Two things few people like—2020 and taxes. Here are some year-end tax planning ideas to help prevent you from leaving the IRS a tip this year or in the future.
General charitable donations are only deductible when your total itemized deductions are above the standard deduction. The 2020 standard deduction is $24,800 for married couples filing jointly and $12,400 for singles. Those who are 65 or older get an extra $1,300.
This means a married couple who donated $10,000 to charity but only had total itemized deductions of $24,801 will only receive an extra $1 deduction for their generosity.
Taking advantage of Qualified Charitable Distributions (QCD) or setting up a Donor Advised Fund are great tax planning techniques to maximize your tax benefit for your donations.
Qualified Charitable Distribution
A QCD is only eligible for those over age 70 1/2 and is limited to $100,000 per year, per individual. The check must come from a qualifying account and go directly to a public charity.
These are the types of accounts you can make a QCD from:
- Traditional IRAs
- Inherited IRAs
- SEP IRA (inactive plans only*)
- SIMPLE IRA (inactive plans only*)
*An inactive plan means you are no longer contributing earnings to the account.
This type of charitable donation is a way to use pre-tax dollars to contribute to a cause you are passionate about. It is most beneficial to those who are forced to take a Required Minimum Distribution (RMD) from pre-tax accounts but do not need the full amount.
For example, if someone has an RMD of $100,000 but only needs $90,000 to cover their lifestyle, this is a way to avoid paying tax on $10,000 without needing a high amount of other itemized deductions to receive the benefit.
If you do this, you or your advisor should have a process for recording this. It is not reflected on the tax documents you receive from where your IRA is held. If you provide your CPA with those documents but don’t tell them, they won’t know you made a QCD, and you will not receive the deduction.
A donor-advised fund is an account that you can contribute money to, receive the tax deduction for that current year, and distribute the funds to charities in the future.
Why would someone contribute to a donor-advised fund over just sending the checks directly?
You would do it because the tax deduction is worth more to you in the current year than it will be in future years.
Picture a doctor who is retiring next year. If you are in the 35% bracket while still working but will be in the 22% bracket in your retired years, that deduction is worth an extra 13% when taken now.
In this case, for someone who typically gives away $10,000 per year, they could save $13,000 by pulling forward 10 years of donations to the current year. A little tax planning can go a long way.
Tax-loss harvesting is a technique that involves selling an investment in a non-qualified account that is (unfortunately) worth less than you paid for it, then using the proceeds to invest in something else.
By doing so, you get a tax deduction while staying invested. The maximum total loss you can use for the current year is $3,000. The rest is carried forward for use in future years.
If you are a married couple filing taxes jointly and will have taxable income (after deductions) under $80,000 ($40,000 for singles), you don’t owe taxes on capital gains.
Tax-gain harvesting can work particularly well for a resident or a physician who recently retired. Unlike tax-loss harvesting, there is no wash sale rule for tax gain-harvesting. You can sell an investment one day and buy the same investment the next and still get the benefit.
As rates currently stand today, executing this tax planning strategy could save your future self a 15-20% tax on those earnings.
A Roth Conversion is a transaction that converts pre-tax money to after-tax Roth money in exchange for paying taxes now rather than in the future.
You may want to do a Roth conversion if you believe your current tax rate is lower than it will be when you need or are forced to pay taxes on that pool of money in the future. This is another good idea for some residents and recently retired physicians under age 72.
If this sounds like it could work for you, it’s important to zoom out and evaluate the big picture.
A resident pursuing Public Service Loan Forgiveness (PSLF) may not want to do a Roth conversion because their loans are on an income-driven repayment plan. The way to maximize PSLF is by keeping your Adjusted Gross Income as low as possible.
Backdoor Roth IRAs
A Backdoor Roth IRA contribution is an advanced retirement saving transaction for high income super savers. It is a way for high income individuals to contribute to a Roth IRA when their income is above the IRS limit.
It involves making a non-deductible contribution to a Traditional IRA, then rolling over the funds to a Roth IRA. In most cases, it only makes sense if you have already maxed out your employer plan since many allow you to contribute on a Roth basis in a much less complicated way.
There are prerequisites and IRS forms to file to complete this transaction properly. You cannot already have a funded Traditional IRA and must file IRS Form 8606 for documentation.
It would be wise to consult a tax professional if you want to take advantage of a Backdoor Roth IRA, but are not comfortable doing it alone.
Student Loan Interest Deduction
Calling all residents and fellows—are you missing out on the student loan interest deduction because your taxable income is just a little too high?
Married couples with Modified Adjusted Gross Income under $140,000 ($70,000 for Singles) can deduct up to $2,500 of student loan interest and a limited amount up to $170,000 ($85,000 for Singles).
Could you contribute more to a pre-tax account or create tax losses to keep your income under the threshold?
Do not forget about state income taxes when tax planning. Many states offer state income tax deductions for contributing to a 529 plan.
Married residents of PA can deduct up to $30,000 per year ($15,000 for singles), per beneficiary. With the PA state income tax rate at 3.07%, that means you get $307 back for every $10,000 you contribute.
A recently added benefit to 529 plans is you can use up to $10,000 for student loan repayment. This has some parents opening 529 plans for themselves.
Since 2015, I have helped return nearly $10,000 to clients of our practice by finding these common errors missed by CPAs and DIY tax filers:
- Forgotten 529 deduction
- Including IRA gains as taxable
- Missed Foreign Tax Credit
- Not recording charitable donations
These types of mistakes are easy to make. Having a second set of eyes on things like this can be beneficial.
This post is not meant to be interpreted as personal tax advice. You should consult a professional or conduct a thorough review of what applies to your situation before executing any of these strategies.
Allegheny Financial Group is a Registered Investment Advisor.
Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.