Do You Know Why 2020 Is A Critical Year For Tax Planning?

Contributed by: Nick Defenthaler, CFP®, RICP®

It’s been quite the year, hasn’t it? 2020 has certainly kicked off the decade in an interesting fashion. In addition to the coronavirus quarantine, it’s also a year that required a significant amount of tax planning and forward-thinking. Why is this year so unique as it relates to taxes? Great question, let's dive in!

SECURE Act

The SECURE ACT was passed in late December 2019 and became effective in 2020. The most meaningful part of the SECURE Act was the elimination of the stretch IRA provision for most non-spouse IRA beneficiaries. Non-spouse beneficiaries now only have a 10-year window to deplete the account which will likely result in the beneficiary being thrust into a higher tax bracket. This update has made many retirees re-think their distribution planning strategy as well as reconsider who they are naming as beneficiaries on certain accounts, given the beneficiary’s current and future tax bracket. Click HERE to read more about this change. 

CARES Act 

Fast forward to March, the CARES Act was passed. This critical stimulus bill provided direct payments to most Americans, extended and increased unemployment benefits, and outlined the parameters for the Paycheck Protection Program for small business relief. Also, another important aspect of the CARES Act was the suspension of Required Minimum Distributions (RMDs) for 2020. This isn’t the first time this has occurred. Back in 2009, RMDs were suspended to provide relief for retirees given the “Great Recession” and financial crisis. However, the reality is that for most Americans who are over 70 1/2 and subject to RMDs (RMDs now begin at age 72 starting in 2020 due to the SECURE Act), actually need the distributions for cash flow purposes. That said, for those retirees who have other income sources (ex. Social Security, large pensions, etc.) and investment accounts to cover cash flow and don’t necessarily “need” their RMD for the year for cash flow, 2020 presents a unique planning opportunity. Not having the RMD from your IRA or 401k flow through to your tax return as income could reduce your overall income tax bracket and also lower your future Medicare premiums (Part B & D premiums are based on your Modified Adjusted Gross Income). We have seen plenty of cases, however, that still make the case for the client to take their RMD or at least a portion of it given their current and projected future tax bracket. There is certainly no “one size fits all” approach with this one and coordination with your financial planner and tax professional is ideal to ensure the best strategy is employed for you. 

Lower Income In 2020

Income for many Americans is lower this year for a myriad of reasons. For those clients still working, it could be due to a pay cut, furlough, or layoff. Unfortunately, we have received several dozen calls and e-mails from clients informing us that they have been affected by one of the aforementioned events. In anomaly years where income is much less than the norm, it presents an opportunity to accelerate income (typically though IRA distributions, Roth IRA conversions, or capital gain harvesting). Every situation is unique so you should chat with your planner about these strategies if you have unfortunately seen a meaningful reduction in pay. 

Thankfully, the market has seen an incredible recovery since mid-March and most diversified portfolios are very close to their January 1st starting balances. However, income generated in after-tax investment accounts through dividends and interest are down a bit given dividend cuts by large corporations and because of our historically low interest rate environment. We were also were very proactive in March and April with a strategy known as tax-loss harvesting, so your capital gain exposure may be muted this year. Many folks will even have losses to carry over into 2021 and beyond which can help offset other forms of income. For these reasons, accelerating income could also be something to consider. 

Higher Tax Rates In 2021, A Very Possible Scenario 

Given current polling numbers, a Democratic sweep seems like a plausible outcome. If this occurs, many analysts are predicting that current, historically low rates could expire effective January 1, 2021. We obviously won’t know how this plays out until November, but if tax rates are expected to see a meaningful increase from where there are now, accelerating income should be explored. Converting money from a Traditional IRA to a Roth IRA or moving funds from a pre-tax, Traditional IRA to an after-tax investment account (assuming you are over the age of 59 1/2 to avoid a 10% early withdrawal penalty) eliminates the future uncertainty of the taxes on those dollars converted or distributed. Ever since the Tax Cuts and Jobs Act was passed in late 2017 and went into law in 2018, we have been taking a close look at these strategies for clients as the low tax rates are set to expire on January 1, 2026. However, if taxes have a very real chance of going back to higher levels as soon as 2021, a more aggressive income acceleration plan could be prudent. 

As you can see, there have been many moving parts and items to consider related to tax planning for 2020. While we spend a great deal of our time managing the investments within your portfolio, our team is also looking at how all of these new laws and ever-changing tax landscape can impact your wealth as well. In our opinion, good tax planning doesn’t mean getting your current year’s tax liability as low as humanly possible. It’s about looking at many different aspects of your plan, including your current income, philanthropy goals, future income, and tax considerations as well as considering the individuals or organizations that will one day inherit your wealth and helping you pay the least amount of tax over your entire lifetime.

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

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All investments are subject to risk. There is no assurance that any investment strategy will be successful. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

Harvesting Losses in Volatile Markets

Contributed by: Robert Ingram, CFP®

In times of market volatility and uncertainty there are still financial strategies available as part of a sound long-term investment plan. One example to keep in the toolbelt can be the use of tax-loss harvesting. It’s when you sell a capital asset at a loss in order to reduce your tax liability.

While this sounds counter-intuitive, taking some measures to harvest losses strategically allows those losses to offset other realized capital gains. In addition, remaining excess losses can offset up to $3,000 of non-investment income, with remaining losses carrying over to the next tax year. This can go a long way in helping to reduce tax liability and improving your net (after tax) returns over time. So, how can this work?

Harvesting losses doesn’t necessarily mean you’re giving up on the position entirely. When you sell to harvest a loss you cannot make a purchase into that security within the 30 days prior to and after the sale.  If you do, you are violating the wash sale rule and the loss is disallowed by the IRS.  Despite these restrictions, there are several ways you can carry out a successful loss harvesting strategy.

Tax-Loss Harvesting Strategies

• Sell the position and hold cash for 30 days before re-purchasing the position. The downside here is that you are out of the investment and give up potential returns (or losses) during the 30 day window.

• Sell and immediately buy a position that is similar to maintain market exposure rather than sitting in cash for those 30 days. After the 30 day window is up you can sell the temporary holding and re-purchase your original investment.

• Purchase the position more than 30 days before you try to harvest a loss. Then after the 30 day time window is up you can sell the originally owned block of shares at the loss. Being able to specifically identify a tax lot of the security to sell will open this option up to you.

Common Mistakes To Avoid When Harvesting

• Don’t forget about reinvested dividends. They count. If you think you may employ this strategy and the position pays and reinvests a monthly dividend, you may want to consider having that dividend pay to cash and just reinvest it yourself when appropriate or you will violate the wash sale rule.

• Purchasing a similar position and that position pays out a capital gain during the short time you own it.

• Creating a gain when selling the fund you moved to temporarily that wipes out any loss you harvest. You want to make the loss you harvest meaningful or be comfortable holding the temporary position longer.

• Buying the position in your IRA. This violates the wash sale rule. This is identified by social security numbers on your tax filing.

As with many specific investment and tax planning strategies, personal circumstances vary widely.  It is critical to work with your tax professional and advisor to discuss more complicated strategies like this. If you have questions or if we can be a resource, please reach out!

Robert Ingram, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® With more than 15 years of industry experience, he is a trusted source for local media outlets and frequent contributor to The Center’s “Money Centered” blog.

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The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Bob Ingram and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

Is Too Much Success a Penalty at Tax Time?

Many investors have been so successful they may face a potentially hefty tax bill for 2013.  This bull market we are experiencing in the U.S. has had such strong legs for a long period of time many investors have few, if any, capital losses to harvest to help offset the gains they have accumulated in their equity investments. In some ways this is a great problem to have. 

Tax Increases

This year there were a couple of noteworthy tax increases to keep in mind.  The maximum tax rate on capital gains has increased from 15% to 20%.  Taxpayers with taxable income north of $400,000 ($450,000 for couples) will be affected by this increase.  There is also the new Medicare investment income “surtax” affecting taxpayers with modified adjusted gross income over $200,000 ($250,000 for couples).  This tax is an additional 3.8% on investment income (interest, capital gains, dividends etc.).

Look for Bond Losses

Some taxpayers may still have tax losses from 2008-2009 to help offset gains, but for many these have run out during the successful run the markets have enjoyed for the past 4 ½ years.  One place to look for some losses this year may be in the bond portion of your portfolio (if applicable).  There may be an opportunity to swap to a similar investment for a short period of time, at least 31 days, to harvest those losses to help offset other gains you may have. 

Harvesting Losses

Make sure you are reviewing your portfolio throughout the year for tax losses to harvest.  Bond losses were at their peak during late summer and into the fall, but if you wait until December to harvest those losses, they could be much diminished from what they were.  The end of the year is rarely the best time of the year to harvest tax losses.  Personal circumstances vary widely so it is critical to work with your tax professional and financial advisor today to prepare for the risk of higher taxes in your future.

Angela Palacios, CFP®is the Portfolio Manager at Center for Financial Planning, Inc. Angela specializes in Investment and Macro economic research. She is a frequent contributor to Money Centered as well asinvestment updates at The Center.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  You should discuss any tax or legal matters with the appropriate professional.

4 Things Corporations Can Do With Their Cash

 After a few very profitable years, many corporations have record amounts of cash on hand.  Wouldn’t this be a nice problem?  I have yet to experience this but feel I am up for the challenge.  I always have an idea of what I could do with extra money...a cute pair of shoes, turn my bathroom into a Tuscan escape, or even set foot on Antarctica.  I could go on for days.  Publicly traded Corporations, on the other hand, have a much more limited list of what they can do with extra cash on the books.  They can:

1. Invest in their own securities through stock buyback programs
2. Invest in capital, Research and Development, or hire more employees
3. Acquire other companies
4. Return the money to shareholders in the form of dividends

The first point is one I would like to dwell on.  Generally, when stock buybacks are announced, investors assume that this will automatically add value to the stock price.  This is logical, fewer shares outstanding means that the remaining shares own a larger slice of the company.  However, this is not always the case.  Often repurchased shares go right back out as part of compensation packages.  Also companies don’t always complete share repurchase programs if they need to use the cash in another way.

The irony is companies are usually flush with cash after business has been booming for a couple years or longer and after their stock prices have already jumped substantially.  This is when they tend to go on their shopping sprees.  When prices are down, in the midst of a crisis like early 2009, companies usually hold on to any cash they may have left, fearfully, rather than taking advantage of short-term depressions in their stock prices. 

David Zion an analyst and accountant for Credit Suisse came out with an excellent report on many stock buybacks over the past decade.  It shows that corporations are just as prone to poor investment behavior with their cash as many investors (maybe even worse).  Looking at one of the largest buyback programs over the eight years of the study, according to the Credit Suisse report, Hewlett Packard (HPQ) averaged an annualized loss of 11.3%!

Many experts are postulating that an increase in dividend taxes, which may occur next year, could lead to an increase in corporate stock buybacks (capital gains could be taxed at a much lower rate than dividends).  Be very skeptical, though, since stock buybacks are no guarantee of generating capital gains!

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The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing materials are accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily of RJFS or Raymond James.  Raymond James Financial Services, Inc., Its affiliates, officers, directors or branch offices may in the normal course of business have a position in securities mentioned in this report.  This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.  As of 12/5/12 close, HPQ was trading at $13.82/share.  HPQ is not closely followed by Raymond James Research.

No Free Lunch – But Maybe a Free Capital Gain?

fThe financial and investment profession is full of acronyms, jargon, and common phrases such as “buy low – sell high” and is “there’s no free lunch when it comes to investing”.  Believe it or not, some things are free in personal finance (and our role is to help you find them) such as the 0% capital gain rate for many taxpayers.  Yes…..0%....and hopefully we don’t have to argue that that is a good rate! 

Single taxpayers with taxable incomes of less than $34,500 and married couples filing jointly with taxable incomes below $69,000 are considered to be in the 10% or 15% marginal bracket.  One of the luxuries of being in the 10% or 15% marginal tax brackets is a 0% capital gain rate through the end of 2012. Those in marginal brackets higher than the 10% and 15% currently are subject to a 15% capital gain rate.   

Here are a few examples of who might benefit from such a rate: 

• Those holding appreciated securities that have been hesitant to sell because of the tax implications.
• Those interested in selling an appreciated security in order to reset the cost basis. (Don’t forget to avoid the wash sale rules)
• Those in higher tax brackets looking to make gifts to relatives that are in lower brackets (say a child that has moved back into their high school bedroom). 

Example:   John and Mary’s son Steven recently graduate and is finding full time employment illusive.  John and Mary expect to help Steven out with expenses for the near future.  John and Mary are in the 28% marginal bracket and Steven (with little income) is in the 10% marginal bracket.  John and Mary can gift Steven appreciated securities….Steven can then sell them and take advantage of the 0% capital gain rate. 

As always, work with your professional advisors before implementing any tax strategies….and possibly enjoy a free lunch thanks to a free capital gain.

Note: Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters.  You should discuss tax or legal matters with the appropriate professional.