Here are a few tax planning items you’ll want to consider as we head towards the end of the year. I recommend you discuss any or all of these with your tax advisor prior to execution.
Stimulus payments and child tax credit
If you didn’t qualify for the 3rd round of stimulus payments because your 2020 income was too high (adjusted gross income (AGI) over $75k – $80k for single filers or $150k – $160k for joint filers) and you’re close to the cutoff for 2021, then consider taking action now to lower your 2021 AGI. You can use pre-tax (i.e. Traditional) 401k, IRA, or HSA contributions. You can also harvest capital losses (see below). Business owners can adjust the timing of deductions or income. You can’t use personal deductions or Roth 401k/IRA contributions as these don’t effect AGI. For a married couple with two kids, the difference between $150,000 to $160,000 of income could mean over $5,600 of lost stimulus benefits. That’s a huge marginal tax rate for that $10,000 income band. The new child tax credit amounts could also come into play as well.
Harvest tax losses
If you have any significant unrealized capital losses, then consider harvesting them. You can offset $3,000 of ordinary income with capital losses from investments and carryover the remainder to future tax years. You’ll need to consider the rule around “wash sales”, which basically say if you sell a security for a loss, you can’t repurchase a substantially identical security within 30 days, or else the loss is disallowed.
However, if you invest using passive index funds (which I highly recommend), you can generally get around this rule. For example, if you own the Vanguard Total Stock Market ETF (VTI), you could sell it and immediately purchase the iShares Core S&P Total U.S. Stock Market ETF (ITOT) or vice versa. Both investments have similar profiles, so you can keep your tax loss without having to forgo 30 days of market exposure.
Charitable donations
If you’re over age 70.5, consider donating from your IRA using a qualified charitable distribution (QCD). You can donate up to $100,000 per year using this method. QCD’s can also be credited against your required minimum distributions (RMD) if you have one. One pitfall to be aware of… most custodians don’t make any special note of the QCD on the Form 1099 so it’s very important to communicate with your tax preparer so they can make the necessary adjustments on your tax return next spring. The last thing you want is to have to pay tax on your charitable donation.
If you’re one of the 85%+ of taxpayers who don’t itemize deductions, you can still deduct modest cash donations ($300 for single, $600 for joint). It’s also a good idea to consider stacking donations into every other year. For example you can make a donation on January 1 and then another one on December 31 of the same year, then skip the next year entirely. Your charity essentially gets the same annual contribution, but perhaps it’s possible that you can itemize your deductions in the “stack” year, and then revert back to claiming the standard deduction in the off years. You can also use a donor advised fund (DAF) to stack multiple years (say perhaps 5 or more) of contributions into one tax year to take advantage of itemizing deductions. Then you can disburse the funds over time and they can grow in the meantime.
If you itemize deductions but can’t do a QCD, then consider giving appreciated securities instead of cash. Any capital gains tied to donated securities are erased for tax purposes, and you still get a deduction. You can then use cash you would have donated to buy the same security at current market values. There are some differences on how much of your income you can offset with cash donations vs appreciated securities, so talk to your advisor about those before deciding.
Roth Conversions
The last item to consider is a Roth IRA conversion. Don’t bother with a conversion if you’re trying to qualify for the stimulus payment by reducing you’re AGI. If you’re in a low tax bracket due to a job change, retirement, or something else, then a conversion could make sense, but each situation requires careful consideration. If you work with an advisor, then ask for an analysis. Otherwise, you can use one of the many Roth conversion calculators available on the web.
