In addition to emergency assistance and health-care response for individuals, families, and businesses, the pandemic relief bill – the CARES Act – passed earlier this year, included a variety of provisions to help protect and enhance savings for workers, retirement savers, and retirees.
Most of these programs are in place until the end of the year. As investors consider year-end planning, they may want to consider many tax-smart strategies before they expire.
Here are some strategies for year-end planning discussions.
1. Time is running out to take a penalty-free distribution
- The CARES Act allows for penalty-free distribution from retirement accounts up to $100,000
- Who is qualified to take a distribution?
- Individuals diagnosed with COVID-19, or a spouse or dependent diagnosed with COVID
- Those who have experienced adverse financial consequences – being quarantined, furloughed/laid off, reduced hours, or job offer withdrawn
- Those who are unable to work due to lack of child care
- Business owners experiencing financial issues as a result of closing or reducing hours
- Recipients of these distributions have the option of re-contributing all or a portion of the distribution into a retirement account within three years to avoid taxation on that portion*
2. Know options to report income from a CARES Act distribution on a tax return
- Though the 10% penalty is waived, the CARES Act distributions from pretax retirement accounts are considered taxable income
- The IRS assumes that this income will be spread evenly over the next three years
- However, taxpayers can also opt to report all of the income on their 2020 tax return if that is more beneficial from a tax perspective
3. Be mindful of changes to charitable contributions
- A new above-the-line $300 deduction and temporary increase in the adjusted gross income (AGI) limit for deducting certain charitable contributions
- For more details on these changes, read our recent blog, "Key changes for charitable giving in 2020."
4. Business owners with losses may consider relaxed tax rules
- Business owners with net operating losses (NOLs) in 2020 are able to carry back and apply those losses to prior tax returns (maximum of five years)
- Also, the CARES Act temporarily removes the taxable income limitation to allow an NOL to fully offset income. Prior to this change, taxpayers were limited to applying an NOL against 80% of taxable income. The 80% limitation will apply again beginning in 2021. Learn more about NOLs in this investor education piece, “Apply a net operating loss to a Roth IRA conversion.”
5. Don’t forget that RMDs are suspended for 2020
- Since many older retirement account owners typically request RMDs annually in December to satisfy minimum distribution requirements, remember that the rules have temporarily changed this year
- The CARES Act suspends RMDs in 2020 for account owners, those who have inherited retirement accounts, and people who reached their required beginning date (RBD) in 2019 but planned on waiting until 2020 to take their first required distribution
6. Unemployment benefits are considered taxable income
- The economic toll from the pandemic crisis resulted in a wave of workers applying for unemployment benefits, many for the first time in their working lives
- Those who are not familiar with unemployment benefits may not realize that these payments are generally considered taxable income at the federal level. Most states tax unemployment benefits as well
- Check your records to see if taxes were withheld from your benefits to avoid a surprise when filing your 2020 tax return next year
* You may recontribute all or part of certain coronavirus-related distributions to an eligible retirement plan (including an IRA) within three years beginning on the day after the date you received the distribution. Repayments will be treated as though they were eligible direct rollovers. Amounts repaid are not subject to any contribution or rollover limits. The distribution is treated as though you repaid it in a direct trustee-to-trustee transfer so you don’t owe federal income tax on the distribution. You can claim a refund for any income taxes paid on amounts previously included in income. Only coronavirus-related distributions that are eligible for tax-free rollover treatment under Section 402(c), 403(a)(4), 403(b)(8), 408(d)(3), or 457(e)(16) may be recontributed.
Financial professionals [login required]:
Major retirement legislation, a pandemic prompting record-breaking fiscal stimulus, and a contentious presidential election have all led to uncertainty around the future of tax rates.
Join me and my colleague Chris Hennessey on our upcoming webcast to talk about the tax landscape and year end planning. REGISTER HERE
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.