WESTON & GREGORY, LLC
CERTIFIED PUBLIC ACCOUNTANTS
100 La Costa Lane, Suite 100
Daytona Beach, FL 32114-8158
Tax compliance and planning for 2020 and 2021 takes place during the COVID-19 pandemic, which in addition to its devastating health and mortality impact has widely affected personal and business finances. New tax rules have been enacted to help mitigate the financial impact of the disease, some of which should be considered for your 2020 taxes as well as planning for 2021.
Major tax changes from recent years generally remain in place, including lower income tax rates, larger standard deductions, limited itemized deductions, elimination of personal exemptions, an increased child tax credit, and a lessened alternative minimum tax (AMT) for individuals, as well as the valuable pass-through deduction available to non-corporate taxpayers with certain income from pass-through entities. Also, still in place is the major corporate tax rate reduction and elimination of the corporate AMT, limits on interest deductions, and generous expensing and depreciation rules for businesses.
The following are some tax planning opportunities that may benefit you as we move into 2021, as well as highlights of some of the more significant tax law changes to assist you in gathering your 2020 tax information and/or highlight areas that may affect your 2020 and 2021 personal tax situation.
Many taxpayers will not be able to itemize because of the high basic standard deduction amounts that apply for 2020 ($24,800 for joint filers, $12,400 for singles and for marrieds filing separately, $18,650 for heads of household), and because many itemized deductions have been reduced or abolished. Like last year, no more than $10,000 of state and local taxes may be deducted; miscellaneous itemized deductions (e.g., unreimbursed employee expenses) are not deductible; and personal casualty and theft losses are deductible only if they are attributable to a federally declared disaster and only to the extent the $100-per-casualty and 10%-of-AGI limits are met. You can still itemize medical expenses but only to the extent they exceed 7.5% of your adjusted gross income, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt, but payments of those items will not save taxes if they do not cumulatively exceed the standard deduction for your filing status. Two COVID-related changes for 2020 may be relevant here: (1) Individuals may claim a $300 above-the-line deduction for cash charitable contributions on top of their standard deduction; and the percentage limit on charitable contributions has been raised from 60% of modified adjusted gross income (MAGI) to 100%.
Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer's taxable income. If you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains that can be sheltered by the 0% rate. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that, when added to regular taxable income, it is not more than the maximum zero rate amount (e.g., $80,000 for a married couple).
Net Investment Income Tax
Higher-income earners must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
Charitable Giving through Individual Retirement Accounts
If you are age 70½ or older, have traditional IRAs, and especially if you are unable to itemize your deductions, consider making charitable donations via qualified charitable distributions from your IRAs. These distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. However, you are still entitled to claim the entire standard deduction. Previously, those who reached reach age 70½ during a year were not permitted to make contributions to a traditional IRA for that year or any later year. While that restriction no longer applies, the qualified charitable distribution amount must be reduced by contributions to an IRA that were deducted for any year in which the contributor was age 70½ or older, unless a previous qualified charitable distribution exclusion was reduced by that post-age 70½ contribution. If you are younger than age 70½, you anticipate that you will not itemize your deductions in later years when you are 70½ or older, consider making maximum contributions to one or more traditional IRAs. Then, in the year you reach age 70½, make your charitable donations by way of qualified charitable distributions from your IRA. Doing this will allow you, in effect, to convert nondeductible charitable contributions that you make in the year you turn 70½ and later years, into deductible-in-2020 IRA contributions and reductions of gross income from later year distributions from the IRAs.
If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in any beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for the tax year, and possibly reduce tax breaks geared to AGI (or modified AGI).
The “Setting Every Community Up for Retirement Enhancement” Act of 2019 (SECURE Act)
The SECURE Act expands opportunities for individuals to increase their savings and makes administrative simplifications to the retirement system. Some of the more important elements of the SECURE Act that have an impact on individuals are as follows:
Repeal of the maximum age for traditional IRA contributions.
Before 2020, traditional IRA contributions were not allowed once the individual attained age 70½. Starting in 2020, the new rules allow an individual of any age to make contributions to a traditional IRA, as long as the individual has compensation, which generally means earned income from wages or self-employment.
Required minimum distribution age raised from 70½ to 72.
Before 2020, retirement plan participants and IRA owners were generally required to begin taking required minimum distributions, or RMDs, from their plan by April 1 of the year following the year they reached age 70½. The age 70½ requirement was first applied in the retirement plan context in the early 1960s and, until recently, had not been adjusted to account for increases in life expectancy. For distributions required to be made after Dec. 31, 2019, for individuals who attain age 70½ after that date, the age at which individuals must begin taking distributions from their retirement plan or IRA is increased from 70½ to 72.
Partial elimination of stretch IRAs.
For deaths of plan participants or IRA owners occurring before 2020, beneficiaries (both spousal and nonspousal) were generally allowed to stretch out the tax-deferral advantages of the plan or IRA by taking distributions over the beneficiary’s life or life expectancy (in the IRA context, this is sometimes referred to as a “stretch IRA”).
However, for deaths of plan participants or IRA owners beginning in 2020 (later for some participants in collectively bargained plans and governmental plans), distributions to most nonspouse beneficiaries are generally required to be distributed within ten years following the plan participant’s or IRA owner’s death. So, for those beneficiaries, the “stretching” strategy is no longer allowed. Exceptions to the 10-year rule are allowed for distributions to (1) the surviving spouse of the plan participant or IRA owner; (2) a child of the plan participant or IRA owner who has not reached majority; (3) a chronically ill individual; and (4) any other individual who is not more than ten years younger than the plan participant or IRA owner. Those beneficiaries who qualify under this exception may generally still take their distributions over their life expectancy (as allowed under the rules in effect for deaths occurring before 2020).
Expansion of Section 529 education savings plans to cover registered apprenticeships and distributions to repay certain student loans.
A Section 529 education savings plan (a 529 plan, also known as a qualified tuition program) is a tax-exempt program established and maintained by a state, or one or more eligible educational institutions (public or private). Any person can make nondeductible cash contributions to a 529 plan on behalf of a designated beneficiary. The earnings on the contributions accumulate tax-free. Distributions from a 529 plan are excludable up to the amount of the designated beneficiary's qualified higher education expenses. Before 2019, qualified higher education expenses did not include the expenses of registered apprenticeships or student loan repayments. But for distributions made after Dec. 31, 2018 (the effective date is retroactive), tax-free distributions from 529 plans can be used to pay for fees, books, supplies, and equipment required for the designated beneficiary’s participation in an apprenticeship program. In addition, tax-free distributions (up to $10,000) are allowed to pay the principal or interest on a qualified education loan of the designated beneficiary, or a sibling of the designated beneficiary.
Kiddie tax changes for gold star children and others.
In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA, P.L. 115-97), which made changes to the so-called “kiddie tax,” which is a tax on the unearned income of certain children. Before enactment of the TCJA, the net unearned income of a child was taxed at the parents' tax rates if the parents' tax rates were higher than the tax rates of the child. Under the TCJA, for tax years beginning after Dec. 31, 2017, the taxable income of a child attributable to net unearned income is taxed according to the brackets applicable to trusts and estates. Children to whom the kiddie tax rules apply and who have net unearned income also have a reduced exemption amount under the alternative minimum tax (AMT) rules. The new rules enacted on Dec. 20, 2019, repeal the kiddie tax measures that were added by the TCJA. So, starting in 2020 (with the option to start retroactively in 2018 and/or 2019), the unearned income of children is taxed under the pre-TCJA rules, and not at trust/estate rates. And starting retroactively in 2018, the new rules also eliminate the reduced AMT exemption amount for children to whom the kiddie tax rules apply and who have net unearned income.
Penalty-free retirement plan withdrawals for expenses related to the birth or adoption of a child.
Generally, a distribution from a retirement plan must be included in income. And, unless an exception applies (for example, distributions in case of financial hardship), a distribution before the age of 59-1/2 is subject to a 10% early withdrawal penalty on the amount includible in income. Starting in 2020, plan distributions (up to $5,000) that are used to pay for expenses related to the birth or adoption of a child are penalty-free. That $5,000 amount applies on an individual basis, so for a married couple, each spouse may receive a penalty-free distribution up to $5,000 for a qualified birth or adoption.
Taxable non-tuition fellowship and stipend payments are treated as compensation for IRA purposes.
Before 2020, stipends and non-tuition fellowship payments received by graduate and postdoctoral students were not treated as compensation for IRA contribution purposes, and so could not be used as the basis for making IRA contributions. Starting in 2020, the new rules remove that obstacle by permitting taxable non-tuition fellowship and stipend payments to be treated as compensation for IRA contribution purposes. This change will enable these students to begin saving for retirement without delay.
Coronavirus Aid, Relief, and Economic Security (CARES) Act
The CARES Act was signed into law on March 27, 2020. Following are some of the tax provisions in this law as they apply to individuals.
Recovery rebates for individuals.
To help individuals stay afloat during this time of economic uncertainty, the government sent up to $1,200 payments to eligible taxpayers and $2,400 for married couples filing joints returns. An additional $500 additional payment was sent to taxpayers for each qualifying child dependent under age 17 (using the qualification rules under the Child Tax Credit).
Waiver of 10% early distribution penalty.
The additional 10% tax on early distributions from IRAs and defined contribution plans (such as 401(k) plans) is waived for distributions made between January 1 and December 31, 2020 by a person who (or whose family) is infected with the Coronavirus or who is economically harmed by the Coronavirus (a qualified individual). Penalty-free distributions are limited to $100,000, and may, subject to guidelines, be re-contributed to the plan or IRA. Income arising from the distributions is spread out over three years unless the employee elects to turn down the spread out. Employers may amend defined contribution plans to provide for these distributions. Additionally, defined contribution plans are permitted additional flexibility in the amount and repayment terms of loans to employees who are qualified individuals.
Waiver of required distribution rules.
Required minimum distributions that otherwise would have to be made in 2020 from defined contribution plans (such as 401(k) plans) and IRAs are waived. This includes distributions that would have been required by April 1, 2020, due to the account owner’s having turned age 70 1/2 in 2019.
Charitable deduction liberalizations.
The CARES Act makes four significant liberalizations to the rules governing charitable deductions:
(1) Individuals will be able to claim a $300 above-the-line deduction for cash contributions made, generally, to public charities in 2020. This rule effectively allows a limited charitable deduction to taxpayers claiming the standard deduction.
(2) The limitation on charitable deductions for individuals that is generally 60% of modified adjusted gross income (the contribution base) does not apply to cash contributions made, generally, to public charities in 2020 (qualifying contributions). Instead, an individual’s qualifying contributions, reduced by other contributions, can be as much as 100% of the contribution base. No connection between the contributions and COVID-19 activities is required.
(3) Similarly, the limitation on charitable deductions for corporations that is generally 10% of (modified) taxable income does not apply to qualifying contributions made in 2020. Instead, a corporation’s qualifying contributions, reduced by other contributions, can be as much as 25% of (modified) taxable income. No connection between the contributions and COVID-19 activities is required.
(4) For contributions of food inventory made in 2020, the deduction limitation increases from 15% to 25% of taxable income for C corporations and, for other taxpayers, from 15% to 25% of the net aggregate income from all businesses from which the contributions were made.
Exclusion for employer payments of student loans.
An employee currently may exclude $5,250 from income for benefits from an employer-sponsored educational assistance program. The CARES Act expands the definition of expenses qualifying for the exclusion to include employer payments of student loan debt made before January 1, 2021.
Break for remote care services provided by high deductible health plans.
For plan years beginning before 2021, the CARES Act allows high deductible health plans to pay for expenses for tele-health and other remote services without regard to the deductible amount for the plan.
Break for nonprescription medical products.
For amounts paid after December 31, 2019, the CARES Act allows amounts paid from Health Savings Accounts and Archer Medical Savings Accounts to be treated as paid for medical care even if they are not paid under a prescription. And, amounts paid for menstrual care products are treated as amounts paid for medical care. For reimbursements after December 31, 2019, the same rules apply to Flexible Spending Arrangements and Health Reimbursement Arrangements.
The Consolidated Appropriations Act, 2021
The COVID-Related Tax Relief Act of 2020 (COVIDTRA) and the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (TCDTR), both part of The Consolidated Appropriations Act, 2021 (CAA, 2021) was signed into law on December 27, 2020 and contains numerous provisions related to individual income tax. Below is a summary of some of those provisions.
New Recovery Rebate.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act, PL 116-136) provided for direct payments/rebates to certain individual taxpayers. These were referred to as Economic Impact Payments (EIPs).
New law. The COVIDTRA contains a new program, which it refers to as "additional 2020 recovery rebates." The provision provides a refundable tax credit to eligible individuals in the amount of $600 per eligible family member. The credit is $600 per taxpayer ($1,200 for married filing jointly), in addition to $600 per qualifying child. The credit phases out starting at $75,000 of modified adjusted gross income ($112,500 for heads of household and $150,000 for married filing jointly) at a rate of $5 per $100 of additional income. The term "eligible individual" does not include any nonresident alien, anyone who qualifies as another person's dependent, and estates or trusts. The credit is available on the taxpayer's 2020 return. The provision provides for Treasury to issue advance payments based on the information on 2019 tax returns. Eligible taxpayers treated as providing returns through the nonfiler portal with respect to their EIP, will also receive payments. In general, taxpayers without an eligible Social Security number are not eligible for the payment. However, married taxpayers filing jointly where one spouse has a Social Security Number and one spouse does not are eligible for a payment of $600, in addition to $600 per child with a Social Security Number. Taxpayers receiving an advance payment that exceeds the amount of their eligible credit will not be required to repay any amount of the payment. If the amount of the credit determined on the taxpayer’s 2020 tax return exceeds the amount of the advance payment, taxpayers will receive the difference as a refundable tax credit. Advance payments are generally not subject to administrative offset for past due federal or state debts. In addition, the payments are protected from bank garnishment or levy by private creditors or debt collectors.
Amendments to CARES Act Economic Impact Payment Rules.
The CARES Act provided for direct payments/rebates to certain individual taxpayers. These were referred to as Economic Impact Payments (EIP).
New law. The COVIDTRA makes the following changes to the CARES Act EIP:
The $150,000 limit on adjusted gross income before the credit amount starts to decrease, which, under the CARES Act applied to joint returns, also applies to surviving spouses.
Changes the requirement, in order to be eligible for an EIP, with respect to providing IRS with the taxpayer's identification number, to conform to that requirement under the new rebate described above under "New Recovery Rebate."
$250 Educator Expense Deduction Applies to PPE.
Eligible educators (i.e., kindergarten through grade 12 teachers, instructors, etc.) are allowed a $250 above-the-line deduction for certain otherwise allowable trade or business expenses paid by them.
New law. COVIDTRA provides that, not later than February 28, 2021, the IRS must, by regulation or other guidance, clarify that personal protective equipment (PPE), disinfectant, and other supplies used for the prevention of the spread of COVID-19 are treated as deductible educator expenses. Such regulations or other guidance will apply to expenses paid or incurred after March 12, 2020.
Emergency Financial Aid Grants.
An individual taxpayer may claim the American opportunity tax credit and/or the Lifetime Learning credit for higher education expenses at accredited post-secondary educational institutions paid for themselves, their spouses, and their dependents. However, under Code Sec. 25A(g)(2), higher education expenses paid for by tax-exempt income can’t be used to claim either of these credits.
New law. COVIDTRA excludes certain CARES Act emergency financial aid grants from the gross income of college and university students. This provision also holds students harmless for purposes of determining their eligibility for the American Opportunity and Lifetime Learning tax credits. This provision applies to qualified emergency financial aid grants made after March 26, 2020.
Individuals May Base 2020 Refundable CTC & EIC on Preceding Year's Earned Income.
Under Code Sec. 24(d)(1)(B)(i), to the extent the child tax credit (CTC) exceeds the taxpayer's tax liability, the taxpayer is eligible for a refundable credit equal to 15% percent of so much of the taxpayer's taxable earned income for the tax year as exceeds $2,500. And under Code Sec. 32(a), the earned income credit (EIC) equals a percentage of the taxpayer's earned income. For both purposes, earned income means wages, salaries, tips, and other employee compensation, if includible in gross income for the tax year. Earned income also includes self-employment income, computed without the deduction for one-half of self-employment tax.
New law. Under the TCDTR, in determining the refundable CTC and the EIC for 2020, taxpayers may elect to substitute the earned income for the preceding tax year if that is greater than the taxpayer's earned income for 2020. For joint returns, the taxpayer's earned income for the preceding tax year is the sum of each spouse's earned income for that preceding tax year. An incorrect use on a return of earned income under TCDTR Sec. 211(a) (above) is a mathematical or clerical error for which IRS may make a summary assessment. The substitution of the previous year's earned income allowed under TCDTR Sec. 211(a) (above) has no other effect on the application of the Internal Revenue Code. These changes apply to the taxpayer's first tax year beginning in 2020.
Certain Charitable Contributions Deductible by Non-Itemizer.
For 2020, individuals who normally do not itemize deductions may take up to a $300 above-the-line deduction for cash contributions to qualified charitable organizations. This $300 limit also applies to married filers. A 20% penalty applies to tax underpayments attributable to any overstated cash contribution by non-itemizers.
New law. The TCDTR extends the above rule through 2021, allowing individual cash contributions of up to $300, ($600 for married filers) to be deducted above-the-line for cash contributions to qualified charitable organizations. An increased penalty of 50% applies to tax underpayments attributable to any overstated cash contribution by non-itemizers.
Modification of Limitations on Charitable Contributions.
Under pre-TCDTR law, individuals could not take an itemized deduction of more than 60% of their contribution base on charitable contributions, of cash, made to 50% charities.
New law. For 2020 and 2021, the percentage limitation rules for individuals making qualified charitable contributions, in cash, to 50% charities do not apply.
Temporary Special Rules for Health and Dependent Care Flexible Spending Arrangements.
A cafeteria plan may permit the carryover of unused amounts remaining in a health FSA as of the end of a plan year to pay or reimburse a participant for medical care expenses incurred during the following plan year, subject to the carryover limit (currently $550). This is sometimes referred to as the carryover rule.
New law. The TCDTR expands the carryover period for 2020, and 2021. The provision also allows employers to extend the grace period for plan years ending in 2020 and 2021 to 12 months after the end of such plan year for unused benefits and contributions to health flexible spending and dependent care flexible spending arrangements. In addition, an employer may allow an employee who ceases to participate in the plan during calendar year 2020 or 2021 to continue to receive reimbursements from unused benefits or contributions through the end of the plan year in which the employee's participation ceased, including any extended grace period. The TCDTR also provides a special carry forward rule for dependent care flexible spending arrangements where the dependent aged out during the pandemic.
Small Business Considerations
Section 199A Passthrough Tax Break
Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2020, if taxable income exceeds $326,600 for a married couple filing jointly, $163,300 for singles, marrieds filing separately, and heads of household, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in; for example, the phase-in applies to joint filers with taxable income between $326,600 and $426,600, and to all other filers with taxable income between $163,300 and $213,300.
Method of Accounting
More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test. For 2020, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts do not exceed $26 million (the dollar amount was $25 million for 2018, and for earlier years it was $1 million for most businesses). Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
Depreciation Related Deductions
Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2020, the expensing limit is $1,040,000, and the investment ceiling limit is $2,590,000. Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It is also available for qualified improvement property (generally, any interior improvement to a building's interior, but not for enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems. The generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment.
Businesses also can claim a 100% bonus first year depreciation deduction for machinery and equipment bought used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property, described above as related to the expensing deduction. The 100% write off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write off is available even if qualifying assets are in service for only a few days in 2020.
Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs do not have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property cannot exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA's report). If there is no AFS, the cost of a unit of property cannot exceed $2,500.
This letter is based on the current federal tax laws, rules, and regulations. Please remember this letter is intended to serve only as a general guideline and each taxpayer’s circumstances should be considered before any significant opportunities are utilized. Please let us know if you would like to schedule a meeting to assist you with all your tax planning needs.
We appreciate having you as a client.
Very truly yours,
Weston & Gregory, LLC