By: Scott Adair, CFP®, Wealth Management Advisor
Before I begin the tax portion of this article, I just want to share a few thoughts I have had while communicating with clients as we work through this challenging time. Extreme uncertainty can make us all more emotional, naturally. However, getting through adversity requires that we keep our faith in the principles that we know have stood the test of time. It is easy to forget how difficult things were after a distant crisis has passed, especially with the benefit of a long stretch of good times. When the next unexpected crisis comes along, we feel like this one is different and worse than anything in history. Psychologists call this the fading affect bias. We must keep things in perspective and remember that our country has persevered through very difficult challenges before. We will get through this challenge too! We don’t know when, but we will persevere by collectively sticking to our principles and values.
Ok, let’s talk about taxes.
For 2020, the maximum contribution to an IRA is $6,000 (plus $1,000 catch up for age 50 and older). The maximum contribution to a 401(k) account is $19,500 (plus $6,500 catch up for age 50 and older). Traditional IRA contributions and 401(k) salary deferrals are pre-tax, so you get the benefit of reducing your taxable income. Also, while we do not know how stocks will perform in the months ahead, they can clearly be bought cheaper now than in the recent past. It is important to continue contributing to your retirement account if you are able because your contribution buys more shares.
Tax Loss Harvesting
While we certainly do not like stock market declines, we do look for opportunities to harvest capital losses that can be used to offset future capital gains taxes. If you own a mutual fund that has declined in value, you can sell it and buy a similar fund to replace it. You can use the capital loss you just “harvested” to offset capital gains and up to $3,000 a year in ordinary income once you have offset all of your capital gains. Capital losses can be carried forward indefinitely. One thing to be careful of: the IRS will disallow the loss you just harvested if you buy the same asset that you just sold within 30 days of selling it.
Qualified Charitable Distributions (QCD)
At age 70½ IRA owners can donate up to $100,000 a year to a qualified charity, directly from their IRA. QCDs satisfy the Required Minimum Distribution, and the distribution is not included as taxable income. For example, let’s say a married couple usually donates $10,000 a year to a qualified charity, and that their annual RMD amount is also about $10,000. Since the standard deduction is now $27,400 for people age 65 and older, the couple may not itemize deductions if their total itemized deductions are less than the standard deduction. If the couple writes checks directly out of their IRAs to the qualified charity, they will get the benefit of reduced adjusted gross income by donating their IRA distribution rather than having to capture it as income on their return. They will also still get the benefit of the $27,400 standard deduction.
Tax Law Changes
The IRS just extended the deadline to file and pay taxes until July 15th. You can still get an extension to file by October 15th if you cannot meet the July 15th deadline.
In December of last year, Congress passed the SECURE Act, which made several changes to the tax law. My colleague Carli Smith wrote a more in-depth article on the SECURE Act in January, and I have summarized a few of the provisions of the law below:
No age restriction on Traditional IRA contributions – Prior to 2020, you could not contribute to a traditional IRA once you reached age 70 ½. The SECURE Act removed this age restriction. If you are age 70 ½ or older and are contributing to a traditional IRA and distributing charitable donations from your IRA, the $100,000 QCD deduction limit is reduced by the amount you contributed to your IRA.
Required Minimum Distribution (RMD) age – Before the SECURE Act, you were required to begin taking distributions from your traditional IRA in the year you turned 70 ½. If you turned 70 ½ on January 1, 2020, or after, you can now delay taking RMDs until age 72.
Inherited non-spousal retirement accounts – Unfortunately, the rules governing inherited retirement accounts are now stricter. Prior to the SECURE Act passage, beneficiaries of inherited retirement accounts were allowed to spread distributions over their own life expectancy, thus lowering their taxable income annually. Now, most non-spouse beneficiaries will be required to distribute the account balance within ten years of the original owner’s death. Exceptions to this stricter ten-year requirement include minor children of the deceased, individuals who are not more than 10 years younger than the deceased, disabled individuals and chronically ill individuals.
Paying student loans with 529 accounts – 529 plan account owners may now withdraw up to $10,000 tax-free for payments toward qualified education loans. The $10,000 limit is a lifetime limit that applies to the 529 plan beneficiary and each of their siblings. For example, a parent with three children may take a $10,000 distribution to pay student loans for each child, for a total of $30,000. One limitation with this is that you cannot use a 529 account to pay student loan interest, and also deduct that student loan interest on your return.
Identity Theft Protection – The IRS has released a resource on their website to help identity theft victims and to help taxpayers avoid being victimized.
As the government explores swift action to combat the economic fallout from the Coronavirus, more tax law changes could be on the horizon. We will continue to keep you informed as things develop. Also, we are always happy to hear from you! Please contact us so we can help answer your questions. ML&R Wealth Management is fully operational, and it is our pleasure to serve you and our community that we all love so much.