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Klingman Insights

2020 Year End Tax Planning

December 4, 2020

While the immediate impact of year-end tax planning opportunities remains uncertain given the Georgia run-off elections, there are several tax planning strategies to consider as we enter the last month of 2020.

From a global pandemic to the national elections, 2020 has been a year filled with uncertainty.  In true 2020 fashion, the outcomes of the January 5th Georgia elections hold control of the Senate in the balance, and with it, the potential for significant short-term tax reform.  As such, the immediate impact of year-end tax planning opportunities also remains uncertain. That said, we do believe there are several planning strategies to consider as we enter the last month of 2020:

Pre-Funding Future Charitable Contributions: For high income families, a Democrat-controlled Senate would likely mean the value of deductions for charitable contributions will not, for some time, be greater than in 2020.  Given this potential, clients can consider pre-funding several years of future expected charitable gifts via a donor advised fund (and using appreciated securities where possible). While Republican control of the Senate will likely be neutral for the value of such deductions, there is little downside to funding a donor-advised fund now, receiving a tax deduction for the full contribution in 2020, and gifting the funds over several subsequent years.

Using Your Lifetime Gift Tax Exemption:  The current lifetime gift tax exception ($11.58 million per individual and $23.16 million per married couple) is set to expire at the end of 2025. However, under a Democrat-controlled Senate, this limit would very likely be reduced to something in the range of $3 - 5 million. Families either with i) net worths in excess of $30 million or ii) assets that are likely to experience significant appreciation in the coming years (e.g. ownership in closely-held businesses, investments in private equity, etc…) may want to consider making irrevocable gifts to family members now in the event the lifetime exemption is reduced.  As with the charitable planning discussed above, there is limited downside to considering such gifts in 2020 (putting aside specific state gift tax exemptions for the moment) as these gifts are likely to be made regardless at some point before the $11.58MM limit sunsets in 2025.

Roth Conversions: Roth IRAs provide attractive long-term tax benefits in that they grow tax free and are not subject to required minimum distributions. Funding Roth accounts (either directly or by converting existing traditional IRAs into Roth IRAs) is most common for younger individuals who have more years to benefit from the tax free growth. Perhaps the most common reason not to use a Roth is the immediate tax burden doing so creates. For some, the pandemic, as terrible as it has been, may create an opportunity. The Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily suspended some of the rules around deducting net operating losses (NOLs) and carrying back those losses. If you are either a small business owner whose business has struggled this year or an employee whose compensation has declined in light of the pandemic, your effective tax bracket might be lower in 2020 than is typically the case. If so, this may be an attractive year to convert a traditional IRA into a Roth IRA.

In addition to these decisions which are somewhat 2020/2021 specific, there remain a set of annual year-end tax planning considerations:

  • Managing Income/Expenses: Consider your likely taxable income for this year and next to determine whether it makes sense to accelerate the realization of income or deductions prior to year end.
  • Annual Gifting/529 Plan Contributions: In addition to the lifetime gift tax exemption, every individual can use the annual gift-tax exclusion to gift up to $15,000 per year to any person (e.g. a married couple can gift $30,000 to each child, every year, with no gift/estate tax implications). These gifts can be made in a number of ways including as direct gifts, gifts to trusts, and contributions to 529 plans (a certain amount of which may be deductible for state income tax purposes).  If you intend to take advantage of this exclusion, please make sure that your gifts for 2020 are made prior to the end of the year.
  • 401(k) Contributions: If you are eligible to contribute to 401(k) or similar retirement plans, determine whether you have contributed the maximum allowable (or affordable) amount for the year ($19,500 for those under 50 years old and $26,000 for those older than 50).