for charitable contributions made in cash. The 85 percent of taxpayers who do not itemize should keep this new deduction in mind in their year-end giving plans. Although there is some ambiguity in the provision, it appears to be available for 2020 only, and the $300 limit applies both for individual and joint returns. Even though the CARES Act eliminated the requirement for required minimum distributions for 2020, IRA account holders over age 70 ½ may still make distributions directly to charities of up to $100,000 in 2020 and keep those distributions out of adjusted gross income.
For employers, there are several relaxations of Social Security withholding tax payments for 2020. There are new credits for COVID-related sick leave and family leave, and for employee retention. These credits can be claimed in advance through reductions in payments with Form 941 or by filing a Form 7200 if entitled to greater credits than the amounts due with Form 941. There is also a deferral provision for the employer portion of Social Security taxes for 2020, repayable in 2021 and 2022. By executive memorandum, President Trump has also authorized employers to not withhold the employee’s share of Social Security taxes for the remainder of 2020. Since Congress has not yet forgiven the repayment of those taxes and they currently must be repaid in the first quarter of 2021, many employers have elected to continue to do the withholding, although the executive branch of the federal government has decided to defer withholding.
Individual retirement account holders and 401(k) plan participants are authorized in 2020 to make penalty-free distributions from retirement plans of up to $100,000 for COVID-19-related expenses, with the ability to repay the distribution in the next three years or pay the tax on the distribution over the next three years. The limit on plan loans is also increased to $100,000 in 2020 for COVID-19-related expenses. Employers must consent to these changes for employer-sponsored plans. Required minimum distributions for 2020 were also waived, although the deadline has now passed for people who made RMDs early in the year to repay the sums without paying tax on the distribution. For 2020 only, employers may also reimburse employees for principal and interest on student loans as part of their $5,250-per-year education reimbursement plan.
For COVID relief related to businesses, a number of provisions of the Tax Cuts and Jobs Act were modified for 2020 and earlier years. Net operating loss carrybacks were restored with a carryback of up to five years, permitting carrybacks as far as 2013 for tax year 2018. The business interest deduction limitation was relaxed by increasing the limit from 30 percent to 50 percent of adjusted taxable income for 2019 and 2020, with special rules for partners and partnerships. The IRS guidance has also created several elections available to taxpayers with respect to the business interest deduction limit. The limitation on losses for noncorporate businesses was also relaxed. The ability to claim a net credit for prior-year minimum tax liability for corporations was also accelerated.
The Tax Cuts and Jobs Act of 2017 required the tax on investment income of children (the “Kiddie Tax”) to be paid at estate and gift tax rates rather than the parent’s tax rate, which often may be a higher rate. The SECURE Act retroactively revised that change and provides an election to taxpayers to amend 2018 and 2019 tax returns to claim the parent’s tax rate if lower.
The act also increased the required minimum distribution age to age 72, permits IRA contributions to continue after age 70 ½, and accelerates the required minimum distribution rules for designated beneficiaries. These changes may warrant consideration of a taxpayer’s continuing IRA contributions and a review of the beneficiary designations on IRAs.
The CARES Act corrected an error in the Tax Cuts and Jobs Act to permit qualified improvement property to be eligible for immediate expensing, rather than being depreciated over the life of the real estate. This creates an opportunity to amend 2018 tax returns or elect to change accounting methods to take advantage of the expense election.
The year 2020 has brought a number of disasters in the form of hurricanes, wildfires, and, impacting almost everyone, the COVID-19 pandemic. While federal natural disaster declarations usually apply for a specific area for a specific time and permit an itemized deduction for casualty losses in the current or prior year, the COVID-19 pandemic has no clear limits as to territory or time.
COVID-19 is a federally declared disaster, so, in addition to the congressionally enacted relied, COVID-19 disaster losses also qualify for a casualty loss deduction in 2020 or the prior year. Due to the unique character of the COVID disaster, further clarification may be needed from the IRS as to what losses qualify for the casualty loss deduction and for how long the disaster continues. Legislation enacted at the end of 2019 also permits special retroactive relief for earlier disasters that also creates the possibility to amend tax returns to claim additional disaster relief.
The Further Consolidated Appropriations Act of 2020 once again extended 33 regularly expiring provisions, many retroactively to 2018. They also generally expire again at the end of 2020. For individuals, these include the tax exclusion for canceled mortgage debt, the mortgage insurance premium deduction, the above-the-line deduction for tuition and fees, the non-business energy property credit, the 7.5 percent floor on the medical expense deduction, and the health coverage tax credit. The remaining credits are primarily energy-related or impact specific industries. Taxpayers should consider taking advantage of these credits in 2020 before they expire and amending prior years’ returns if the savings are sufficient to warrant the expense of amending returns.
Future tax law changes
With the November elections at hand, many taxpayers are considering year-end 2020 tax planning that could be affected by the election outcome. Strategies include reviewing estate plans to take maximum advantage of the current exemption levels or to freeze the value of estates at current levels, realizing capital gains in anticipation of possible rate increases, and taking maximum advantage of Roth IRAs to help reduce future taxable income.
Tax planning for 2020 will require planning surrounded by uncertainty. How long will the economy be impacted by the COVID-19 pandemic? Will Congress enact additional economic stimulus? What will the 2020 election mean for taxes in the future? What will the growing national debt mean for taxes in the future? In addition to the usual strategies revolving around postponing income and accelerating deductions, many additional factors at play in 2020 will warrant thorough year-end discussions between tax advisors and their clients.