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Recent news and alerts surrounding the CARES stimulus package have focused primarily on the short-term cash needs of businesses and individuals. Each day more information is released on the widely applied for Paycheck Protection Program (PPP) and the individual stimulus payments.  While these measures are important for those impacted financially amid the ongoing COVID-19 pandemic, there are other key provisions in the CARES Act that are just as important from a personal tax planning perspective. This alert will cover some tax planning opportunities individuals can take advantage of.

Suspended RMDs and Low Current Market Valuations

Traditionally, taxpayers that have reached retirement age are required to take distributions from their retirement account annually. These Required Minimum Distributions (RMDs) are a mathematical calculation based on a life expectancy factor and the value of the account on December 31st of the preceding year. When the distributions are coming from traditional retirement accounts (think traditional IRAs/401(k)s, etc.) the beneficiary has taxable income to report in the year of the distribution. This income is added to all other sources of income in computing taxable income and the corresponding liability for the year. Under the CARES Act, these RMDs are suspended for tax year 2020.

The RMD suspension coupled with the current decline in market values makes ROTH conversions appear more desirable for many taxpayers in 2020. This retirement-related provision in the tax code allows taxpayers to take traditional retirement accounts and roll them into ROTH accounts. These ROTH conversions are taxable in the year the conversion occurs, but any future earnings in the account are distributed in retirement tax-free under the ROTH rules. Traditionally, taxpayers find these conversions most beneficial when two conditions exist simultaneously which are currently present for many taxpayers:

  • Low fair market value of the account
  • A dip in other sources of income for the year

The amount of the conversion should be carefully planned with your tax advisor to ensure you convert up to the next tax bracket to take advantage of the reduction in income.

Charitable Contributions

The CARES Act lifts the traditional Adjusted Gross Income (AGI) limitations on charitable contributions. Taxpayers were previously limited to a deduction of 60% of AGI. With the AGI limitations temporarily lifted for tax year 2020, there is more room for charitably inclined taxpayers to make current donations or use up and unused contribution carryovers.

The key to ensuring all contributions are ultimately tax deductible requires careful planning of the donor’s taxable income for the year. Lower investment returns and other factors are likely to impact overall taxable income for the year, which in turn limits the contribution that is tax deductible.

A Refresher on the Capital Loss Rules

Another provision worth reviewing while experiencing a depressed stock market is the capital loss rules. A taxpayer that sustains a capital loss during the tax year should be aware of how that loss impacts their overall taxable income for the year. Federally, a capital loss can offset all capital gains as well as up to $3,000 of other sources of income for the year. Any unused excess carried forward until fully absorbed.

While many states follow Federal treatment for capital losses, certain states further limit their deductibility. New Jersey and Pennsylvania are two states of these states. For these states, losses can fully offset capital gains, however, the $3,000 deduction against other sources of income and the carryover provisions do not apply. Put simply, it’s use it, or lose it. To retain the tax savings for capital losses, residents of these states can consider harvesting gains up to the point of losses to neutralize the loss. If the gain was harvested from a stock the taxpayer still would like to hold in their portfolio, they can simply repurchase the asset after the gain was harvested thereby stepping up the basis in the position. (Keep in mind the traditional wash sale rules do not apply to gains.)

Questions? Ask a WG Advisor