TAX PLANNING GUIDE year-round strategies to make the tax laws work for you

2020 2021 Tax planning in unprecedented times

t has become a cliché in 2020, but what word other than “unprecedented” can be used to describe the events we’ve experienced this year? During such times, tax planning is far from I top of mind. But it’s still important. Smart tax planning can soften the impact of an uncertain economy and provide much-needed relief to owners of struggling businesses.

To take advantage of all available breaks, you need to be aware of some major changes under this year’s Coronavirus Aid, Relief and Economic Security (CARES) Act and last year’s Setting Every Community Up for Retirement Enhancement (SECURE) Act. You also can’t forget about the massive Tax Cuts and Jobs Act (TCJA) that generally went into effect two years ago but still impacts tax planning. Plus, it’s possible that there could be more tax law changes before year end — or that the potential for changes next year could affect 2020 planning.

This guide provides an overview of some of the most significant tax law changes going into effect this year and other key tax provisions you need to be aware of. It offers a variety of strategies for minimizing your taxes in the current tax environment. Use it to work closely with your tax advisor to identify the best strategies for your particular situation. He or she also can keep you apprised of any new tax law developments that might affect you.

Contents Income & Deductions...... 2 Executive Compensation...... 6 Investing...... 8 Real Estate...... 12 Business Ownership...... 14 Charitable Giving...... 16 Family & Education...... 18 Retirement...... 20 Estate Planning...... 22 Tax Rates...... 24 2 Income & Deductions

Control the timing of income and deductions to your tax advantage

ax rates on “ordinary income” y U.S. Treasury bill income, and Suspension of miscellaneous itemized are higher than those that deductions subject to the 2% floor. y Retirement plan distributions, to T apply to much of your This deduction for expenses such as the extent they won’t be subject investment income. Ordinary income certain professional fees, investment to early-withdrawal penalties and generally includes salary, income from expenses and unreimbursed employee aren’t required. (See page 20.) self-employment or business activities, business expenses is suspended through interest, and distributions from tax- 2025. While this eliminates the home Some expenses with potentially deferred retirement accounts. Some of office deduction for employees who controllable timing are mortgage it may also be subject to payroll tax, work from home (even if your employer interest, investment interest expense or you may have to pay the alternative has required it during the pandemic), and charitable contributions. minimum tax (AMT), under which if you’re self-employed, you may still be different tax rates apply. This is why able to deduct home office expenses. careful planning for ordinary income Impact of the TCJA (See page 12.) and deductible expenses continues to on timing strategies be important. The TCJA has made timing income More-restricted personal casualty and and deductions more challenging theft loss deduction. Through 2025, this Timing income and expenses because some strategies that tax- itemized deduction is suspended except Smart timing of income and expenses payers used to implement no longer if the loss was due to an event officially can reduce your tax liability, and poor are making sense. Here’s a look and declared a disaster by the President. timing can unnecessarily increase it. some significant changes that have When you don’t expect to be subject affected deductions: Increased standard deduction. The to the AMT (see page 3) in the current TCJA nearly doubled the standard year or the next year, deferring income to Reduced deduction for state and deduction. While many higher-income the next year and accelerating deductible local tax. Property tax used to be a taxpayers will still benefit from itemiz- expenses into the current year may be popular expense to time. But with the ing, some — such as those in low-tax a good idea. Why? Because it will defer TCJA’s limit on the state and local states, who don’t have mortgages or tax, which usually is beneficial. tax deduction, property tax timing who aren’t charitably inclined — may will likely provide little, if any, benefit now save more tax by claiming the But when you expect to be in a higher for higher-income taxpayers. (See standard deduction. (See Chart 1 for tax bracket next year — or you expect Case Study 1 at right.) If you reside the 2020 standard deduction amounts.) tax rates to rise — the opposite approach in a state with no, or low, income tax, may be beneficial: Accelerating income this change might be less relevant. Tax-advantaged will allow more income to be taxed at But keep in mind that deducting sales saving for health care tax instead of income tax may be your current year’s lower rate. And defer- If medical expenses not paid via beneficial, especially if you purchased ring expenses will make the deductions tax-advantaged accounts or reimburs- a major item, such as a car or boat. more valuable, because deductions save able by insurance exceed a certain more tax when you’re subject to a higher tax rate. CHART 1 2020 standard deduction Whatever the reason behind your desire to time income and expenses, Filing status Standard deduction1 you may be able to control the timing Singles and separate filers $12,400 of these income items: Heads of households $18,650 y Bonuses, Joint filers $24,800 1  Taxpayers age 65 or older or blind can claim an additional standard deduction: $1,300 if married, y Consulting or other self-employment $1,650 if unmarried. income, Income & Deductions 3

FSA. You can redirect pretax income CASE Factor state and local tax to an employer-sponsored Flexible STUDY 1 deduction limits into timing strategies Spending Account up to an employer- determined limit — not to exceed $2,750 Last year, Justin earned a promotion along with a significant salary increase and in 2020. The plan pays or reimburses you bonus, and his state income tax liability increased accordingly. When he filed for qualified medical expenses. What his 2019 tax return, he was surprised to find that he could no longer deduct all of his state and local income and property taxes. This meant that prepaying his you don’t use by the plan year’s end, you 2019 property tax bill due in early 2020 hadn’t helped him. He’d always done his generally lose — though your plan might income taxes himself, but he decided it was time to consult a tax professional. allow you to roll over up to $550 to 2021. Or it might give you a 2½-month grace She told Justin that, through 2025, under the TCJA, his entire itemized deduction period to incur expenses to use up the for state and local taxes — including property tax and either income or sales previous year’s contribution. In response tax — is limited to $10,000 ($5,000 for married taxpayers filing separately). The to the COVID-19 crisis, the IRS has downside of Justin’s raise and bonus was temporarily made FSAs a little more flex- that his 2019 state and local tax liability ible. Contact your employer for details. exceeded $10,000, so a portion of this If you have an HSA, your FSA is limited liability was no longer deductible. to funding certain permitted expenses. The tax advisor went on to explain that the limit significantly impacts higher-income Smaller AMT threat taxpayers with large state and local income The top AMT rate is 28%, compared tax and/or large property tax bills. She to the top regular ordinary-income tax advised that Justin take this into account in rate of 37%. But the AMT rate typically his income and deduction timing strategies applies to a higher taxable income base. going forward. You must pay the AMT if your AMT liability exceeds your regular tax liability. percentage of your adjusted gross If one spouse has high medical The TCJA substantially increases the income (AGI), you can claim an expenses and a relatively lower AMT exemptions through 2025. (See itemized deduction for the amount AGI, filing separately may allow Chart 8 on page 24.) This means fewer exceeding that “floor.” This floor that spouse to exceed the AGI floor taxpayers will have to pay the AMT. In can be difficult for higher-income and deduct some medical expenses addition, deductions used to calculate taxpayers to exceed. that wouldn’t be deductible if the regular tax that aren’t allowed under the couple filed jointly. Warning: Because AMT can trigger AMT liability, and The TCJA had reduced the floor from the AMT exemption for separate there aren’t as many differences between 10% to 7.5% for 2017 and 2018, and returns is considerably lower than what’s deductible for AMT purposes last year the 7.5% floor was extended the exemption for joint returns, filing and regular tax purposes. (See Chart 2 to 2019 and 2020. But it will return to separately to exceed the floor could on page 4.) This also reduces AMT risk. 10% for 2021 unless Congress extends trigger the AMT. However, AMT will remain a threat for the lower floor again. (Check with your some higher-income taxpayers. tax advisor for the latest information.) You may be able to save taxes without having to worry about the medical So before timing your income and Eligible expenses may include expense deduction floor by contributing expenses, determine whether you’re health insurance premiums, to one of these accounts: already likely to be subject to the long-term-care insurance premiums AMT — or whether the actions (limits apply), medical and dental HSA. If you’re covered by a qualified you’re considering might trigger it. services, and prescription drugs. high deductible health plan, you In addition to deduction differences, Mileage driven for health care pur- can contribute pretax income to an some income items might trigger or poses also can be deducted — at 17 employer-sponsored Health Savings increase AMT liability: cents per mile for 2020. Account — or make deductible contributions to an HSA you set up y Long-term capital gains and qualified Consider bunching elective medical yourself — up to $3,550 for self-only dividend income, procedures (and any other services and coverage and $7,100 for family y Accelerated depreciation adjustments purchases whose timing you can control coverage for 2020 (plus $1,000 if and related gain or loss differences without negatively affecting your or you’re age 55 or older). HSAs can when assets are sold, and your family’s health) into alternating bear interest or be invested, growing years if it would help you exceed the tax-deferred similar to an IRA. y Tax-exempt interest on certain applicable floor and you’d have enough Withdrawals for qualified medical private-activity municipal bonds. total itemized deductions to benefit expenses are tax-free, and you can (For an exception, see the warning from itemizing. carry over a balance from year to year. on page 11.) 4 Income & Deductions

Finally, in certain situations exercising incentive stock options (ISOs) can CHART 2 What itemized deductions are trigger significant AMT liability. (See also deductible for AMT purposes? the warning at the top of page 7.) Expense Regular tax AMT For more information Avoiding or reducing AMT See “Impact of the TCJA on State and local income tax n With proper planning, you may be timing strategies” on page 2. able to avoid the AMT, reduce its See “Home-related Property tax n impact or even take advantage of its deductions” on page 12. lower maximum rate: See “Home-related Mortgage interest n n deductions” on page 12. If you could be subject to the AMT Interest on home equity debt See “Home-related this year … consider accelerating used to improve your principal n n deductions” on page 12. income into this year, which may residence or second residence allow you to benefit from the lower See Case Study 5 on Investment interest n n maximum AMT rate. And deferring page 11. expenses you can’t deduct for AMT See “Tax-advantaged saving Medical expenses n n purposes may allow you to preserve for health care” on page 2. those deductions (but watch out for the annual limit on the state and Charitable contributions n n See page 16. local tax deduction). If you also defer expenses you can deduct for more per biweekly pay period aren’t Additional 0.9% Medicare tax AMT purposes, the deductions may eligible. As of this writing, there Another payroll tax that higher- become more valuable because of are many open questions about the income taxpayers must be aware of the higher maximum regular tax deferral. Contact your tax advisor is the additional 0.9% Medicare tax. rate. Finally, carefully consider the for the latest information. It applies to FICA wages and net tax consequences of exercising ISOs. self-employment income exceeding Self-employment taxes $200,000 per year ($250,000 if married If you could be subject to the AMT If you’re self-employed, you pay filing jointly and $125,000 if married next year … consider taking the both the employee and employer filing separately). opposite approach. For instance, defer portions of payroll taxes on your income to next year, because you’ll self-employment income. The If your wages or self-employment likely pay a relatively lower AMT employer portion (6.2% for Social income varies significantly from year rate. Also, before year end consider Security tax and 1.45% for Medicare to year or you’re nearing the threshold selling any private-activity municipal tax) is deductible above the line. for triggering the additional Medicare bonds whose interest could be subject You also may be eligible for some tax, income timing strategies may help to the AMT. COVID-19 payroll tax relief. (See you avoid or minimize it. For example, “What’s new!” at right.) if you’re an employee, perhaps you Also be aware that, in certain circum- can time when you receive a bonus stances, you may be entitled to an As a self-employed taxpayer, you may or exercise stock options. If you’re AMT credit. benefit from other above-the-line self-employed, you may have flexibility deductions as well. You can deduct on when you purchase new equipment Payroll taxes 100% of health insurance costs or invoice customers. If you’re an In addition to income tax, you must for yourself, your spouse and your S corporation shareholder-employee, pay Social Security and Medicare dependents, up to your net self- you might save tax by adjusting how taxes on earned income, such as employment income. You also can much you receive as salary vs. distribu- salary and bonuses. The 12.4% Social deduct contributions to a retirement tions. (See “Owner-employees” at right.) Security tax applies only up to the plan and, if you’re eligible, an HSA Social Security wage base of $137,700 for yourself. And you might be able Also consider the withholding rules. for 2020. All earned income is subject to deduct home office expenses. (See Employers must withhold the addi- to the 2.9% Medicare tax. Both page 12.) Above-the-line deductions tional tax beginning in the pay period taxes are split equally between the are particularly valuable because when wages exceed $200,000 for the employee and the employer. they reduce your AGI and, depend- calendar year — without regard to an ing on the specific deduction, your employee’s filing status or income from Also, an Aug. 8 presidential mem- modified AGI (MAGI), which are other sources. So your employer might orandum offers a deferral of the the triggers for certain additional withhold the tax even if you aren’t liable employee share of Social Security taxes and the phaseouts of many for it — or it might not withhold the tax taxes, but those earning $4,000 or tax breaks. even though you are liable for it. Income & Deductions 5

If you don’t owe the tax but your the income isn’t distributed to you. C corporations. Only income you employer is withholding it, you can But such income may not be subject receive as salary is subject to payroll claim a credit on your 2020 income tax to self-employment taxes if you’re a taxes and, if applicable, the 0.9% return. If you do owe the tax but your limited partner or the LLC member Medicare tax. Nonetheless, you may employer isn’t withholding it, consider equivalent. Check with your tax prefer to take more income as salary filing a W-4 form to request additional advisor on whether the additional 0.9% (which is deductible at the corporate income tax withholding, which can be Medicare tax on earned income or the level) as opposed to dividends (which used to cover the shortfall and avoid 3.8% NIIT (see page 11) will apply. aren’t deductible at the corporate level interest and penalties. Or you can yet are still taxed at the shareholder make estimated tax payments. S corporations. Only income you level and could be subject to the 3.8% receive as salary is subject to payroll NIIT) if the overall tax paid by both Owner-employees taxes and, if applicable, the 0.9% the corporation and you would be less. There are special considerations if Medicare tax. To reduce these taxes, you’re a business owner who also you may want to keep your salary Warning: The IRS scrutinizes corporate works in the business, depending on relatively — but not unreasonably — payments to shareholder-employees its structure: low and increase the income that is for possible misclassification, so tread taxed to you through your Schedule K-1 carefully. Partnerships and limited liability by virtue of your share of the earnings companies. Generally, all trade or from the business. That income isn’t Estimated payments business income that flows through to subject to the corporate level tax or and withholding you for income tax purposes is subject the 0.9% Medicare tax and, typically, You can be subject to penalties if you to self-employment taxes — even if is not subject to the 3.8% NIIT. don’t pay enough tax during the year through estimated tax payments and withholding. Here are some strategies WHAT’S to help avoid underpayment penalties: NEW! COVID-19 payroll tax relief for the self-employed Know the minimum payment rules. To help the self-employed — and employers — during For you to avoid penalties, your the COVID-19 crisis, the CARES Act allows the pay- estimated payments and withholding ment of the employer share (6.2% of wages) of the must equal at least 90% of your tax Social Security payroll tax to be deferred. Taxpayers liability for 2020 or 110% of your can pay the tax over the next two years, with the first 2019 tax (100% if your 2019 AGI half due by Dec. 31, 2021, and the second half due was $150,000 or less or, if married by Dec. 31, 2022. Be aware that, as of this writing, filing separately, $75,000 or less). it appears that the deferral of the employee share of Social Security taxes noted under “Payroll taxes” at left isn’t available to the self-employed. Check with Use the annualized income installment your tax advisor for the latest information. method. This method often benefits taxpayers who have large variability in If you have employees, additional payroll tax breaks may be available to you: income from month to month due to bonuses, investment gains and losses, or Payroll tax credit. Under the CARES Act, this credit is generally available to seasonal income (at least if it’s skewed employers whose operations have been fully or partially suspended because of a toward the end of the year). Annualizing COVID-19-related governmental shutdown order or whose gross receipts have computes the tax due based on income, dropped more than 50% compared to the same quarter in the previous year. The gains, losses and deductions through credit equals 50% of up to $10,000 in compensation, including health care bene- each estimated tax period. fits, paid to an eligible employee after March 12, 2020, through Dec. 31, 2020. Estimate your tax liability and increase Paid leave credit. The Families First Coronavirus Response Act generally withholding. If you determine you’ve requires employers with fewer than 500 employees to provide paid leave in underpaid, consider having the tax certain COVID-19-related situations. Covered employers generally can take a shortfall withheld from your salary or federal payroll tax credit for 100% of the qualified sick and family leave wages year end bonus by Dec. 31. Because they pay each quarter, up to $511 per day for leave taken for the employee’s withholding is considered to have been own illness or quarantine and $200 for leaves taken to care for others. paid ratably throughout the year, this is often a better strategy than making Additional rules and limits apply to these breaks, and it’s possible they could up the difference with an increased be expanded or extended by the time you’re reading this or that additional quarterly tax payment, which may relief for employers could become available. Check with your tax advisor for still leave you exposed to penalties for the latest information. earlier quarters. 6 Executive Compensation

Smart tax planning for your exec comp package is critical

ompensation may take several There are some potential disad- Such a delay will defer income tax forms, including salary, fringe vantages of a Sec. 83(b) election, and may allow you to reduce or avoid C benefits and bonuses. If you’re however. First, prepaying tax in the exposure to the additional 0.9% an executive or other key employee, you current year could push you into a Medicare tax (because the RSUs are might receive stock-based compensa- higher income tax bracket and trigger treated as FICA income). However, tion, such as restricted stock, restricted or increase your exposure to the any income deferral must satisfy stock units (RSUs) or stock options additional 0.9% Medicare tax. But the strict requirements of Internal (either incentive or nonqualified). if your company is in the earlier Revenue Code Section 409A. Also Nonqualified deferred compensation stages of development, the income keep in mind that it might be better (NQDC) may also be included in your recognized may be relatively small. to recognize income now because of exec comp package. The tax conse- the currently low tax rates. quences of these types of compensation Second, any taxes you pay because of can be complex — subject to ordinary the election can’t be refunded if you Incentive stock options income, capital gains, payroll and other eventually forfeit the stock or sell it ISOs allow you to buy company taxes. So smart tax planning is critical. at a decreased value. However, you’d stock in the future (but before a set have a capital loss in those situations. expiration date) at a fixed price equal Restricted stock to or greater than the stock’s FMV Restricted stock is stock your employer Third, when you sell the shares, any at the date of the grant. Thus, ISOs grants to you subject to a substantial risk gain will be included in net investment don’t provide a benefit until the stock of forfeiture. Income recognition is nor- income and could trigger or increase appreciates in value. If it does, you mally deferred until the stock is no longer your liability for the 3.8% NIIT. (See can buy shares at a price below what subject to that risk (that is, it’s vested) or page 11.) they’re then trading for, provided you sell it. When the restriction lapses, you’re eligible to exercise the options. you pay taxes on the stock’s fair market See Case Study 2 for additional value (FMV) at your ordinary-income information, and work with your ISOs receive tax-favored treatment rate. (The FMV will be considered FICA tax advisor to map out whether the but must comply with many rules. income, so it could trigger or increase Sec. 83(b) election is appropriate Here are the key tax consequences: your exposure to the additional 0.9% for your situation. Medicare tax. See page 4.) y You owe no tax when ISOs are RSUs granted. But you can instead make a RSUs are contractual rights to y You owe no regular income tax Section 83(b) election to recognize receive stock, or its cash value, when you exercise the ISOs. ordinary income when you receive the after the award has vested. Unlike stock. This election, which you must restricted stock, RSUs aren’t eligible y If you sell the stock after holding make within 30 days after receiving the for the Sec. 83(b) election. So the shares at least one year from the stock, allows you to convert potential there’s no opportunity to convert exercise date and two years from future appreciation from ordinary income ordinary income into capital gains. the grant date, you pay tax on the to long-term capital gains income and sale at your long-term capital gains defer it until the stock is sold. But they do offer a limited ability rate. You also may owe the NIIT. to defer income taxes: Unlike y If you sell the stock before long-term The election can be beneficial if the restricted stock, which becomes capital gains treatment applies, a income at the grant date is negligible taxable immediately upon vesting, “disqualifying disposition” occurs and or the stock is likely to appreciate RSUs aren’t taxable until the any gain is taxed as compensation at significantly before income would employee actually receives the ordinary-income rates. (Disqualified otherwise be recognized. And with stock. So rather than having the dispositions aren’t, however, subject ordinary-income rates now especially stock delivered immediately upon to FICA and Medicare tax, including low under the TCJA, it might be a vesting, you may be able to arrange the additional 0.9% Medicare tax.) good time to recognize income. with your employer to delay delivery. Executive Compensation 7

Warning: If you don’t sell the stock gains rate and the NIIT. See Case favor highly compensated employees, in the year of exercise, a tax “prefer- Study 2 for additional information but plan funding isn’t protected from ence” item is created for the difference and, with your tax advisor, evaluate the employer’s creditors. (For more on between the stock’s FMV and the the risks and crunch the numbers to 401(k)s, see page 20.) exercise price (the “bargain element”) determine the best strategy for you. that can trigger the AMT. A future One important NQDC tax issue is AMT credit, however, should mitigate Nonqualified stock options that payroll taxes (see page 4) are this AMT hit. Plus, you may now be at The tax treatment of NQSOs is different generally due once services have been lower AMT risk because of the higher from the tax treatment of ISOs: NQSOs performed and there’s no longer a AMT exemption and exemption create compensation income (taxed at substantial risk of forfeiture — even phaseout range under the TCJA. (See ordinary-income rates) on the bargain though compensation may not be paid Chart 8 on page 24.) Consult your tax element when exercised (regardless of or recognized for income tax purposes advisor because the rules are complex. whether the stock is held or sold imme- until much later. So your employer diately), but they don’t create an AMT may withhold your portion of the If you’ve received ISOs, plan carefully preference item. payroll taxes from your salary or ask when to exercise them and whether to you to write a check for the liability. immediately sell shares received from You may need to make estimated tax Or it may pay your portion, in which an exercise or hold them. Waiting payments or increase withholding to case you’ll have additional taxable to exercise ISOs until just before the fully cover the tax on the exercise. income. Warning: The additional expiration date (when the stock value Keep in mind that an exercise could 0.9% Medicare tax could also apply. may be the highest, assuming the stock trigger or increase exposure to top tax is appreciating) and holding on to the rates, the additional 0.9% Medicare Keep in mind that the rules for NQDC stock long enough to garner long- tax and the NIIT. plans are tighter than they once were, term capital gains treatment often is and the penalties for noncompliance beneficial. But there’s also market risk NQDC plans can be severe: You could be taxed on to consider. Plus, acting earlier can be plan benefits at the time of vesting, and advantageous in several situations: These plans pay executives in the future a 20% penalty and potential interest for services to be currently performed. charges also could apply. So check y Exercise early to start the holding They differ from qualified plans, such as with your employer to make sure it’s period so you can sell and receive 401(k)s, in several ways. For example, addressing any compliance issues. long-term capital gains treatment unlike 401(k) plans, NQDC plans can sooner. y Exercise when the bargain element CASE Some stock-based compensation is small or when the market price is STUDY 2 may qualify for TCJA tax deferral close to bottoming out to reduce or eliminate AMT liability. Mario was about to receive some stock-based compensation from y Exercise annually so you can buy his employer, so he contacted only the number of shares that will his tax advisor to find out what achieve a breakeven point between the tax consequences would be. the AMT and regular tax and His advisor explained that the tax thereby incur no additional tax. treatment would depend on the type of stock-based compensa- y Sell in a disqualifying disposition and tion. For example, Mario might pay the higher ordinary-income rate be able to take advantage of to avoid the AMT on potentially the Section 83(b) election. (See disappearing appreciation. “Restricted stock” at left.) Or he might be eligible for a tax break On the negative side, exercising early under the TCJA. accelerates the need for funds to buy the stock, exposes you to a loss if the The TCJA break allows for the shares’ value drops below your exercise deferral of tax on stock-based cost, and may create a tax cost if the compensation in certain circumstances. Generally, it gives taxpayers the oppor- tunity to match the taxation of restricted stock and stock options with the timing preference item from the exercise of the sale of the stock. It’s intended for situations in which there is no ready generates an AMT liability. market for the sale of the stock.

The timing of ISO exercises also could The availability of the deferral opportunity is limited, however. It generally will positively or negatively affect your lia- apply only if at least 80% of full-time employees are covered by the stock-based bility for the higher ordinary-income compensation plan. tax rates, the 20% long-term capital 8 Investing

Uncertainty further complicates tax planning for investments

ax treatment of investments Being tax-smart with losses against ordinary income (such as wages, T varies dramatically based Losses aren’t truly losses until they’re self-employment and business income, on factors such as type of realized — that is, generally until you interest, dividends, and taxable retire- investment, type of income it produces, sell the investment for less than what ment plan distributions). But you can how long you’ve held it and whether you paid for it. So while it’s distressing carry forward excess losses until death. any special limitations or breaks apply. to see an account statement that shows On top of that, economic uncertainty a large loss, the loss won’t affect your If you don’t have enough gains to absorb has made tax planning for investments current tax situation as long as you still losses, you could be left with losses in especially challenging this year. own the investment. excess of the annual ordinary-income deduction limit. So think twice before And there are many additional factors to Realized capital losses are netted against selling an investment at a loss. After evaluate before deciding whether to sell realized capital gains to determine all, if you hold on to the investment, or hold an investment, such as invest- capital gains tax liability. If net losses it may recover the lost value. In fact, ment goals, time horizon, risk tolerance, exceed net gains, you can deduct only a buy-and-hold strategy works well for factors related to the investment itself, $3,000 ($1,500 for married taxpayers many long-term investors because it can fees and charges that apply to buying and filing separately) of losses per year minimize the effects of market volatility. selling securities, and your need for cash. But taxes are still important to consider. CHART 3 What’s the maximum 2020 capital gains tax rate? Capital gains tax and timing Although time, not timing, is gener- Type of gain Rate1 ally the key to long-term investment Taxpayer’s ordinary- Short-term (assets held 12 months or less) success, timing can have a dramatic income tax rate impact on the tax consequences of Long-term (assets held more than 12 months) 15% investment activities. Your marginal long-term capital gains rate can be as Some key exceptions much as 20 percentage points lower Long-term gain of certain higher-income taxpayers 20%2 than your ordinary-income tax rate. Most long-term gain that would be taxed at 10% or 0% 12% based on the taxpayer’s ordinary-income rate The long-term capital gains rate applies Long-term gain on collectibles, such as artwork to investments held for more than 12 28% months. The applicable rate depends and antiques Long-term gain attributable to certain recapture of on your income level and the type of 25% asset you’ve sold. (See Chart 3.) prior depreciation on real property Gain on qualified small business (QSB) stock held Because of TCJA-related changes to more than 5 years the brackets, through 2025, the top n Acquired before Feb. 18, 2009 14%3 long-term gains rate of 20% kicks n Acquired on or after Feb. 18, 2009, and before in before the top ordinary-income 7%4 Sept. 28, 2010 rate does. (See Chart 8 on page 24.) Higher rates still apply to certain n Acquired on or after Sept. 28, 2010 0% types of assets. (See Chart 3.) 1 In addition, the 3.8% net investment income tax (NIIT) applies to net investment income to the extent that modified adjusted gross income (MAGI) exceeds $200,000 (singles and heads of Holding on to an investment until households), $250,000 (married filing jointly) or $125,000 (married filing separately). 2 The 20% rate applies only to those with taxable income exceeding $441,450 (singles), $469,050 you’ve owned it more than one year (heads of households), $496,600 (joint filers), or $248,300 (separate filers). may help substantially cut tax on any 3  Effective rate based on a 50% exclusion from a 28% rate. gain. Keeping it even longer can also 4  Effective rate based on a 75% exclusion from a 28% rate. make tax sense. Investing 9

Mutual funds CASE STUDY 3 Use capital losses to absorb unrecognized gains Investing in mutual funds is an easy way to diversify your portfolio. But Marisa’s year-to-date net beware of the tax pitfalls. realized losses are $53,000. Her portfolio includes First, mutual funds with high turnover $100,000 of stock that rates can create income that’s taxed she paid only $50,000 for. at ordinary-income rates. Choosing Marisa has been thinking funds that provide primarily long-term about selling it to diversify gains can save you more tax dollars her portfolio and because because of the lower long-term rates. year-to-date the stock had dropped from $130,000 to Second, earnings on mutual funds $100,000 in value and she’s are typically reinvested. Unless you not confident it will recover. or your investment advisor increases But she’s been concerned your basis accordingly, you may report about the capital gains tax. more gain than required when you sell the fund. Brokerage firms are required Her tax advisor suggests to track (and report to the IRS) your that now might be a good cost basis in mutual funds acquired time to sell the stock because her $50,000 gain would essentially be tax-free: during the tax year. The gain would absorb $50,000 of losses, leaving Marisa with a $3,000 net loss, the maximum that she could use to offset ordinary income. Third, buying equity mutual fund shares late in the year can be costly Of course, an investment might con- Fortunately, there are ways to avoid taxwise. Such funds often declare tinue to lose value. That’s one reason triggering the wash sale rule and a large capital gains distribution at why tax considerations shouldn’t still achieve your goals. For example, year end, which is a taxable event. be the primary driver of investment you can: If you own the shares on the distri- decisions. If you’re ready to divest bution’s record date, you’ll receive yourself of a poorly performing stock y Sell the security and immediately and be taxed on the full distribution because, for example, you don’t think buy securities of a different company amount even if it includes significant its performance will improve or your in the same industry or shares in a gains realized by the fund before you investment objective or risk tolerance mutual fund that holds securities owned the shares. And you’ll pay tax has changed, don’t hesitate solely for much like the ones you sold, on those gains in the current year — tax reasons. even if you reinvest the distribution. y Sell the security and wait 31 days to repurchase the same security, or Plus, building up losses for future Small business stock use could be beneficial. This may y Before selling the security, purchase By purchasing stock in certain small be especially true if you have a large additional shares of that security businesses, you can diversify your investment portfolio, real estate equal to the number you want to portfolio. You also may enjoy prefer- holdings or a closely held business sell at a loss, and then wait 31 days ential tax treatment: that might generate substantial to sell the original portion. future gains, or if tax rates increase. Conversion of capital loss to Alternatively, you can do a bond swap, ordinary loss. If you sell qualifying Finally, remember that capital gains where you sell a bond, take a loss and Section 1244 small business stock at distributions from mutual funds can then immediately buy another bond a loss, you can treat up to $50,000 also absorb capital losses. of similar quality and duration from a ($100,000, if married filing jointly) different issuer. Generally, the wash as an ordinary, rather than a capital, Wash sale rule sale rule doesn’t apply because the loss — regardless of your holding If you want to achieve a tax loss with bonds aren’t considered substantially period. This means you can use it to minimal change in your portfolio’s identical. Thus, you can achieve a offset ordinary income, reducing your asset allocation, consider the wash sale tax loss with virtually no change in tax by as much as 37% of this portion rule. It prevents you from taking a loss economic position. of the loss. Sec. 1244 applies only if on a security if you buy a substantially total capital invested isn’t more than identical security (or an option to buy Warning: You can’t avoid the wash $1 million. such a security) within 30 days before sale rule by selling stock at a loss in or after you sell the security that created a taxable account and purchasing Tax-free gain rollovers. If within 60 the loss. You can recognize the loss only the same stock within 30 days in a days of selling qualified small business when you sell the replacement security. tax-advantaged retirement account. (QSB) stock you buy other QSB stock 10 Investing

claim will be able to withstand IRS CASE How to qualify for the 0% capital gains rate scrutiny, carefully track and document STUDY 4 your time. Contemporaneous record- keeping is better than records that are Faced with a long-term capital gains created after the fact. tax rate of 23.8% (20% for the top tax bracket, plus the 3.8% NIIT), Michael and Jennifer decide to give some If you don’t pass the material partici- appreciated stock to their adult son, pation test, consider: Ian. Just out of college and making only enough from his entry-level job to leave Increasing your involvement. If you him with $25,000 in taxable income, can exceed 500 hours, the activity Ian falls into the 12% ordinary-income no longer will be subject to passive tax bracket and the 0% long-term activity rules. capital gains bracket. Grouping activities. You may be able However, the 0% rate applies only to the extent that capital gains “fill up” the gap to group certain activities together between Ian’s taxable income and the top end of the 0% bracket. For 2020, the to be treated as one activity for tax 0% bracket for singles tops out at $40,000 (just $125 less than the top of the purposes and exceed the 500-hour 12% ordinary-income bracket). So if Ian sells the stock his parents transferred threshold. But the rules are complex, to him and his gains are $15,000, the entire amount will qualify for the 0% rate. and there are potential downsides The sale will be tax-free vs. the $3,570 Michael and Jennifer would have owed to consider. had they sold the stock themselves.

Warning: If Ian had been subject to the “kiddie tax” (see page 18), the results Looking at other activities. If you would have been quite different. It’s also important to consider any gift tax con- have passive losses, one option is to sequences before transferring stock. (See page 22.) limit your participation in another activity that’s generating income, so that you don’t meet the 500-hour test. with the proceeds, you can defer the Keep in mind that all three of these Another is to invest in an additional tax on your gain until you dispose of tax benefits are subject to additional income-producing trade or business the new stock. The rolled-over gain requirements and limits. Consult your that will be passive to you. Under reduces your basis in the new stock. For tax and financial advisors to be sure both strategies, you’ll have passive determining long-term capital gains an investment in small business stock income that can absorb some or all treatment, the new stock’s holding is right for you. of your passive losses. period includes the holding period of the stock you sold. To be a QSB, a Passive activities Disposing of the activity. This business must be engaged in an active If you’ve invested in a trade or business generally allows you to deduct all trade or business and must not have in which you don’t materially partic- passive losses — including any loss assets that exceed $50 million, among ipate and where income or loss flows on disposition (subject to basis and other requirements. through to your tax return, remember capital loss limitations). But, again, the passive activity rules. Why? Passive the rules are complex. Exclusion of gain. Generally, tax- activity income may be subject to the payers selling QSB stock are allowed 3.8% NIIT (see page 11), and passive Even if you do pass the material to exclude up to 100% of their gain if activity losses generally are deductible participation test, be aware that your they’ve held the stock for more than only against income from other passive loss deduction might be affected by five years. But, depending on the activities. You can carry forward the TCJA’s rules for deducting business acquisition date, the exclusion may be disallowed losses to the following year, losses. (See “What’s new!” on page 14.) less: The exclusion is 75% for stock subject to the same limits. acquired on or after Feb. 18, 2009, and Income investments before Sept. 28, 2010, and 50% for To avoid passive activity treatment, Qualified dividends are taxed at the stock acquired before Feb. 18, 2009. you must “materially participate” in favorable long-term capital gains the activity, which typically means you tax rate rather than at your higher When the exclusion is less than 100%, must participate in the trade or business ordinary-income tax rate. Interest the taxable portion of any QSB gain more than 500 hours during the year income, however, generally is taxed at will be subject to the lesser of your or demonstrate that your involvement ordinary-income rates. ordinary-income rate or 28%, rather constitutes substantially all of the than the normal long-term gains rate. participation in the activity. But there So stocks that pay qualified dividends (See Chart 3 on page 8.) Thus, if the are other ways to meet the material may be more attractive taxwise than 28% rate and the 50% exclusion apply, participation test. Plus, there are special other income investments, such as the effective rate on the QSB gain will rules that apply to real estate. (See CDs and taxable bonds. But there are be 14% (28% × 50%). page 13.) To help ensure your hours exceptions. Investing 11

Some dividends, for example, are sub- y Bonds (except U.S. savings bonds) The fact that a bond is exempt from ject to ordinary-income rates. These with original issue discount (OID) federal tax doesn’t necessarily make it a include certain dividends from: build up “interest” as they rise toward better choice than a comparable taxable maturity. You’re generally considered bond. Municipal bonds, for example, y Real estate investment trusts to earn a portion of that interest typically offer lower yields than compa- (REITs), annually — even though the bonds rable corporate bonds. To make a fair don’t pay this interest annually — comparison, you need to calculate the y Regulated investment companies and you must pay tax on it. tax-equivalent yield — which incor- (RICs), porates tax savings into the municipal y Interest on U.S. government bonds y Money market mutual funds, and bond’s yield — using this formula: is taxable on federal returns but y Certain foreign investments. exempt by federal law on state and Tax-equivalent yield = actual yield / local returns. (1 – your marginal tax rate). The tax treatment of bond income y Interest on state and local govern- varies. For example: ment bonds is excludable on federal But you also need to consider factors returns. If the bonds were issued in such as risk and how well each bond y Corporate bond interest is fully your home state, interest also may will help achieve your overall invest- taxable for federal and state be excludable on your state return, ment goals. purposes. depending on the state. Warning: Tax-exempt interest from CASE Can you deduct investment interest expense? private-activity municipal bonds can STUDY 5 trigger or increase AMT liability. However, any income from tax-exempt Frank borrowed to make some bonds issued in 2009 and 2010 (along investments this year, and he was with 2009 and 2010 re-fundings of wondering if the interest would be bonds issued after Dec. 31, 2003, and deductible. So he consulted his before Jan. 1, 2009) is excluded from tax advisor. the AMT. And AMT is less of a risk She told him that investment for most taxpayers now. (See page 3.) interest expense — interest on debt used to buy assets held for 3.8% NIIT investment, such as margin debt Taxpayers with modified adjusted used to buy securities — generally gross income (MAGI) over $200,000 is deductible for both regular tax ($250,000 if married filing jointly and and alternative minimum tax (see $125,000 if married filing separately) page 3) purposes. But special may owe the net investment income rules apply. tax (NIIT) on top of whatever other First, Frank’s investment interest tax they owe on their investment expense deduction would be income. The NIIT equals 3.8% of the limited to his net investment lesser of net investment income or the income, which, for the purposes amount by which MAGI exceeds the of this deduction, generally applicable threshold. includes taxable interest, nonqualified dividends and net short-term capital gains (but not long-term capital gains), reduced by other investment expenses. Any Net investment income can include disallowed interest expense is carried forward, and Frank can deduct it in a later capital gains, dividends, interest, passive year against net investment income. business income, rental income and other investment-related income. But If his interest expense exceeds his net investment income, Frank may elect to it doesn’t include business or self-rental treat all or a portion of his net long-term capital gains or qualified dividends as income from an active trade or business. investment income in order to deduct more of his investment interest expense. But if he does, that portion of the long-term capital gain or dividend will be taxed Many of the strategies that can help at ordinary-income rates. you save or defer income tax on your Frank’s advisor also explained that payments a short seller makes to the stock investments can also help you avoid lender in lieu of dividends may be deductible as investment interest expense. or defer NIIT liability. And because But interest on debt used to buy securities that pay tax-exempt income, such the threshold for the NIIT is based as municipal bonds, isn’t deductible. Finally, she told Frank to keep in mind on MAGI, strategies that reduce your that passive interest expense — interest on debt incurred to fund a passive MAGI — such as making retirement activity — becomes part of his overall passive activity income or loss, subject plan contributions (see page 20) — to limitations. (See page 10.) could also help you avoid or reduce NIIT liability. 12 Real Estate

Make the most of tax breaks for your home and other real estate

here are many ways you can Home office deduction. Under the depreciate the portion of their home maximize the tax benefits TCJA, employees can no longer deduct that’s used as an office, they can claim T associated with owning a home office expenses, because of the mortgage interest, property taxes and principal residence, vacation home or suspension of miscellaneous deductions casualty losses as itemized deductions to rental property. The TCJA has limited subject to the 2% of adjusted gross the extent otherwise allowable, without certain breaks, but the CARES Act income (AGI) floor. (See page 2.) But needing to apportion them between provides some relief. Tax planning is the self-employed can still claim the personal and business use of the home. also important if you’d like to sell your deduction, as long as their home office home or other real estate this year. is their principal place of business (or Home rental rules used substantially and regularly to If you rent out all or a portion of your Home-related deductions conduct business) and that’s the only principal residence or second home Consider these itemized deductions in use of the space. for less than 15 days, you don’t have to your tax planning: report the income. But expenses directly They can deduct from their self- associated with the rental, such as adver- Property tax deduction. Under the employment income a portion of their tising and cleaning, won’t be deductible. TCJA, through 2025, the property mortgage interest, property taxes, tax deduction is subject to a $10,000 insurance, utilities and certain other If you rent out your principal residence limit ($5,000 if you’re married filing expenses, and the depreciation allocable or second home for 15 days or more, separately) on combined deductions to the space. Or they can use the you’ll have to report the income. But you for state and local taxes (SALT). simplified method for calculating the may be entitled to deduct some or all of (See page 2 for more details.) deduction — $5 per square foot for up your rental expenses — such as utilities, Higher-income taxpayers owning to 300 square feet. Although taxpayers repairs, insurance and depreciation. valuable homes in high-property-tax using this method won’t be able to Exactly what you can deduct depends on locations have seen a huge drop in the federal tax benefit they receive from their property tax payments. WHAT’S CARES Act QIP correction NEW! increases deductions — retroactively Mortgage interest deduction. You Prior to the TCJA, qualified retail improvement property, restaurant property generally can deduct interest on mort- and leasehold improvement property were depreciated over 15 years under the gage debt incurred to purchase, build modified accelerated cost recovery system (MACRS). The TCJA classifies all of or improve your principal residence these property types as qualified improvement property (QIP). and a second residence. Points paid related to your principal residence also Congress intended QIP placed in service after 2017 to have a 15-year MACRS may be deductible. Through 2025, the recovery period and, in turn, qualify for 100% bonus depreciation. Bonus depre- TCJA reduces the mortgage debt limit ciation is additional first-year depreciation of 100% for qualified property placed from $1 million to $750,000 for debt in service through Dec. 31, 2022. For 2023 through 2026, bonus depreciation incurred after Dec. 15, 2017 ($500,000 is scheduled to be gradually reduced. and $375,000, respectively, for separate filers), with some limited exceptions. But the statutory language didn’t define QIP as 15-year property. So QIP defaulted to a 39-year recovery period, making it ineligible for bonus depreciation. Home equity debt interest deduction. Through 2025, the TCJA effectively The CARES Act corrected this drafting error. Taxpayers that have made qualified limits the home equity interest deduction improvements during the past two years can claim an immediate tax refund for the to debt that would qualify for the home bonus depreciation they missed. Taxpayers investing in QIP in 2020 and beyond also mortgage interest deduction. (Under can claim bonus depreciation going forward, according to the phaseout schedule. In pre-TCJA law, interest was deductible some cases, however, it might be more beneficial to claim depreciation over 15 years. on up to $100,000 of home equity debt Warning: Under the TCJA, real estate businesses that elect to deduct 100% of used for any purpose, such as to pay off their business interest are ineligible for bonus depreciation. credit card debt or to buy a car.) Real Estate 13 whether the home is classified as a rental property for tax purposes (based on the WHAT’S CARES Act temporarily eases amount of personal vs. rental use): NEW! TCJA interest deduction rules

Generally, under the TCJA, interest paid or accrued by a business is deductible Rental property. You can deduct rental only up to 30% of adjusted taxable income (ATI). Taxpayers with average annual expenses, including losses, subject to gross receipts of $25 million or less for the three previous tax years generally the real estate activity rules discussed are exempt from the limitation. Larger real property businesses can elect to con- at right. Property tax attributable to tinue to fully deduct their interest, but then they’re required to use the alternative the rental use of the home isn’t subject depreciation system for real property used in the business. to the SALT limit. You can’t deduct any interest that’s attributable to your The CARES Act increases the interest expense deduction limit to 50% of ATI personal use of the home. However, for the 2019 and 2020 tax years. (Special partnership rules apply for 2019.) It you can take the personal portion of also permits businesses to elect to use 2019 ATI, rather than 2020 ATI, for the property tax as an itemized deduction 2020 calculation, which may increase the amount of the deduction. (subject to the SALT limit). If these changes reduce your tax liability for 2019, you may be able to file an Nonrental property. You can deduct amended return to receive a refund now. rental expenses only to the extent of your rental or other passive income. Any excess can be carried forward to Real estate activity rules for the following improvements to offset rental income in future years. You Income and losses from investment real nonresidential real property: roofs, also can take an itemized deduction for estate or rental property are passive by HVAC equipment, fire protection and the personal portion of both mortgage definition — unless you’re a real estate alarm systems, and security systems. interest and property taxes, subject to professional. Why is this important? the applicable limits. In some instances, Passive activity income and losses have For qualifying property placed in it may be beneficial to reduce personal some negative tax consequences. (See service in 2020, the expensing limit use of a residence so it will be classified “Passive activities” on page 10.) is $1.04 million. The break begins as a rental property. to phase out dollar-for-dollar when To qualify as a real estate professional, asset acquisitions for the year exceed Home sales you must annually perform: $2.59 million. (These amounts are When you sell your principal residence, adjusted annually for inflation.) you can exclude up to $250,000 of gain y More than 50% of your personal ($500,000 for married couples filing services in real property trades or Other valuable breaks include bonus jointly) if you meet certain tests. Gain businesses in which you materially depreciation and accelerated deprecia- that qualifies for exclusion will also be participate, and tion. (See “What’s new!” at left.) excluded from the 3.8% NIIT. (See y More than 750 hours of service in page 11.) To support an accurate tax Tax-deferral strategies these businesses during the year. basis, maintain thorough records, includ- It’s possible to divest yourself of appreci- ing information on your original cost ated investment real estate but defer the Keep in mind that special rules for and subsequent improvements, reduced tax liability. Such strategies may even spouses may help you meet the material by any casualty losses and depreciation help you keep your income low enough participation test. Warning: To help claimed based on business use. Warning: to avoid triggering the 3.8% NIIT and withstand IRS scrutiny, be sure to keep Gain that’s allocable to a period of “non- the 20% long-term capital gains rate. adequate records of time spent. qualified” use generally isn’t excludable. Consider these deferral strategies:

Losses on the sale of any personal Depreciation-related breaks Installment sale. An installment sale residence aren’t deductible. But if part Valuable depreciation-related allows you to defer gains by spreading of your home is rented out or used breaks may be available to real them over several years as you receive exclusively for your business, the loss estate investors. One such break is the proceeds. Warning: Ordinary gain attributable to that portion may be the Sec. 179 expensing election. It from certain depreciation recapture is deductible. allows you to deduct (rather than recognized in the year of sale, even if depreciate over a number of years) no cash is received. Because a second home is ineligible for qualified improvement property — the gain exclusion, consider converting a definition expanded by the TCJA Sec. 1031 exchange. Also known as it to rental use before selling. It can be from leasehold-improvement, restau- a “like-kind” exchange, this technique considered a business asset, and you may rant and retail-improvement property. allows you to exchange one real estate be able to defer tax on any gains through investment property for another and an installment sale or a Section 1031 The TCJA also allows Sec. 179 defer paying tax on any gain until exchange. Or you may be able to deduct expensing for certain depreciable you sell the replacement property. a loss, but only to the extent attributable tangible personal property used pre- Discuss the limits and risks with your to a decline in value after the conversion. dominantly to furnish lodging and tax advisor. 14 Business Ownership

Don’t forget about tomorrow while addressing today’s challenges

his has been a challenging treated as sole proprietorships or as When the income-based limit applies year for business owners. partnerships for tax purposes. The to owners of pass-through entities, the T Many have had to focus on deduction generally equals 20% of 199A deduction generally can’t exceed doing everything they can just to keep qualified business income (QBI), the greater of the owner’s share of: their business afloat, while others have subject to limitations that can begin had to respond to increased demand for to apply if taxable income exceeds y 50% of the amount of W-2 wages their products or services coupled with the applicable threshold — $163,300 paid to employees by the qualified supply chain disruptions and staffing or, if married filing jointly, $326,600. business during the tax year, or issues. At the same time, owners must The limits fully apply when tax- y The sum of 25% of W-2 wages plus keep their eye on available tax breaks able income exceeds $213,300 and 2.5% of the cost of qualified property. and their own financial future, which $426,600, respectively. requires keeping a long-term outlook Another limitation for taxpayers subject as well. QBI is generally defined as the net to the income-based limit is that the amount of qualified items of income, 199A deduction generally isn’t available Business structure gain, deduction and loss that are for income from “specified service busi- effectively connected with the con- Income taxation and owner liability nesses.” Examples include businesses are the main factors that differentiate duct of a U.S. business. one business structure from another. Many business owners choose entities WHAT’S CARES Act helps struggling business that combine pass-through taxation NEW! owners by enhancing tax breaks for losses with limited liability, namely limited liability companies (LLCs) and To provide COVID-19 relief, the CARES Act has made some temporary S corporations. The TCJA signifi- changes to tax breaks related to business losses. A loss occurs when a cantly changed the tax consequences business’s expenses and other deductions for the year exceed its revenues: of business structure. 1. Net operating losses (NOLs). For NOLs that arise in 2018 and later tax years, the TCJA generally reduces the maximum amount of taxable income The now-flat corporate rate (21%) that can be offset with NOL deductions from 100% to 80%. In addition, the is significantly lower than the top TCJA generally prohibits NOLs incurred in 2018 and later tax years from individual rate (37%), providing sig- being carried back to an earlier tax year — but it allows them to be carried nificant tax benefits to C corporations forward indefinitely (as opposed to the 20-year limit under pre-TCJA law). and helping to mitigate the impact of double taxation for their owners. But, Under the CARES Act, taxpayers are now eligible to carry back NOLs arising in the TCJA also introduced a powerful 2018 through 2020 tax years to the previous five tax years. The CARES Act also deduction for owners of pass-through allows taxpayers to potentially claim an NOL deduction equal to 100% of taxable entities. (See below.) income for prior-year NOLs carried forward into tax years beginning before 2021.

For tax or other reasons, a structure 2. Pass-through entity “excess” business losses. Through 2025, the TCJA change may be beneficial in certain applies a limit to deductions for current-year business losses incurred by non- situations. But there also may be corporate taxpayers: Such losses generally can’t offset more than $250,000 unwelcome tax consequences that ($500,000 for married couples filing jointly) of income from other sources, effectively prevent such a change. such as salary, self-employment income, interest, dividends and capital gains. (The limit is annually adjusted for inflation.) “Excess” losses are carried forward Sec. 199A deduction for to later tax years and can then be deducted under the NOL rules. pass-through businesses The CARES Act temporarily eliminates the limitation. These taxpayers can Through 2025, the TCJA provides now deduct 100% of business losses arising in 2018, 2019 and 2020. the Sec. 199A deduction for sole pro- prietors and owners of pass-through If any of these changes reduce your tax liability for 2018 or 2019, you may business entities, such as partnerships, be able to file amended returns to receive a refund now. S corporations and LLCs that are Business Ownership 15 that provide investment-type services and most professional practices (other CHART 4 Profit-sharing plan vs. SEP: than engineering and architecture). How much can you contribute?

The W-2 wage and property limitations Profit-sharing plan SEP and the service business limitation don’t 2020 maximum contribution: 2020 maximum contribution: apply if your taxable income is under the $57,000 or $63,500 $57,000 applicable threshold. In that case, you Additional limits: You can’t contribute Additional limits: You can’t contribute should qualify for the full 20% deduction. more than 25% of your compensation more than 25% of your eligible com- generally. But you can contribute 100% pensation. (Special rules apply if you’re up to the 401(k) limits if the plan includes Retirement saving self-employed.) a 401(k) arrangement. If most of your money is tied up in your To make the maximum contribution, your To qualify for the $63,500 limit, your plan eligible compensation must be at least business, retirement can be a challenge. must include a 401(k) arrangement. And $228,000 ($285,000 before the deduction So if you haven’t already set up a tax- you must be eligible to make catch-up if you’re self-employed). advantaged retirement plan, consider contributions (that is, be age 50 or older). doing so this year. If you might be subject Note: Other factors may further limit your maximum contribution. to the 3.8% NIIT (see page 11), this may be particularly beneficial because retirement plan contributions can reduce You can make deductible 2020 con- Sale or acquisition your modified adjusted gross income tributions until the due date of your Whether you’re selling your business (MAGI) and thus help you reduce or 2020 income tax return, including as part of an exit strategy or acquiring avoid the NIIT. Keep in mind that, if extensions — provided your plan exists another company to help grow your you have employees, they generally must on Dec. 31, 2020. Warning: Employer business, the tax consequences can be allowed to participate in the plan, contributions generally are required. have a major impact on the trans- provided they work enough hours and action’s success or failure. Consider meet other qualification requirements. Exit planning installment sales, for example. A Here are a few options: An exit strategy is a plan for passing taxable sale might be structured on responsibility for running the as an installment sale if the buyer Profit-sharing plan. This is a defined company, transferring ownership lacks sufficient cash or pays a contin- contribution plan that allows discre- and extracting your money from the gent amount based on the business’s tionary employer contributions and business. This requires planning well performance. flexibility in plan design. You can make in advance of the transition. Here are deductible 2020 contributions (see the most common exit options: An installment sale also may make Chart 4 for limits) as late as the due sense if the seller wishes to spread date of your 2020 income tax return, Buy-sell agreement. When a business the gain over a number of years. This including extensions — provided your has more than one owner, a buy-sell could be especially beneficial if it plan exists on Dec. 31, 2020. agreement can control what happens would allow the seller to stay under to the business when a specified event the thresholds for triggering the 3.8% SEP. A Simplified Employee Pension occurs, such as an owner’s retirement, NIIT or the 20% long-term capital is a defined contribution plan that disability or death. It’s critical to gains rate. But an installment sale can provides benefits similar to those of factor in tax and funding issues when backfire on the seller. For example: a profit-sharing plan. But you can drafting a buy-sell agreement. establish a SEP in 2021 and still make y Depreciation recapture must be deductible 2020 contributions as late Succession within the family. You reported as gain in the year of sale, as the due date of your 2020 income can pass your business on to family no matter how much cash the tax return, including extensions. (See members by giving them interests, seller receives. Chart 4 for contribution limits.) selling them interests or doing some y If tax rates increase, the overall tax of each. Now may be a particularly could wind up being more. Defined benefit plan. This plan sets a good time to transfer ownership inter- future pension benefit and then actuari- ests in your business. (See page 22 to With a corporation, a key consider- ally calculates the contributions needed learn why.) ation is whether the deal should be to attain that benefit. The maximum structured as an asset sale or a stock compensation for benefit purposes for ESOP. An employee stock owner- sale. If a stock sale is chosen, another 2020 is generally $230,000 or 100% of ship plan is a qualified retirement important question is whether it average earned income for the highest plan created primarily to purchase should be a tax-deferred transfer or three consecutive years, if less. Because your company’s stock. It can provide a taxable sale. it’s actuarially driven, the 2020 contribu- liquidity and various tax benefits. tion needed to attain the future benefit Of course, tax consequences are only may exceed the maximum contributions Sale to an outsider. If you can find one of many important considerations allowed by other plans, depending on the right buyer, you may be able to when planning a sale or acquisition. your age and the desired benefit. sell the business at a premium. 16 Charitable Giving

Donations may be more impactful this year — to you and the recipients

he events of 2020 have Stock donations increased AGI limit for cash gifts to T caused many charities to Appreciated publicly traded securities public charities might mean that cash need support more than ever. you’ve held more than one year are gifts will make more sense in 2020. In addition, the CARES Act includes long-term capital gains property, which (See “What’s new! at right.) some tax incentives for donating this often makes one of the best charitable year. If you can still afford to give and gifts. Why? You can deduct the current Don’t donate stock that’s worth less you keep in mind the various rules fair market value and avoid the capital than your basis. Instead, sell the stock and limits, such as that you generally gains tax you’d pay if you sold the so you can deduct the loss and then must itemize tax deductions to ben- property. This will be especially benefi- donate the cash proceeds to charity. efit, charitable giving can play a key cial to taxpayers facing the 3.8% NIIT role in your tax planning while you (see page 11) or the top 20% long-term IRA donations support organizations whose missions capital gains rate this year. Taxpayers age 701 or older are allowed are important to you. to make direct contributions from Donations of long-term capital their IRA to qualified charitable orga- Cash donations gains property are subject to tighter nizations, up to $100,000 per tax year. Outright gifts of cash (which include deduction limits, however — 30% Note that the age for these qualified donations made via check, credit card of AGI for gifts to public charities, charitable distributions (QCDs) hasn’t and payroll deduction) are the easiest to 20% for gifts to nonoperating private changed even though the SECURE make. The substantiation requirements foundations. In some situations, the Act increased the age after which depend on the gift’s value:

CHART 5 y Gifts under $250 can be supported How much can you deduct for your donation? by a canceled check, credit card receipt or written communication Cash. This includes not just actual cash but gifts made by check, credit card or payroll from the charity. deduction. You may deduct 100%. y Gifts of $250 or more must be Ordinary-income property. Examples include stocks and bonds held one year or less, inventory, and property subject to depreciation recapture. You generally may deduct substantiated by the charity. only the lesser of fair market value or your tax basis.

Deductions for cash gifts to public Long-term capital gains property. You may deduct the current fair market value of appreciated stocks, bonds and other securities and real estate held more than one year. charities normally can’t exceed 60% of your adjusted gross income (AGI), Tangible personal property. Your deduction depends on the situation: but this limit has been substantially n If the property isn’t related to the charity’s tax-exempt function (such as an increased for 2020. (See “What’s new!” antique donated for a charity auction), your deduction is limited to your basis. on page 17.) The AGI limit remains at n If the property is related to the charity’s tax-exempt function (such as an antique 30% for cash donations to nonoperat- donated to a museum for its collection), you can deduct the fair market value. ing private foundations. Contributions Vehicle. Unless it’s being used by the charity, you generally may deduct only the exceeding the applicable AGI limit can amount the charity receives when it sells the vehicle. be carried forward for up to five years. Use of property. Examples include use of a vacation home and a loan of artwork. Generally, you receive no deduction because it isn’t considered a completed gift. Warning: Charitable contribution There may, however, be ways to structure the gift to enable you to get a deduction. deductions are allowed for alternative Services. You may deduct only your out-of-pocket expenses, not the fair market value minimum tax (AMT) purposes, but of your services. You can deduct 14 cents per charitable mile driven. your tax savings may be less if you’re Payments made in exchange for college athletic event seating rights. Under the subject to the AMT. For example, TCJA, these are no longer deductible. if you’re in the 37% tax bracket for Note: Nonitemizers are limited to deducting $300 of cash donations for 2020. If you itemize, your annual regular income tax purposes, but the charitable deductions may be reduced if they exceed certain limits based on your AGI, the type of dona- 28% tax bracket for AMT purposes, tion and the type of charity receiving the donation. If you receive some benefit from the charity relating to your donation, such as services or products, your deduction must be reduced by the value of the benefit your deduction may be worth only you receive. Various substantiation requirements also apply. Consult your tax advisor for additional details. 28% instead of 37%. Charitable Giving 17 required minimum distributions (RMDs) generally must begin from WHAT’S CARES Act boosts tax benefits 701 to 72. (See page 21.) NEW! of charitable giving this year

Making large cash donations to public charities this year might be beneficial A charitable deduction can’t be because the CARES Act increased the 2020 deduction limit for such gifts from claimed for QCDs. But QCDs aren’t 60% of adjusted gross income (AGI) to 100% of AGI. Normally donations of included in taxable income and can appreciated stock provide the biggest tax-saving opportunities, but this year cash be used to satisfy an IRA owner’s donations might prove more beneficial because of the 100% of AGI deduction limit. RMD — though RMDs have been waived for 2020. (See page 21.) If you don’t itemize deductions, normally you can’t deduct charitable donations. But, the CARES Act allows taxpayers who claim the standard deduction to A QCD might be tax-smart if you deduct up to $300 of cash donations to qualified charities in 2020. won’t benefit from the charitable deduction. To be a QCD, the transfer Also keep in mind that, if itemizing no longer will save you tax because of the must be made by the IRA trustee increased standard deduction, you might benefit from “bunching” donations into directly to an eligible charity. alternating years so that your total itemized deductions in those years would then surpass your standard deduction. You can then itemize just in those years. Making gifts over time If you don’t know which charities you You may owe capital gains tax when your lifetime gift tax exemption you’ll want to benefit but you’d like to start you receive the payments. However, have to use up. If the trust’s earnings making large contributions now, con- because the payments are spread outperform the Sec. 7520 rate, the sider a private foundation. It offers you over time, much of the liability will excess earnings will be transferred to significant control over how your dona- be deferred. Plus, a portion of each the remainder beneficiaries gift- and tions ultimately will be used. You must payment might be considered tax-free estate-tax-free. comply with complex rules, however, return of principal. This may help which can make foundations expensive you reduce or avoid exposure to the Because the Sec. 7520 rate is currently to run. Also, the AGI limits for deduct- 3.8% NIIT and the 20% top long-term very low, now may be a good time to ibility of contributions to nonoperating capital gains rate. lock in a low rate while still available foundations are lower. (See “Cash and take the chance that your actual donations” and “Stock donations.”) You can name someone other than return will outperform it. Keep in yourself as income beneficiary or fund mind, however, that the increased gift If you’d like to influence how your the CRT at your death, but the tax and estate tax exemption may reduce donations are spent but avoid a consequences will be different. the tax benefits of a CLT, depending foundation’s downsides, consider a on your specific situation. (For more donor-advised fund (DAF). Many larger Charitable lead trusts on estate and gift taxes, see page 22.) public charities and investment firms To benefit charity while transferring offer them. Warning: To deduct your assets to loved ones at a reduced tax You can name yourself as the remainder DAF contribution, obtain a written cost, consider a CLT. It works as follows: beneficiary or fund the CLT at your acknowledgment from the sponsoring death, but the tax consequences will organization that it has exclusive legal y For a given term, the CLT pays an be different. control over the assets contributed. amount to one or more charities. Qualified charities y At the term’s end, the CLT’s Charitable remainder trusts Before you donate, it’s critical to make remaining assets pass to one or To benefit a charity while helping sure the charity you’re considering more loved ones you name as ensure your own financial future, is indeed a qualified charity — that remainder beneficiaries. consider a CRT. Here’s how it works: it’s eligible to receive tax-deductible y When you fund the CLT, you make contributions. y For a given term, the CRT pays an a taxable gift equal to the present amount to you annually (some of value of the amount that will go to The IRS’s online search tool, Tax which generally is taxable). the remainder beneficiaries. Exempt Organization Search, can help you more easily find out whether y At the term’s end, the CRT’s y The property is removed from your an organization is eligible to receive remaining assets pass to one or taxable estate. tax-deductible charitable contributions. more charities. You can access the tool at IRS.gov. For gift tax purposes, the amount of the y When you fund the CRT, you According to the IRS, you may rely on remainder interest is determined using receive an income tax deduction this list in determining deductibility of the assumption that the trust assets for the present value of the amount your contributions. will grow at the Section 7520 rate. The that will go to charity. lower the Sec. 7520 rate, the smaller Also, don’t forget that political dona- y The property is removed from your the remainder interest and the lower tions aren’t deductible. taxable estate. the possible gift tax — or the less of 18 Family & Education

Focusing in on children’s financial future

hen it comes to family and If you adopt, you might be eligible than half of their own support from education, much of the focus for the adoption credit. It’s $14,300 earned income). The TCJA had made W in 2020 has been on the for 2020, but it’s subject to a MAGI- the kiddie tax harsher, taxing income impact of the COVID-19 crisis, such based phaseout that’s lower than for subject to the tax according to the tax as managing remote learning and the child credit ($214,520–$254,520 brackets used for trusts and estates. finding creative ways for grandparents for both heads of households and and grandchildren to safely connect. joint filers). Before 2018, such income was gen- But whether you’re a parent or a erally taxed at the parents’ tax rate. grandparent, it’s still important to also “Kiddie tax” In many cases, the TCJA would have do what you can to start the children The “kiddie tax” generally applies caused children’s unearned income in your life off on the right financial to unearned income beyond $2,200 to be taxed at higher rates than their track. This includes showing them the (for 2020) of children under age 19 parents’ income, because higher rates value of saving and providing them and of full-time students under age kick in at much lower income levels with the best education possible. By 24 (unless the students provide more for trusts and estates. taking advantage of tax breaks, your family can do both. CASE Why Roth IRAs are tax-smart for teens Child credit STUDY 6

Some higher-income taxpayers who Madison, 16, is starting her first part-time job this year. Madison’s parents would couldn’t benefit from the child credit like to get her in the habit of saving for the future, and they ask their tax advisor before the TCJA went into effect are for the most tax-advantaged option. He suggests a Roth IRA, which can be per- now finding that they do. The TCJA fect for teenagers because they likely have many decades to let their accounts has significantly raised the modified grow tax-free. adjusted gross income (MAGI) phase- out ranges for the credit. Through 2025, Roth IRA contributions aren’t deductible, but if Madison earns no more than the the total credit amount a taxpayer is standard deduction for singles ($12,400 for 2020) and has no unearned income, allowed to claim is reduced by $50 for she’ll pay zero federal income tax anyway. So the tax-free treatment of future every $1,000 (or part of a $1,000) by qualified distributions will be well worth the loss of any current deduction. Even which MAGI exceeds $200,000, or if Madison’s earned income exceeds the standard deduction, she’ll probably be $400,000 for married couples filing taxed at a very low rate. So the long-term tax benefits of a Roth IRA will typically still outweigh the benefit of a current jointly. The thresholds used to be only deduction with a traditional IRA. $75,000 and $110,000, respectively. If Madison doesn’t want to invest too Tax credits reduce your tax bill dollar much of her hard-earned money, her for dollar (unlike deductions, which parents could give her some of the just reduce the amount of income amount she’s eligible to contribute. subject to tax), so they’re particularly For example, if Madison earns $6,000 valuable. Under the TCJA: for the year but only wants to con- tribute $1,000 of it to the Roth IRA, y For each child under age 17 at the her parents could give her $5,000 so end of 2020, you may be able to she could contribute the full $6,000 claim a $2,000 credit. she’s eligible to contribute but still have $5,000 to spend as she wishes y For each qualifying dependent other (or save for a shorter-term goal). than a qualifying child (such as a But Madison’s parents should first dependent child age 17 or older or consider any potential gift tax or a dependent elderly parent), a $500 college financial aid consequences. family credit may be available. Family & Education 19

Fortunately, tax legislation signed into mandatory fees, books, supplies, com- ESAs are worth considering if you’d law at the end of 2019 returned the puter equipment, software, Internet like to have direct control over how kiddie tax to pre-TCJA law, retroactive service and, generally, room and your contributions are invested or to 2018. If your family paid the kiddie board) are income-tax-free for federal if you want to fund elementary or tax for 2018 under the TCJA rules, purposes and typically for state pur- secondary education expenses in you might be eligible for a refund for a poses as well, making the tax deferral excess of $10,000 per year or that portion of that tax. a permanent savings. aren’t tuition.

529 plans The TCJA permanently allows tax-free But the $2,000 contribution limit Section 529 plans provide another distributions for elementary and sec- is low, and it begins to phase out at tax-advantaged savings opportunity. ondary school tuition up to $10,000 per a MAGI of $190,000 for married You can choose a prepaid tuition plan year per student. The SECURE Act couples filing jointly and $95,000 for to secure current tuition rates or a further expands 529 plans by allowing other filers. No contribution can be tax-advantaged savings plan to fund them to be used to pay up to $10,000 made when MAGI hits $220,000 and education expenses. Here are some of student loans per beneficiary. $110,000, respectively. of the possible benefits of such plans: The biggest downside may be that you Also, contributions can generally y Although contributions aren’t don’t have direct control over invest- be made only for beneficiaries under deductible for federal purposes, any ment decisions; you’re limited to the age 18. When the beneficiary turns growth is tax-deferred. (Some states options the plan offers. Additionally, age 30, the ESA generally must be do offer tax breaks for contributing.) for funds already in the plan, you can distributed within 30 days, and any make changes to your investment earnings may be subject to tax and a y The plans usually offer high con- options only twice during the year or 10% penalty. tribution limits, and there are no when you change beneficiaries. For income limits for contributing. these reasons, some taxpayers prefer ABLE accounts y There’s generally no beneficiary Coverdell ESAs. Achieving a Better Life Experience age limit for contributions or accounts offer a tax-advantaged way distributions. But each time you make a new con- to fund qualified disability expenses tribution to a 529 savings plan, you for a beneficiary who became blind y You can control the account, even can select a different option for that or disabled before age 26. For federal after the child is of legal age. contribution, regardless of how many purposes, tax treatment is similar to y You can make tax-free rollovers to times you contribute throughout the that of Sec. 529 college savings plans. another qualifying family member. year. And every 12 months you can make a tax-free rollover to a different Under the TCJA, through 2025, y A special break for 529 plans allows 529 plan for the same child. 529 plan funds can be rolled over to you to front-load five years’ worth of an ABLE account without penalty annual gift tax exclusions and make ESAs if the ABLE account is owned by up to a $75,000 contribution (or Coverdell Education Savings Accounts the beneficiary of the 529 plan or a $150,000 if you split the gift with are like 529 savings plans in that con- member of the beneficiary’s family. your spouse) per beneficiary in 2020. tributions aren’t deductible for federal Such rolled-over amounts count purposes, but plan assets can grow toward the ABLE account annual Prepaid tuition vs. savings plan tax-deferred and distributions used to rollover and contribution limit With a 529 prepaid tuition plan, if your pay qualified education expenses are ($15,000 for 2020). contract is for four years of tuition, income-tax-free. tuition is guaranteed regardless of its American Opportunity credit cost at the time the beneficiary actually One of the biggest ESA advantages When your child enters college, you attends the school. One downside is used to be that they allowed tax-free may not qualify for the American that there’s uncertainty in how benefits distributions for elementary and Opportunity credit because your will be applied if the beneficiary attends secondary school costs and 529 plans income is too high (phaseout range of a different school. Another negative is didn’t. With the TCJA enhance- $80,000–$90,000; $160,000–$180,000 that the plan doesn’t cover costs other ments to 529 plans, this is less of for joint filers), but your child might. than tuition, such as room and board. an advantage. But ESAs still have The maximum credit, per student, is a leg up because they can be used $2,500 per year for the first four years A 529 college savings plan, on the other for elementary and secondary school of postsecondary education. And both hand, can be used to pay a student’s expenses other than just tuition — the credit and a tax-free 529 plan or expenses at most postsecondary and there’s no dollar limit on these ESA distribution can be taken as long educational institutions. Distributions annual distributions. Another as expenses paid with the distribution used to pay qualified postsecondary advantage is that you have more aren’t used to claim the credit. school expenses (such as tuition, investment options. 20 Retirement

Leverage the might of tax-advantaged retirement plans — and avoid tax traps

lthough you’re allowed to If you participate in a 401(k), 403(b) If you don’t have a traditional IRA, contribute only a limited or 457 plan, it may allow you to consider a “back door” Roth IRA: You A amount to tax-advantaged designate some or all of your contri- set up a traditional account and make retirement plans, those tax advantages butions as Roth contributions. While a nondeductible contribution to it. You make the plans especially powerful Roth contributions don’t reduce your then wait until the transaction clears for taxpayers in the top income tax current MAGI, qualified distributions and convert the traditional account to a brackets. But it’s also important to will be tax-free. Roth contributions Roth account. The only tax due will be revisit your retirement plans this year may be especially beneficial for higher- on any growth in the account between in light of new tax law changes plus income earners, who are ineligible to the time you made the contribution and the impact of the COVID-19 crisis. contribute to a Roth IRA. the date of conversion. Only then can you minimize taxes and maximize returns. Roth IRA conversions Early withdrawals If you have a traditional IRA, a partial With a few exceptions (see “What’s Retirement plan contributions or full conversion to a Roth IRA can new!” above right for a 2020 exception), Contributing the maximum you’re allow you to turn tax-deferred future retirement plan distributions before allowed (see Chart 6) to an employer- growth into tax-free growth. It also age 591 are subject to a 10% penalty sponsored defined contribution can provide estate planning advan- on top of any income tax that ordinarily plan, such as a 401(k), is likely a tages. Unlike other retirement plans, would be due on a withdrawal. This smart move: Roth IRAs don’t require you to take means that, if you’re in the top tax distributions during your lifetime, so bracket of 37%, you can lose almost y Contributions are typically you can let the entire balance grow half of your withdrawal to taxes and pretax, reducing your modified tax-free for the benefit of your heirs. penalties — and perhaps more than half adjusted gross income (MAGI). if you’re also subject to state income This in turn can help you reduce But the converted amount is taxable taxes and/or penalties. Additionally, or avoid exposure to the 3.8% in the year of the conversion. With you’ll lose the potential tax-deferred NIIT. (See page 11.) tax rates particularly low now under future growth on the withdrawn amount. the TCJA (and perhaps a better y Plan assets can grow tax- chance that your rate at retirement If you have a Roth account, you can deferred — meaning you pay will be higher), it may be a good withdraw up to your contribution no income tax until you take time for a Roth conversion. Your tax amount without incurring taxes or distributions. advisor can run the numbers and help penalties. But you’ll be losing the y Your employer may match some you decide if a conversion is right for potential tax-free growth on the with- or all of your contributions. you this year. drawn amount.

So if you’re in need of cash, consider tap- CHART 6 Retirement plan contribution limits for 2020 ping your taxable investment accounts rather than dipping into your retirement Regular contribution Catch-up contribution1 plan. (See page 8 for information on the Traditional and Roth IRAs $ 6,000 $ 1,000 tax treatment of investments.) 401(k)s, 403(b)s, $ 19,500 $ 6,500 Leaving a job 457s and SARSEPs2 When you change jobs or retire, avoid SIMPLEs $ 13,500 $ 3,000 taking a lump-sum distribution from 1 For taxpayers age 50 or older by the end of the tax year. your employer’s retirement plan because 2 Includes Roth versions where applicable. it generally will be taxable — and Note: Other factors may further limit your maximum contribution. If you’re a business owner or potentially subject to the 10% early- self-employed, you may be able to set up a plan that allows you to make much larger contributions. (See Chart 4 on page 15.) withdrawal penalty. These options help avoid current income tax and penalties: Retirement 21

Staying put. You may be allowed to leave WHAT’S your money in your old plan. But if you’ll CARES Act provides retirement plan relief be participating in a new employer’s plan NEW! or you already have an IRA, keeping track of multiple plans can make manag- In response to the COVID-19 crisis, the CARES Act provides some temporary ing your retirement assets more difficult. relief to retirement plan owners: 1. Owners who need funds from their accounts to help them financially A rollover to your new employer’s plan. survive the crisis. The act waives the 10% early withdrawal penalty — If you’re changing jobs and this will leave along with providing additional tax advantages that taxpayers age 59½ and you with only one retirement plan to older can also benefit from — on COVID-19-related distributions up to keep track of, it may be a good solution. $100,000. These generally are 2020 withdrawals made by someone who But evaluate how well the new plan’s has been (or whose family has been) infected with COVID-19 or who has investment options meet your needs. been economically harmed by the virus.

A rollover to an IRA. If you participate Distributions may be recontributed to the retirement plan over the three-year in a new employer’s plan, this will require period starting the day after the withdrawal. If distributions aren’t recontributed, keeping track of two plans. But it may be income tax payments can be spread out over three years. Many additional rules the best alternative because IRAs offer apply, so contact your tax advisor for details. nearly unlimited investment choices. 2. Owners who don’t need funds from their accounts this year. The act If you choose a rollover, request a direct waives retirement plan required minimum distributions for 2020. This poten- rollover from your old plan to your tially allows taxpayers to avoid having to sell plan investments during a down new plan or IRA. If the funds are sent market, giving time to recover lost value and providing continued tax deferral. to you by check, you’ll need to make an indirect rollover within 60 days to avoid tax and potential penalties. RMDs When RMD rules apply, if you don’t Historically, after a taxpayer has comply, you can owe a penalty equal Warning: If you don’t do a direct roll- reached age 701, he or she has had to to 50% of the amount you should have over, the check you receive from your old begin to take annual required mini- withdrawn but didn’t. You can avoid plan may be net of 20% federal income mum distributions from his or her IRAs the RMD rule for a non-IRA Roth plan tax withholding. Your subsequent indi- (except Roth IRAs) and, generally, by rolling the funds into a Roth IRA. rect rollover must be of the gross amount from any defined contribution plans. (making up for the withheld amount However, the age has increased — see Waiting as long as possible to take with other funds) or you’ll be subject to “What’s new!” below. In addition, the distributions generally is advantageous income tax — and potentially the 10% RMD rule has been waived for 2020 — because of tax-deferred compounding. penalty — on the difference. see “What’s new!” above. But a distribution (or larger distribu- tion) in a year your tax rate is lower than usual may save tax. WHAT’S NEW! Could you be affected by SECURE Act changes? Be sure, however, to consider the lost future tax-deferred growth and, if appli- The Setting Every Community Up for Retirement Enhance- cable, whether the distribution could: ment (SECURE) Act, signed into law in late 2019, makes 1) cause Social Security payments to a variety of tax law changes related to retirement plans. become taxable, 2) increase income- Here are some key changes that could affect you: based Medicare premiums and prescrip- tion drug charges, or 3) affect other n Allows penalty-free IRA withdrawals of up to $5,000 tax breaks with income-based limits. for the birth or adoption of a child, n Repeals the maximum age of 70½ for making traditional IRA contributions, Warning: While retirement plan distributions aren’t subject to the n Increases the age for beginning required minimum distributions (RMDs) additional 0.9% Medicare tax (see from age 70½ to age 72, for taxpayers who didn’t turn age 70½ before page 4) or 3.8% NIIT, they are Jan. 1, 2020 (that is, were born after June 30, 1949), and included in your MAGI. That means n Reduces the time period for taking IRA distributions to 10 years for they could trigger or increase the beneficiaries — other than surviving spouses and certain others — NIIT, because the thresholds for that inheriting IRAs after Dec. 31, 2019. tax are based on MAGI.

The SECURE Act also includes many provisions intended to make employer- If you’ve inherited a retirement plan, sponsored retirement plans more readily available. Contact your tax advisor or consult your tax advisor about the employee benefits advisor for more details. distribution rules that apply to you. 22 Estate Planning

Taking the right steps now can save taxes later

state planning is about much Chart 7.) Any gift tax exemption used The GST tax exemption can be a more than reducing taxes; during your lifetime reduces the estate valuable tax-saving tool for taxpayers E it’s about ensuring your loved tax exemption available at death. Using with large estates whose children ones are provided for after you’re gone up some of your exemption during your also have — or may eventually and that your assets are passed on lifetime can be tax-smart, especially if have — large estates. With proper according to your wishes. And because your estate exceeds roughly $6 million planning, they can use the exemption the TCJA has put estate, gift and (twice that if you’re married). (See Case to make transfers to grandchildren generation-skipping transfer (GST) Study 7.) and avoid any tax at their children’s tax exemptions at record-high levels, generation. far fewer taxpayers are worrying about You also can exclude certain gifts of these taxes. But the high exemptions up to $15,000 per recipient in 2020 State taxes currently are available only through ($30,000 per recipient if your spouse Even before the TCJA, many states 2025. And it’s possible the limits elects to split the gift with you or imposed estate tax at a lower thresh- could be reduced sooner. So whether you’re giving joint or community old than the federal government did. or not you’d be subject to estate taxes property) without depleting any of Now the differences in some states under the current exemptions, it’s a your gift and estate tax exemption. are even more dramatic. To avoid good idea to consider whether there unexpected tax liability or other are steps you can take now to save Warning: Each year you need to use unintended consequences, it’s critical taxes later. your annual exclusion by Dec. 31. to consider state law. Consult a tax The exclusion doesn’t carry over from advisor familiar with the law of your Estate tax year to year. For example, if you don’t particular state. While the TCJA keeps the estate make an annual exclusion gift to your tax rate at 40%, it has doubled granddaughter this year, you can’t add Exemption portability the exemption base amount from $15,000 to your 2021 exclusion to make a $30,000 tax-free gift to her next year. If one spouse dies and part (or all) $5 million to $10 million. The of his or her estate tax exemption is inflation-adjusted amount for 2020 unused at his or her death, the estate GST tax is $11.58 million. (See Chart 7.) can elect to permit the surviving The generation-skipping transfer (GST) spouse to use the deceased spouse’s Without further legislation, the tax generally applies to transfers (both remaining estate tax exemption. estate tax exemption will return to during your lifetime and at death) made This exemption “portability” pro- an inflation-adjusted $5 million in to people more than one generation vides flexibility at the time of the 2026. So taxpayers with estates in below you, such as your grandchildren. first spouse’s death, but it has some the roughly $6 million to $11 million This is in addition to any gift or estate limits. Portability is available only range (twice that for married couples), tax due. The GST tax continues to from the most recently deceased whose estates would escape estate follow the estate tax, so the GST tax spouse, doesn’t apply to the GST taxes if they were to die while the exemption also has increased under the tax exemption and isn’t recognized doubled exemption is in effect, still TCJA. (See Chart 7.) by many states. need to keep potential post-2025 estate tax liability in mind in their estate planning. It’s also possible the CHART 7 2020 transfer tax exemptions and rates exemption could be reduced sooner than 2026. Estate tax Gift tax GST tax Gift tax Exemption $11.58 million1 $11.58 million $11.58 million The gift tax continues to follow the Rate 40% 40% 40% estate tax, so the gift tax exemption also 1 Less any gift tax exemption already used during life. has increased under the TCJA. (See Estate Planning 23

And portability doesn’t protect future growth on assets from estate tax like CASE Taking advantage of valuation discounts applying the exemption to a credit STUDY 7 shelter (or bypass) trust does. Such Celia had been planning to begin succession planning a trust offers other benefits as well, for her business in a few years. But with the events of such as creditor protection, remarriage 2020, she decided she should start planning sooner. protection, GST tax planning and So she made an appointment with her tax and estate possible state estate tax benefits. planning advisors.

So married couples should still They recommended that she begin leveraging her consider these trusts — and consider gift tax exclusions and exemption by gifting owner- transferring assets to each other to the ship interests, which may be eligible for valuation extent necessary to fully fund them at discounts. So, for example, if the combined discount is 25%, in 2020 she can the first death. Transfers to a spouse gift an ownership interest equal to as much as $20,000 tax-free because the (during life or at death) aren’t subject discounted value doesn’t exceed the $15,000 annual exclusion. to gift or estate tax as long as he or If her business has declined in value because of 2020 events, a silver lining is she is a U.S. citizen. that Celia may be able to transfer an even larger portion of her business tax-free.

Tax-smart giving But she doesn’t want to transfer ownership interests to her children who aren’t Giving away assets now will help reduce active in the business. Her advisors suggest that she can still potentially benefit the size of your taxable estate. Here are from valuation discounts on transfers of other assets to them by setting up a some strategies for tax-smart giving: family limited partnership. She can fund the FLP with public stock and real estate, and then gift limited partnership interests. Choose gifts wisely. Consider both Celia’s advisors warn her that the IRS may challenge valuation discounts; they estate and income tax consequences recommend a professional, independent valuation. The IRS also scrutinizes and the economic aspects of any gifts FLPs, so she must be sure to properly set up and operate hers. you’d like to make: y To minimize estate tax, gift property Make gifts to charity. Donations to savings while preserving some control with the greatest future appreciation qualified charities aren’t subject to over what happens to the transferred potential. gift tax. They may also be eligible for assets. For those with large estates, an income tax deduction, but this funding them now, while the gift tax y To minimize your beneficiary’s deduction may benefit fewer taxpayers exemption is high, may be particularly income tax, gift property that hasn’t than in the past. (See page 16.) tax-smart. Here are some types of appreciated significantly while trusts to consider: you’ve owned it. Consider “taxable” gifts. Making y To minimize your own income tax, some gifts beyond annual exclusion A qualified personal residence trust don’t gift property that’s declined in gifts and using some or all of your life- (QPRT). It allows you to give your value. Instead, consider selling the time exemption can make sense if you home to your children today — property so you can take the tax loss have a large estate. These “taxable” removing it from your taxable estate and then gifting the sale proceeds. gifts can protect transfers from gift and at a reduced gift tax cost (provided estate tax, even if the exemption drops you survive the trust’s term) — while Plan gifts to grandchildren carefully. in the future. They also remove the you retain the right to live in it for a Annual exclusion gifts are generally future appreciation from your estate. certain period. exempt from the GST tax, so they also help you preserve your GST tax You do, however, need to keep in mind A grantor-retained annuity trust exemption for other transfers. For your beneficiaries’ income tax. Gifted (GRAT). It works on the same gifts to a grandchild that don’t qualify assets don’t receive the “step-up” in principle as a QPRT, but allows you for the exclusion to be tax-free, you basis that bequeathed assets do. This to transfer other assets; you receive generally must apply both your GST means that, if beneficiaries sell assets payments back from the trust for a tax exemption and your gift tax gifted to them, their taxable capital certain period. exemption. gains will be determined based on your basis in the assets. So their capital A GST — or “dynasty” — trust. It Pay tuition and medical expenses. gains tax could be higher than if they can help you leverage both your gift You may pay these expenses without inherited the same assets. and GST tax exemptions. And it can the payment being treated as a taxable be an excellent way to potentially gift to the student or patient, as long Trusts lock in the currently high exemptions as the payment is made directly to Trusts can provide a way to transfer while removing future appreciation the provider. assets and potentially enjoy some tax from your estate. 24 Tax Rates

CHART 8 2020 individual income tax rate schedules

Tax rate Regular tax brackets Married filing jointly Married filing Single Head of household or surviving spouse separately 10% $ 0 – $ 9,875 $ 0 – $ 14,100 $ 0 – $ 19,750 $ 0 – $ 9,875 12% $ 9,876 – $ 40,125 $ 14,101 – $ 53,700 $ 19,751 – $ 80,250 $ 9,876 – $ 40,125 22% $ 40,126 – $ 85,525 $ 53,701 – $ 85,500 $ 80,251 – $ 171,050 $ 40,126 – $ 85,525 24% $ 85,526 – $ 163,300 $ 85,501 – $ 163,300 $ 171,051 – $ 326,600 $ 85,526 – $ 163,300 32% $ 163,301 – $ 207,350 $ 163,301 – $ 207,350 $ 326,601 – $ 414,700 $ 163,301 – $ 207,350 35% $ 207,351 – $ 518,400 $ 207,351 – $ 518,400 $ 414,701 – $ 622,050 $ 207,351 – $ 311,025 37% Over $ 518,400 Over $ 518,400 Over $ 622,050 Over $ 311,025 Tax rate AMT brackets

Married filing jointly Married filing Single Head of household or surviving spouse separately 26% $ 0 – $ 197,900 $ 0 – $ 197,900 $ 0 – $ 197,900 $ 0 – $ 98,950 28% Over $ 197,900 Over $ 197,900 Over $ 197,900 Over $ 98,950 AMT exemptions

Married filing jointly Married filing Single Head of household or surviving spouse separately Amount $ 72,900 $ 72,900 $ 113,400 $ 56,700 Phaseout1 $ 518,400 – $ 810,000 $ 518,400 – $ 810,000 $ 1,036,800 – $ 1,490,400 $ 518,400 – $ 745,200

1 The AMT income ranges over which the exemption phases out and only a partial exemption is available. The exemption is completely phased out if AMT income exceeds the top of the applicable range. Note: Consult your tax advisor for AMT rates and exemptions for children subject to the “kiddie tax.”

CHART 9 2020 corporate income tax rates

Tax rate Type of corporation 21% C corporation 21% Personal service corporation

CHART 10 2020 estate and trust income tax rate schedule

Tax rate Tax brackets 10% $ 0 – $ 2,600 24% $ 2,601 – $ 9,450 35% $ 9,451 – $ 12,950 37% Over $ 12,950

This publication was developed by a third-party publisher and is distributed with the understanding that the publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters and recommend you consult an attorney, accountant, tax professional, financial advisor or other appropriate industry professional. This publication reflects tax law as of Aug. 31, 2020. Some material may be affected by subsequent changes in the laws or in the interpretation of such laws. Therefore, the services of a legal or tax advisor should be sought before implementing any ideas contained in this publication. © 2020 401 DeMers Avenue, Suite 300 24 West Central Avenue 2257 Third Avenue West P.O. Box 14296 P.O. Box 848 Dickinson, ND 58601-2605 Grand Forks, ND 58208-4296 Minot, ND 58702-0848 (701) 483-6000 (701) 775-4685 (701) 852-0196 Fax: (701) 483-6004 Fax: (701) 795-7498 Fax: (701) 839-5452 117 South Broadway Crookston, MN 56716 (218) 281-3789 Fax: (218) 281-5245 207 East Broadway Avenue 100 East 3rd Street P.O. Box 1297 P.O. Box 790 2537 S University Dr Bismarck, ND 58502-1297 Thief River Falls, MN 56701-0790 Fargo, ND 58103 (701) 223-1717 (218) 681-6265 701-280-2100 Fax: (701) 222-0894 Fax: (218) 681-1789 Fax: 701-280-0719

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