In Part 2 of our month long discussion on year-end tax strategies we will put tax policy aside and talk more about income tax planning using blocking and tackling techniques. These techniques are things that should be reviewed with your accountant each year to insure you are reducing your taxable income as much as possible. Let’s take a look at eight block and tackle methods, you may even be familiar with.

The techniques below are things that should be reviewed with your accountant as we are not tax advisors. The information provided is for education purposes only, your tax situation is unique so we encourage you to work with Grover Financial Services and your accountant to maximize your strategy.

8 Block & Tackle Methods

Volatility and Tax-Loss Harvesting

No one likes losing money to market volatility and when this happens a paper loss can occur. This means that on paper you have lost the money that year but you haven’t taken the money out of the market. Even though this isn’t great, there is a silver lining. You may be able to off-set these losses against any capital gains you may have taken earlier in the year or that may have been paid out by mutual funds. To “harvest” these losses you can sell losing positions which can lower your tax bill.  

However, when you make any changes to your portfolio it’s important to bring it back into balance and we can make sure you do. We do this buy purchasing a security or ETF similar to the sold security. In doing this we avoid a “wash sale” which is a tax rule that doesn’t allow you to take a capital loss if you purchase the same or “substantially identical” security in 30 days. 

Tax-Efficient Trust Distributions

Trusts are taxed at the highest rate, 37%, and this rate kicks in at a mere $12,950. In addition, trusts also pay a 3.8% Net Investment Income Tax at that level. If you have a family trust that isn’t going to distribute income this tax year you may want to consider making current distributions to some of the beneficiaries. If you do this we can help you find tax-efficient ways to distribute the money.

Be Aware of the Kiddie Tax

The 2017 Tax Cuts and Jobs Act (TCJA) created unexpected tax increases to many. With the act any investment income and capital gains in a child’s account is taxed at their parents’ highest rate. This applies to all children under age 18 and to those between the ages of 18 and 23 who are full-time students.

Using Breakpoints in the Long-Term Capital Gains Rate Schedule

If your income is less than $40,000 single or $80,000 married filing jointly, you will be taxed at a 0% rate on capital gains. This usually happens for younger folks just entering the work force or for those who are in retirement. However, taxable retirement accounts and trust distributions are part of the income calculation, so it’s important to plan carefully. By doing that you and your tax-preparer may achieve beneficial results.

Fully Fund Your IRA or 401(k)

Contributions to your IRA or 401(k) are deducted from income, a plus, but they are subject to limitations, a minus. Be sure to revisit the limits with your accountant if you are over age 50 so you can be sure you’re taking full advantage of the opportunity.

Consider Converting a Traditional IRA to a Roth IRA

The benefit of converting your IRA to a Roth IRA is in the fact that while the amount is included in your taxable income in the year of conversion, the Roth IRA will continue on tax-free and is not subject to income tax when withdrawn. There are a few things to consider when doing this, like the long-term effectiveness of a conversion, so be sure to discuss it with your tax preparer.

Make Annual Exclusion Gifts

If you are lucky enough to be in a position to gift money, you can give up to $15,000 per year to an unlimited number of individuals free of gift tax. You can also create income tax savings by giving property to heirs in a lower income tax bracket during your lifetime. Be sure to speak with your accountant about how to maximize the value received by your heirs by giving cash or high-basis assets so the recipient isn’t burdened with income tax consequences. With low-basis, highly appreciated assets are used more tax-efficiently for charitable gifts.

Fund 529 Plans

Over 30 states offer a state income tax credit or deduction when you make a contribution to a 529 plan for an individual and you don’t have to be related to get the benefit. Funds in the plan accumulate income tax-free and are never subject to income tax unless used for unapproved purposes. A 529 plan can even be the recipient of an annual exclusion gift. Recent federal legislative changes now permit the use of 529 plan funds for K–12 private education, college and graduate school and vocational and trade schools.

I hope I have given you some food for thought and some things to discuss with us and especially with your accountant. Join us next week for Part 3 of our month long discussion on year-end tax strategies when we will take a look at using tax efficient charitable gifts to soften the blow. Have a wonderful week!

P.S. If you enjoyed what you've read here and found it beneficial, we encourage you to share it with your friends and family. I firmly believe that and educated investor is more confident, which leads to healthy finances and fewer sleepless nights. 

Source: 2020 Year-End Tax Planning