Dear Clients and Friends:

 

This year has been unlike any other in recent memory. Front and center, the COVID-19 pandemic has touched virtually every aspect of daily living and business activity in 2020. In addition to other financial consequences, the resulting fallout is likely to have a significant impact on year-end tax planning for both individuals and small businesses.

 

Furthermore, the national elections are expected to affect tax issues for the rest of the year and beyond. 

 

In response to the pandemic, Congress authorized economic stimulus payments and favorable business loans as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act also features key changes relating to income and payroll taxes. This new law follows close on the heels of the massive Tax Cuts and Jobs Act (TCJA) of 2017. The TCJA revised whole sections of the tax code and includes notable provisions for both individuals and businesses.

 

This is the time to paint your overall tax picture for 2020. By developing a year-end plan, you can maximize the tax breaks currently on the books and avoid potential pitfalls. 

 

Keeping all that in mind, we have prepared the following 2020 Year-End Tax Letter. For your convenience, the letter is divided into three sections:

 

* Individual Tax Planning

 

* Business Tax Planning

 

* Financial Tax Planning

 

Be aware that the concepts discussed in this letter are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with a tax professional.

 

INDIVIDUAL TAX PLANNING

 

Charitable Donations

Generally, itemizers can deduct amounts donated to qualified charitable organizations, as long as substantiation requirements are met. Be aware that the TCJA increased the annual deduction limit on monetary contributions from 50% of adjusted gross income (AGI) to 60% for 2018 through 2025. Even better, the CARES Act raises the threshold to 100% for 2020.

 

In addition, the CARES Act authorizes an above-the-line deduction of up to $300 for monetary contributions made by a non-itemizer in 2020 ($600 for a married couple). 

 

YEAR-END MOVE: In most cases, you should try to “bunch” charitable donations in the year they will do you the most tax good. For instance, if you will be itemizing in 2020, boost your gift giving at the end of the year. Conversely, if you expect to claim the standard deduction this year, you may decide to postpone contributions to 2021.

 

For donations of appreciated property that you have owned longer than one year, you can generally deduct an amount equal to the property’s fair market value (FMV). Otherwise, the deduction is typically limited to your initial cost. Also, other special rules may apply to gifts of property. Notably, the annual deduction for property donations generally cannot exceed 30% of AGI.

 

Note: If you donate to a charity by credit card in December—for example, you make an online contribution—you can still write off the donation on your 2020 return, even if you do not actually pay the credit card charge until January.

 

Family Income-Splitting

The time-tested technique of family income-splitting still works. Currently, the top ordinary income tax rate is 37%, while the rate for taxpayers in the lowest income tax bracket is only 10%. Thus, the tax rate differential between you and a low-taxed family member, such as a child or grandchild, could be as much as 27%—not even counting the 3.8% net investment income tax (more on this later).

 

               YEAR-END MOVE: Shift income-producing property, such as securities, to family members in low tax brackets through direct gifts or trusts. This will lower the overall family tax bill. But remember that you are giving up control over those assets. In other words, you no longer have any legal claim to the property.

 

               Also, be aware of potential complications caused by the “kiddie tax.” Generally, unearned income above $2,200 received in 2020 by a child younger than age 19, or a child who is a full-time student younger than age 24, is taxed at the top marginal tax rate of the child’s parents. (Recent legislation reverses a TCJA change on the tax treatment.) The kiddie tax could affect family income-splitting strategies at the end of the year

 

Note: If there is a danger that the kiddie tax could be triggered in 2020, some of the same income deferral strategies that are available to adults may be used for dependent children. For example, you may arrange for a child to postpone a large capital gain from a securities sale to 2021 or realize a capital loss at year-end to offset previous capital gains (see page 8). 

Higher Education Expenses

The tax law provides tax breaks to parents of children in college, subject to certain limits. This often includes a choice between one of two higher education credits and a tuition-and-fees deduction.

 

YEAR-END MOVE: When appropriate, pay qualified expenses for next semester by the end of this year. Generally, the costs will be eligible for a credit or deduction in 2020, even if the semester does not begin until 2021.

 

Typically, you can claim either the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC). The maximum AOTC of $2,500 is available for qualified expenses of each student, while the maximum $2,000 LLC is claimed on a per-family basis. Thus, the AOTC is usually preferable. Both credits are phased out based on modified adjusted gross income (MAGI).

 

Alternatively, you may claim the tuition-and-fees deduction, which is either $4,000 or $2,000 before it is phased out based on MAGI, as shown below

                                                                             

 

Note: The tuition-and-fees deduction, which has expired and been revived several times, is scheduled to end after 2020, but could be reinstated again by Congress.

 

Medical and Dental Expenses

Previously, taxpayers could only deduct unreimbursed medical and dental expenses above 10% of their AGI. But the TCJA temporarily lowered the threshold to 7.5% of AGI for 2017 and 2018. Subsequent legislation extended this tax break through 2020.

              

               YEAR-END MOVE: When it is possible, accelerate non-emergency expenses into this year to benefit from the lower threshold. For instance, if you expect to itemize deductions and have already surpassed the 7.5%-of-AGI threshold this year, or you expect to clear it soon, accelerate elective expenses into 2020. Of course, the 7.5%-of-AGI threshold may be extended again, but you should maximize the tax deduction when you can.  

 

               To qualify for a deduction, the expense must be for the diagnosis, cure, mitigation, treatment or prevention of disease or payments for treatments affecting any structure or function of the body. But any costs for your general health or well-being are nondeductible.

 

Note: Don’t forget to count unreimbursed medical and dental expenses you have paid for your immediate family members, as well as other tax dependents such as an elderly parent or in-law. These extra expenses can push you over the 7.5%-of-AGI mark for the year or boost an existing deduction.

 

Estimated Tax Payments

The IRS requires you to pay federal income tax through any combination of quarterly installments and tax withholding. Otherwise, it may impose an “estimated tax” penalty.

 

YEAR-END MOVE: No estimated tax penalty is assessed if you meet one of these three “safe harbor” exceptions under the tax law.

 

1. Your annual payments equal at least 90% of your current liability;

 

2. Your annual payments equal at least 100% of the prior year’s tax liability (110% if your AGI for the prior year exceeded $150,000); or

 

3. You make installment payments under an “annualized income” method. This option may be available to taxpayers who receive most of their income during the holiday season.

 

Note: If you have received unemployment benefits in 2020—for example, if you lost your job due to the COVID-19 pandemic—remember that those benefits are subject to income tax. Factor this into your estimated tax calculations for the year.

 

Miscellaneous

               * Watch out for the alternative minimum tax (AMT). The AMT applies if a separate complex calculation involving “tax preference items” and certain adjustments exceeds your regular tax liability. Have an assessment of your AMT liability made to determine your year-end approach. 

 

* Make home improvements that qualify for mortgage interest deductions as acquisition debt. This includes loans made to substantially improve your principal residence or one other home. Note that the TCJA suspended deductions for home equity debt for 2018 through 2025.

 

* With a Section 529 plan, you can set up an account for a child’s college education that can grow without any current tax erosion. Distributions used to pay for qualified expenses are exempt from tax. Beginning in 2018, the TCJA expanded the use of 529 plans for tuition payments of up to $10,000 a year for a child’s kindergarten, elementary or secondary school education.

 

* Consider the tax impact of a divorce or separation. The TCJA repealed the deduction for alimony expenses for payers and the corresponding inclusion in income for recipients, for divorce and separation agreements executed after 2018. Note that deductions may still be available for pre-2019 agreements that are modified after 2018.

 

* Meet student loan obligations. Under the CARES Act, payment on many student loans was suspended tax-free until September 30 and then through December 31 by an executive order. Barring any further developments, you must resume required payments in 2021. 

 

* If you own property that was damaged in a federal disaster area in 2020, you may qualify for quick casualty loss relief by filing an amended 2019 return. The TCJA suspended the deduction for casualty losses for 2018 through 2025, but retained a current deduction for disaster-area losses.

 

BUSINESS TAX PLANNING

 

Depreciation-Related Deductions

Under current law, a business may benefit from a combination of three depreciation-based tax breaks: (1) The Section 179 deduction, (2) “bonus” depreciation and (3) regular depreciation.

 

YEAR-END MOVE: Place qualified property in service before the end of the year. Typically, a small business can write off most, if not all, of the cost in 2020 as shown below.

 

1. Section 179 deductions: This tax code section allows you to “expense” (i.e., currently deduct) the cost of qualified property placed in service anytime during the year. The maximum annual deduction is phased out on a dollar-for-dollar basis above a specified threshold.

 

The maximum Section 179 allowance has been gradually raised over the last decade since it was doubled to $500,000 in 2010. As shown below, the TCJA increased the amount again in 2018.

 

Tax year	Deduction limit	Phase-out threshold
2010–2015	$500,000	$2 million
2016	$500,000	$2.01 million
2017	$510,000	$2.03 million
2018	$1 million	$2.50 million
2019	$1.02 million	$2.55 million
2020	$1.04 million	$2.59 million

 

However, be aware that the Section 179 deduction cannot exceed the taxable income from all your business activities this year. This could limit your deduction for 2020.

 

2. Bonus depreciation: The TCJA doubled the 50% first-year bonus depreciation deduction to 100% for property placed in service after September 27, 2017 and expanded the definition of qualified property to include used, not just new, property. However, the TCJA gradually phases out bonus depreciation after 2022.

 

3. Regular depreciation: Finally, if there is any remaining acquisition cost, the balance may be deducted over time under the Modified Accelerated Cost Recovery System (MACRS).

 

            Note: The CARES Act fixes a glitch in the TCJA relating to “qualified improvement property” (QIP). Under the new law, QIP is eligible for bonus depreciation, retroactive to 2018. Therefore, your business may choose to file an amended return for the appropriate tax year.

 

Payroll Tax Deferral

               Normally, employers must deposit payroll taxes with the IRS under a schedule based on the size of the company revenue. Most small businesses are on a monthly schedule.  

 

YEAR-END MOVE: Take advantage of a payroll tax deferral break. Under the CARES Act, an employer can defer payment of the 6.2% Social Security tax portion of payroll taxes for the period spanning March 27, 2020, through December 31, 2020.

 

Half of the deferred amount is due at the end of 2021. The employer must pay the other half by the end of 2022. If you choose this approach, make sure you will have the funds needed to meet your company’s obligations in the future. 

 

Note: Don’t confuse the payroll tax deferral with the “payroll tax holiday” for employees created by an executive order in August. The payroll tax deferral discussed above refers to a separate provision in the CARES Act applying to employers.

 

Business Interest

Prior to 2018, business interest was fully deductible. But the TCJA generally limited the deduction for business interest to 30% of adjusted taxable income (ATI). Now the CARES Act raises the deduction to 50% of ATI, but only for 2019 and 2020.

 

YEAR-END MOVE: Determine if you qualify for a special exception. The 50%-of-ATI limit does not apply to a business with average gross receipts of $25 million (indexed for inflation) or less for the three prior years. The threshold for 2020 is $26 million.

 

For these purposes, ATI is defined as your business income without regard to any income, deduction, gain or loss not properly allocable to a business; business interest income and expense; net operating losses (NOLs); the 20% qualified business income (QBI) deduction; and, for tax years beginning before 2022, depreciation, amortization or depletion.

 

Note: If the business interest limit applies, you can carry forward the excess indefinitely until it is exhausted.

 

Employee Retention Credit

               Many small businesses have been unable to continue regular operations during the COVID-19 pandemic. Frequently, they are facing difficult decisions concerning employment of workers.

 

               YEAR-END MOVE: Keep employees on the books, if you can, through the end of 2020. The CARES Act authorizes an employee retention credit (ERC) to offset some of the cost.

              

               The ERC equals 50% of the qualified wages an employer pays to employees after March 12, 2020 and before January 1, 2021. For these purposes, “qualified wages” are limited to the first $10,000 of wages paid to each worker during this time period.

 

               Your business qualifies for the credit if it fully or partially suspended operation during any calendar quarter in 2020 due to government orders relating to the COVID-19 outbreak or if it experienced a significant decline in gross receipts (i.e., gross receipts equal to less than 50% of the gross receipts for the same calendar quarter in 2019).

 

            Note: The Families First Coronavirus Response Act (FFCRA), which followed soon after the CARES Act, also provides a tax credit to certain small businesses that have provided emergency paid leave due to the COVID-19 pandemic. The FFCRA provision initially offsets the Social Security tax component of payroll tax. Any excess credit is refundable.

Bad Debt Deduction

               During this turbulent year, many small businesses are struggling to stay afloat, resulting in large numbers of outstanding receivables and collectibles.

 

               YEAR-END MOVE: Increase your collection activities now. For instance, you may issue a series of dunning letters to debtors asking for payment. Then, if you are still unable to collect the unpaid amount, you can generally write off the debt as a business bad debt in 2020.

 

               Generally, business bad debts are claimed in the year they become worthless. To qualify as a business bad debt, a loan or advance must have been created or acquired in connection with your business operation and result in a loss to the business entity if it cannot be repaid.

 

               Note: Keep detailed records of all your collection activities—including letters, telephone calls, e-mails and efforts of collection agencies—in your files. This documentation can help support your position claiming worthlessness of the debt if the IRS ever challenges the bad debt deduction.

 

Miscellaneous

* Maximize the QBI deduction that is available for pass-through entities and self-employed individuals. Be aware you must observe special rules if you’re in a “specified service trade or business” (SSTB).

 

* If you buy a heavy-duty SUV or van for business, you may claim a first-year Section 179 deduction of up to $25,000. The “luxury car” limits do not apply to certain heavy-duty vehicles.

 

* If you pay year-end bonuses to employees in 2020, the bonuses are generally deductible by your company and taxable to the employees in 2020. A calendar-year company operating on the accrual basis may be able to deduct bonuses paid as late as March 15, 2021, on its 2020 return.

 

* Generally, repairs are currently deductible, while capital improvements must be depreciated over time. Therefore, make minor repairs before 2021 to increase your 2020 deduction.