Tax

If you are thinking of getting married or divorced, you need to consider December 31, 2020, in your tax planning. 

Here’s another planning question: Do you give money to family or friends (other than your children, who are subject to the kiddie tax)? If so, you need to consider the zero-taxes planning strategy. 

And now, consider your children who are under age 18. Have you paid them for work they’ve done for your business? Have you paid them the right way?

Here are five strategies to consider as we come to the end of 2020.

1. Put Your Children on Your Payroll

If you have a child under the age of 18 and you operate your business as a Schedule C sole proprietor or as a spousal partnership, you absolutely need to consider having that child on your payroll. Why? 

• First, neither you nor your child would pay payroll taxes on the child’s income. 
• Second, with a traditional IRA, the child can avoid all federal income taxes on up to $18,400 in income.

If you operate your business as a corporation, you can still benefit by employing the child even though both your corporation and your child suffer payroll taxes.

2. Get Divorced after December 31

The marriage rule works like this: you are considered married for the entire year if you are married on December 31.

Although lawmakers have made many changes to eliminate the differences between married and single taxpayers, in most cases the joint return will work to your advantage.

Warning on alimony! The Tax Cuts and Jobs Act (TCJA) changed the tax treatment of alimony payments under divorce and separate maintenance agreements executed after December 31, 2018:

• Under the old rules, the payor deducts alimony payments and the recipient includes the payments in income.
• Under the new rules, which apply to all agreements executed after December 31, 2018, the payor gets no tax deduction and the recipient does not recognize income.

3. Stay Single to Increase Mortgage Deductions

Two single people can deduct more mortgage interest than a married couple. 

If you own a home with someone other than a spouse, and you bought it on or before December 15, 2017, you individually can deduct mortgage interest on up to $1 million of a qualifying mortgage. 

For example, if you and your unmarried partner live together and own the home together, the mortgage ceiling on deductions for the two of you is $2 million. If you get married, the ceiling drops to $1 million.

If you bought your house after December 15, 2017, then the reduced $750,000 mortgage limit from the TCJA applies. In that case, for two single people, the maximum deduction for mortgage interest is based on a ceiling of $1.5 million.

4. Get Married on or before December 31

Remember, if you are married on December 31, you are married for the entire year.

If you are thinking of getting married in 2020, you might want to rethink that plan for the same reasons that apply in a divorce (as described above). The IRS could make big savings available to you if you get married on or before December 31, 2020.

You have to run the numbers in your tax return both ways to know the tax benefits and detriments for your particular case. But a quick trip to the courthouse may save you thousands.

5. Make Use of the 0 Percent Tax Bracket

In the old days, you used this strategy with your college student. Today, this strategy does not work with the college student, because the kiddie tax now applies to students up to age 24. 

But this strategy is a good one, so ask yourself this question: Do I give money to my parents or other loved ones to make their lives more comfortable?

If the answer is yes, is your loved one in the 0 percent capital gains tax bracket? The 0 percent capital gains tax bracket applies to a single person with less than $40,000 in taxable income and to a married couple with less than $80,000 in taxable income.

If the parent or other loved one is in the 0 percent capital gains tax bracket, you can get extra bang for your buck by giving this person appreciated stock rather than cash.

Example. You give Aunt Millie shares of stock with a fair market value of $20,000, for which you paid $2,000. Aunt Millie sells the stock and pays zero capital gains taxes. She now has $20,000 in after-tax cash to spend, which should take care of things for a while.

Had you sold the stock, you would have paid taxes of $4,284 in your tax bracket (23.8 percent times the $18,000 gain).

Of course, $5,000 of the $20,000 you gifted goes against your $11.4 million estate tax exemption if you are single. But if you’re married and you made the gift together, you each have a $15,000 gift-tax exclusion, for a total of $30,000, and you have no gift-tax concerns other than the requirement to file a gift-tax return that shows you split the gift.

I know that taxes can cause confusion. Remember, that’s why you have me and I’m always here to be of service. If you want to discuss any of the strategies above, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 20, 2020

When you take advantage of the tax code’s offset game, your stock market portfolio can represent a little gold mine of opportunities to reduce your 2020 income taxes. 

The tax code contains the basic rules for this game, and once you know the rules, you can apply the correct strategies. 

Here’s the basic strategy:

• Avoid the high taxes (up to 40.8 percent) on short-term capital gains and ordinary income.
• Lower the taxes to zero—or if you can’t do that, then lower them to 23.8 percent or less by making the profits subject to long-term capital gains.

Think of this: you are paying taxes at a 71.4 percent higher rate when you pay at 40.8 percent rather than the tax-favored 23.8 percent. 

To avoid the higher rates, here are seven possible tax planning strategies.

Strategy 1

Examine your portfolio for stocks that you want to unload, and make sales where you offset short-term gains subject to a high tax rate such as 40.8 percent with long-term losses (up to 23.8 percent). 

In other words, make the high taxes disappear by offsetting them with low-taxed losses, and pocket the difference.

Strategy 2

Use long-term losses to create the $3,000 deduction allowed against ordinary income. 

Again, you are trying to use the 23.8 percent loss to kill a 40.8 percent rate of tax (or a 0 percent loss to kill a 12 percent tax, if you are in the 12 percent or lower tax bracket).

Strategy 3

As an individual investor, avoid the wash-sale loss rule. 

Under the wash-sale loss rule, if you sell a stock or other security and purchase substantially identical stock or securities within 30 days before or after the date of sale, you don’t recognize your loss on that sale. Instead, the code makes you add the loss amount to the basis of your new stock.

If you want to use the loss in 2020, then you’ll have to sell the stock and sit on your hands for more than 30 days before repurchasing that stock.

Strategy 4

If you have lots of capital losses or capital loss carryovers and the $3,000 allowance is looking extra tiny, sell additional stocks, rental properties, and other assets to create offsetting capital gains.

If you sell stocks to purge the capital losses, you can immediately repurchase the stock after you sell it—there’s no wash-sale “gain” rule.

Strategy 5

Do you give money to your parents to assist them with their retirement or living expenses? How about children (specifically, children not subject to the kiddie tax)?

If so, consider giving appreciated stock to your parents and your non-kiddie-tax children. Why? If the parents or children are in lower tax brackets than you are, you get a bigger bang for your buck by 

• gifting them stock, 
• having them sell the stock, and then
• having them pay taxes on the stock sale at their lower tax rates.

Strategy 6

If you are going to make a donation to a charity, consider appreciated stock rather than cash, because a donation of appreciated stock gives you more tax benefit.

It works like this: 

• Benefit 1. You deduct the fair market value of the stock as a charitable donation.
• Benefit 2. You don’t pay any of the taxes you would have had to pay if you sold the stock.

Example. You bought a publicly traded stock for $1,000, and it’s now worth $11,000. You give it to a 501(c)(3) charity, and the following happens:

• You get a tax deduction for $11,000. 
• You pay no taxes on the $10,000 profit.

Two rules to know:

1. Your deductions for donating appreciated stocks to 501(c)(3) organizations may not exceed 30 percent of your adjusted gross income.
2. If your publicly traded stock donation exceeds the 30 percent, no problem. Tax law allows you to carry forward the excess until used, for up to five years.

Strategy 7

If you could sell a publicly traded stock at a loss, do not give that loss-deduction stock to a 501(c)(3) charity. Why? If you sell the stock, you have a tax loss that you can deduct. If you give the stock to a charity, you get no deduction for the loss—in other words, you can just kiss that tax-reducing loss goodbye.

The stock strategies have a long history in tax planning. If you need my help with any of these strategies, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 18, 2020

The clock continues to tick. Your retirement is one year closer.

You have time before December 31 to take steps that will help you fund the retirement you desire. Here are four things to consider:

1. Establish Your 2020 Retirement Plan

First, a question: As you read this, do you have your (or your corporation’s) retirement plan in place?  

If not, and if you have some cash you can put into a retirement plan, get busy and put that retirement plan in place so you can obtain a tax deduction for 2020.

For most defined contribution plans, such as 401(k) plans, you (the owner-employee) are both an employee and the employer, whether you operate as a corporation or as a proprietorship. And that’s good because you can make both the employer and the employee contributions, allowing you to put a good chunk of money away.

2. Claim the New, Improved Retirement Plan Start-Up Tax Credit of Up to $15,000

By establishing a new qualified retirement plan (such as a profit-sharing plan, 401(k) plan, or defined benefit pension plan), a SIMPLE IRA plan, or a SEP, you can qualify for a non-refundable tax credit that’s the greater of

• $500 or
• the lesser of (a) $250 multiplied by the number of your non-highly compensated employees who are eligible to participate in the plan, or (b) $5,000.

The credit is based on your “qualified start-up costs,” which means any ordinary and necessary expenses of an eligible employer that are paid or incurred in connection with

• the establishment or administration of an eligible employer plan, or
• the retirement-related education of employees with respect to such plan.

3. Claim the New Automatic Enrollment $500 Tax Credit for Each of Three Years ($1,500 Total)

The SECURE Act added a nonrefundable credit of $500 per year for up to three years beginning with the first taxable year beginning in 2020 or later in which you, as an eligible small employer, include an automatic contribution arrangement in a 401(k) or SIMPLE plan.

The new $500 auto contribution tax credit is in addition to the start-up credit and can apply to both newly created and existing retirement plans. Further, you don’t have to spend any money to trigger the credit. You simply need to add the auto-enrollment feature.

4. Convert to a Roth IRA

Consider converting your 401(k) or traditional IRA to a Roth IRA.

If you make good money on your IRA investments and you won’t need your IRA money during the next five years, the Roth IRA over its lifetime can produce financial results far superior to the traditional retirement plan.

You first need to answer this question: How much tax will I have to pay now to convert my existing plan to a Roth IRA? With the answer to this, you know how much cash you need on hand to pay the extra taxes caused by the conversion to a Roth IRA.

Here are four reasons you should consider converting your retirement plan to a Roth IRA:

1. You can withdraw the monies you put into your Roth IRA (the contributions) at any time, both tax-free and penalty-free, because you invested previously taxed money into the Roth account.
2. You can withdraw the money you converted from the traditional plan to the Roth IRA at any time, tax-free. (If you make that conversion withdrawal within five years, however, you pay a 10 percent penalty. Each conversion has its own five-year period.)
3. When you have your money in a Roth IRA, you pay no tax on qualified withdrawals (earnings), which are distributions taken after age 59 1/2, provided you’ve had your Roth IRA open for at least five years.
4. Unlike with the traditional IRA, you don’t have to receive required minimum distributions from a Roth IRA when you reach age 72—or to put this another way, you can keep your Roth IRA intact and earning money until you die. (After your death, the Roth IRA can continue to earn money, but someone else will be making the investment decisions and enjoying your cash.)

If you would like my help with any of the above, please give me a call on my direct line at 408-778-9651.

• By Leon Clinton
• November 16, 2020