Tax considerations affect virtually all areas of a financial plan, including retirement, education, investment planning, insurance planning, and estate planning. Learn some tax planning tools to maximize the value of your resources for YOUR goals.
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Understanding the breakdown of your pay stub will help you better understand your tax withholding and optimize your savings. So here is a breakdown of the major items in your paystub, from your gross pay to your take home income. Everyone is different, so little differences may apply to you.
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As we approach the year-end and get ready for the holidays, let’s consider doing some tax planning for 2020 and beyond. This year, we break our discussion of year-end tax planning into two parts. We cover some business tax planning tools in this post, and continue with individual tax planning in the next post.
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End of summer is a great time to review your paycheck against the taxes you may owe the IRS for the year. One very useful tool on the IRS site is their Withholding Estimator. If you are a W-2 employee, I suggest you use it now to estimate your tax liability and see if you are with your taxes for the year. Don’t wait.
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Looking for inspiration to kickstart 2021? Check out the top 10 list of what our readers liked the most in 2020. Our most-read posts dealt with tax-efficient strategies, Coronavirus uncertainty, goals-based investing, employee equity compensation, early retirement, and medicare planning. Not surprising given the uncertainty we experienced in 2020. The best way to cope with uncertainty is to set goals, have a plan, and make the most out of your resources. Our number one post was about breaking down your paystub to know where your gross income is going. If you are looking for ideas that will open your eyes to your finances, check out our winners!
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This post shows you how important having the right withdrawal strategy can be, and uses an example to illustrate how to find opportunities for efficient withdrawals.
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We encourage business owners to check out the SBA COVID-19 relief page. In response to the Coronavirus (COVID-19) pandemic, small business owners in all U.S. states, Washington D.C., and territories are eligible to apply for an Economic Injury Disaster Loan advance of up to $10,000.
The SBA’s Economic Injury Disaster Loan program provides small businesses with working capital loans of up to $2 million that can provide vital economic support to small businesses to help overcome the temporary loss of revenue they are experiencing. The loan advance will provide economic relief to businesses that are currently experiencing a temporary loss of revenue. Funds will be made available within three days of a successful application, and this loan advance will not have to be repaid.
Here is an instructional video for how to apply. You can find the complete application here.
Until Next Time!
Massi De Santis is an Austin, TX fee-only financial planner. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.
The CARES Act is an economic relief plan for individuals and businesses of unprecedented size, totaling about $2 trillion. As a comparison, the 2019 US GDP was about 21 Trillion. The Act is very broad and includes many different programs aimed at reaching broad sections of the economy. Our goal is simply to inform readers and clients of parts of the Act that may affect their financial plans, not to dig deep. This commentary should not be viewed as tax advice. Consult with your advisor or tax professional, or schedule a call with us if you think any of the items we discuss may impact you, or want to learn more.
This is the item that has garnered the most attention. Taxpayers may receive tax rebates up to $1,200 for single filers and up to $2,400 for married filing jointly. The credit amount is further increased by up to $500 for each child under the age of 17. The rebates are phased out according to the following schedule.
The Tax Foundation estimates that over 90% of filers will get a rebate, and nearly all filers below the 80th percentile of income.
If you have not filed for 2019, consider filing now if your 2019 income is lower than 2018. Otherwise you can decide to wait until July 15. The tax rebate will be based on the latest income tax return that you filed (2018 or 2019). A lower income may give you a higher rebate. The final rebate amount will depend on 2020 income (with tax returns filed in 2021). Taxpayers who receive a smaller rebate than they are eligible for based on 2020 income will receive the difference after filing a 2020 tax return, but overpayments of rebates due to a higher income in 2020 will not be clawed back.
The act relaxes requirements for qualified distributions under employer sponsored plans and IRA accounts. Up to $100,000 can be withdrawn in total across such plans by someone affected by the Coronavirus. The withdrawals will be:
The act also relaxes some of the constraints on loans from retirement plans. Loan amounts are increased to $100K and 100% of the vested amount can be withdrawn.
Student loan payments on federal student loans are deferred until Sept 30, 2020. Over the six months, no interest is accrued on the loans. You have to proactively suspend the payments. So, if you have a federal student loan, call your provider to suspend them. If you think you may qualify for student loan forgiveness, you may want to suspend the payments in case the loan is forgiven in the future.
The act also contains a special provision that allows payments of student loans by employers to be excluded by taxable income, up to the $5,250 amount typically allocated to employer educational assistance programs. If your employer has an educational assistance program, ask them if they are willing to include student loan repayments for you this year.
The act contains a number of programs to help small businesses affected by the coronavirus. Here is a rundown. Check the SBA website for details and to apply. The criteria are intentionally broad, so if you are a small business affected by COVID-19, chances are there is a program for you. One catch is to apply early, as some of these may be on a first-come first-served basis. Check out our instructional video to apply for a disaster relief loan on the SBA website.
Small businesses may take out loans to help pay for payroll costs, health insurance premiums, rent, mortgage interest, and other costs. A portion or all of the loan may be forgiven if used in the first eight weeks on eligible expenses. In addition, the maximum interest rate that can be charged for a loan made under this program is 4% and the term of the loans can be up to 10 years. That can be a good rate for many small businesses. Finally, payments on these loans can be deferred for six months.
The SBA has additional programs to help small businesses, so we encourage you to check them out.
Employers whose activity was partially or completely suspended may be eligible for a payroll tax credit. The credit is equal to 50% of wages paid to each employee, up to a maximum of $10,000 of wages per employee, subject to caveats.
In addition, according to the Act, employers are able to defer payroll taxes through the end of 2020, until the end of 2021 and 2022. Specifically, 50% of the payroll taxes that would otherwise be due throughout 2020 can be deferred until December 31, 2021. The remaining 50% is due on December 31, 2022.
The CARES Act allows NOL from 2018, 2019, or 2020 to be carried back up to five years. This should allow companies to reduce prior years’ tax bills, allowing them to claim refunds of amounts previously paid to provide further liquidity to get them through the COVID-19 crisis. The law allows for up to 100% of taxable income to be offset for 2018, 2019, and 2020.
The Act eliminates any RMD that needs to be taken in 2020. If you have taken your RMD within 60 days, you can roll it over to your retirement account by the end of the 60 days window.
Charitable contributions may drop during this crisis period. To reduce this drop, the Act introduces a new above-the-line deduction (directly reduces your adjusted gross income or AGI) of $300 for charitable contributions. In addition, the AGI limit for cash contributions (currently limited at 60% of a taxfiler’s AGI) is raised to 100%.
The Act gives a substantial boost to unemployment benefits. The first week of unemployment is now covered. In addition, there is a boost to the benefits of $600 a week, and a 13 week extension beyond the normal duration determined at the state level (26 weeks in Texas).
Overall, the CARES Act addresses a number of key issues that individuals and businesses are facing right now as a result of COVID-19, so it is a welcome development. Take a look at the list and the links provided, and consult your tax professional or financial advisor to learn more. Act quickly, as some of these programs have time limits or are on a first-come-first-serve basis.
Until Next Time!
Massi De Santis is an Austin, TX fee-only financial planner. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.
Tax considerations affect virtually all areas of a comprehensive financial plan. Optimal choices in retirement planning, education planning, investment planning, risk management, insurance planning, and estate planning all need to consider taxation. In this post we review the use of some tax planning tools, including tax-loss harvesting, retirement accounts, 529 plans, charitable donations and distributions, depreciation of capital investments, and others.
All information in this post is provided for illustrative and educational purposes only and should not be considered tax or investment advice, or a recommendation to buy or sell any type of securities.
As the year is coming to its end and you start setting up holiday decorations, we know you may be thinking about the close of the 2019 tax year (just don’t do it while you are on a ladder with Christmas lights). You’d like to find ways to keep more of your hard earned money. We hear you, and we have a few ideas to share. As always though, we challenge you to think beyond today or this year. Good tax planning is a key component of a comprehensive financial plan, and should therefore take a long view. Much larger gains can be achieved by taking consistent tax planning actions every year than trying to find an additional deduction this year. Some of our suggestions may not result in a reduction of 2019 taxable income, or may not apply to you, but acting today in some of these areas can mean reducing your taxable income for years to come: when retiring, when paying for college expenses, or when transferring wealth to your loved ones or your favorite charity. Talk to us or your tax professional if you want to know more about tax planning.
When you look across your investments, chances are some have increased in value while others have lost value, relative to the initial cost of the investments (or cost basis). In a taxable account, selling investments that have lost value can help you reduce your taxable income. Why would you need to sell? Maybe you need liquidity for planned expenses, or are revising your asset allocation. Selling only appreciated assets will generate capital gains, and a tax liability. You can use losers to reduce that tax liability or even turn it into a deduction against ordinary income. Once you netted your realized gains and losses, you can use up to $3,000 in losses to reduce your taxable income this year. If your loss is greater than $3,000 you can carry the additional amount to future tax years, indefinitely, until the entire loss is used up.
Review your asset allocation, and for each investment with losses ask: Do I need this investment in my portfolio? Even if the answer is yes, you can still harvest the loss if there is a close substitute. The simplest example is index funds. You can sell an index fund from manager A that has experienced losses and buy a fund that tracks the same index from manager B. Your asset allocation hasn’t changed, but your taxable income is. You have realized a loss from a tax perspective but not from an investment perspective. Notice since losses can occur any time of the year, there is no reason to wait until year-end, like many investors or advisors do. You or your advisor can harvest losses this way throughout the year.
Besides reducing your modified adjusted gross income (MAGI), capital gains can also reduce your investment income. For example, capital gains are included in the calculation of investment income to which the 3.8% Medicare surtax is applied. This surtax affects households with income above the thresholds defined here.
In a year when you have a lower taxable income, it may be a good time to harvest your gains, not just losses. Capital gains tax rates depend on income. Suppose your income is below the 0% capital gains tax rate ($78,000 for married filing jointly), then it may make sense to sell your appreciated investments this year since you have no tax liability. If your investment has a close substitute, like funds A and B above, then you can reduce your future tax liability.
Start by making sure you have contributed to your 401(k) or similar plan to take advantage of the employer match. Contributing any amount up to the $19,000 limit (plus an additional $6,000 if you are 50 or older) will lower your adjusted gross income. Don’t just focus on reducing your taxable income this year though. If you are in a low income bracket and can contribute to a Roth IRA, consider doing so. In a Roth account, you contribute after tax money, and your savings is never taxed again. If you are in a low tax bracket, consider contributing to a Roth. Your tax rates may go up in the future, either because the 2017 Tax Cut and Jobs Act (TCJA) ends or because you will make more money, and having tax-free savings in a Roth account can help you generate greater wealth in retirement.
If you have a health savings account or HSA, a great tax saving strategy is to fully fund the account for the year. You can contribute up to $3,500 (single) or $7,000 (family) of pre-tax money. Contributions to an HSA are free of federal income tax and social security and medicare taxes. In previous posts, we have talked about how the HSA can be a key element of a retirement plan. If you are enrolled in a high deductible plan that meets HSA requirements, you can open an HSA whether or not your employer offers one. In addition, regardless of when you become eligible for the HSA in the year (as late as December 1) you are eligible for the entire year, so you can make the full yearly contribution to it. Fully funding your HSA is a great way to lower your taxable income and get ahead on your retirement plan.
We suggested contributing to a Roth account if you are in lower tax brackets. Doing so will reduce future taxation and help you keep more of your growing investments. On the other hand, contributing to a traditional IRA can help you lower your taxable income this year, which may be useful for people in higher income brackets. Everyone with earned income can contribute to an IRA. If you don’t have earned income but your spouse does, you can still contribute to an IRA. Your contribution is fully deductible if you are not an active participant in an employer plan, like a 401(k). If you are an active participant, part of the contribution may be taxable. In that case, it is better to only contribute the deductible portion to a traditional IRA and the taxable part to a Roth IRA. After tax contributions are always better in a Roth account than in a traditional IRA. The combined IRA (traditional + Roth) for 2019 is $6,000 plus an additional $1,000 if you are 50 or older.
Roth contributions are phased out at higher levels of income, so all you have left may be a taxable traditional IRA contribution. Making the contribution can still save you on future taxes, because your money grows tax-deferred in the account. But there is something else you can do: use the traditional IRA and then convert that non-deductible contribution to a Roth IRA. When you convert an IRA to a Roth IRA, you pay taxes on any amount that is converted that is above your basis. If you have other IRA accounts, your basis must be calculated using a pro-rata formula. All IRA accounts are aggregated and your conversion will be part non-deductible and part deductible (if you have deductible contributions in your IRAs), so you may have a taxable event when you convert. The upside is that that money will never be taxed again!
As an estate planning strategy, 529 plans are a great way to use your annual exclusion to pass your wealth out to loved ones without gift or estate tax consequences. Using the annual gift exemption, you can donate up to $15,000 (if single) or $30,000 (if married) per individual recipient. As a parent who is planning to send their kids to college, 529 contributions allow you to take advantage of tax exempt growth and future withdrawals for qualified expenses. So while not a tax reduction today, a tax reduction in the future for acting today.
A donation to a qualified charity can reduce your taxable income as an itemized deduction. But it can help you in other ways too. For example, consider donating appreciated investments instead of cash. Say you want to donate $20,000 to a charity and are on the 15% capital gain tax bracket. You need more than $20,000 to raise $20,000 in cash with appreciated assets. For example, if you have $10,000 in capital gains, you have a tax liability of $1,500. By donating directly, you save the $1,500, and since charitable institutions do not pay taxes on appreciated property, the charity gets the full $20,000 value. Your investment custodian can help you donate your investments. See, for example, the various ways you can do it with Betterment. There is a limit on donating appreciated property, typically 30% of your AGI.
If you turn 70 and ½ or older in 2019 and have traditional IRAs, there is one more way to benefit from charitable donations. Consider donating part or all of your required minimum distribution (RMD) from an IRA. Such distributions (QCDs) can be made directly to charities from the IRA and the amount of the contribution directly reduces your adjusted gross income (AGI). Reducing your AGI reduces your taxable income and can reduce the taxability of your Social Security benefits.
Business owners should consider making a planned capital investment in 2019. If you have been planning to purchase depreciable property in the near future, consider whether it is worth making the purchase before the end of the year. Section 179 of the tax code allows a deduction of up to $1,020,000 of the cost of certain property placed into service in 2019 as an expense, with phase out at $2,550,000. After you apply section 179, the tax code allows for an additional special deduction called bonus depreciation, before you apply regular depreciation to the remaining amount, if any. The Tax Cut and Jobs Act (TCJA) increased the bonus depreciation percentage temporarily to 100 percent for qualified property acquired and placed in service after Sept 27, 2017, and before Jan 1, 2023.
There are limits on section 179 and bonus depreciation for passenger vehicles and heavy SUV. Heavy is defined as having a manufacturer weight rating of more than 6,000 pounds. For passenger vehicles (with a weight rating of less than 6,000 pounds) placed into service in 2019, the greatest allowable depreciation schedule is $10,000, $16,000, $9,600, $5,760, for years 1, 2, 3, 4 and after, respectively. If claiming the special depreciation, the first year depreciation can be $18,000. For heavy SUVs, section 179 is limited at $25,000, but the 100% bonus depreciation applies in full for vehicles purchased and placed in service in 2019.
We are not saying you should make capital expenditures or buy an SUV for your business for the sake of getting the deductions. What we are saying is that together, section 179 and special depreciation create an incentive to make planned investments.
Because of the higher standard deduction contained in the TCJA and the new limits on state income taxes, more people are opting for standard deductions. But if you have planned itemized expenses, consider bunching them together. For example make a multi-year charitable donation this year. Or consider pre-paying for deductible expenses that you know you will incur in 2020, such as medical expenses. If you have planned any surgery or larger medical expense for 2020, consider paying before the end of 2019.
When it comes to taxes, no one likes bad surprises, like having to pay more than they were expecting. Consider doing a tax projection, and adjust your tax withholding for the rest of the year. This will allow you to reduce or eliminate the chance of an underpayment penalty. The IRS hosts a withholding estimator here. Use the YTD section of your last paystub to help you go through the questions. The more questions you can answer the more precise the estimate. At the end of the process, the estimator will suggest the number of allowances to claim on your W4 form to get on track.
We tried to list some of the more common items that can have a larger impact on your taxes throughout your life. Not all of these may apply to you, and the ones that do may not lead to a tax saving this year, like a Roth contribution. But you should see tax planning as helping you keep more of what you earn throughout your life not just this year. Finally, a warning. The tax code is complex and each situation is unique. Make sure you consult with a tax professional to see if and how any of these ideas apply to your situation.
Until next time!
Massi De Santis is an Austin, TX fee-only financial planner. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.
