Five Smart End of Year Tax Moves – And a Bonus Strategy! (Video)

Five Smart End of Year Tax Moves – And a Bonus Move!  Video and Blog follows Below

Here are some ideas to consider, reducing your taxes both now and possibly in the future.

First, Consider saving more in tax advantaged ways. You should always maximize your contribution to your 401K, traditional IRA, or Roth. If you think you will be in a higher tax bracket now than you will be in retirement then you should focus your contributions on pre-tax vehicles, the traditional 401K and traditional IRA. If you think you may be in a higher bracket in retirement, then consider the Roth 401K (if available) or a Roth outside your employer. You should also consider an HSA which has to be combined with a qualifying high deductible health insurance plan. Many employers offer them and the money in the HSA can be withdrawn to pay for medical expenses on a tax-free basis. If you do not use the funds, they can grow tax deferred as within an IRA. You could accumulate significant amounts in an HAS since the contribution amount is $6750 per family annually. In retirement you can use it for living expenses without penalty just as you can with an IRA. One planning point once you qualify for Medicare Part A you can no longer contribute to an HSA. Therefore you may want to consider how and when you should apply for Medicare, that is a complex issue that can have significant ramifications if you do not apply for it in the 7 month window centered (three months before and four months after) around your 65th birthday.

Second, Harvest Capital Losses and RebalanceIn many cases it makes sense to sell investments that have a loss since the loss can be used to offset gains on other investments. If you do not use the losses to offset gains in the same year, they can be carried forward forever to offset gains in future years. In years where you do not have capital gains you can use $3,000 to offset other income (a ridiculously low amount which sadly has been the same for years!). In effect losses create a deferred tax asset. It makes the most sense to take losses in years when you are in a higher bracket, it makes less sense to have them carryover to years when you may be in a low bracket perhaps in retirement. So, if you have carryover losses consider trying to use them up before you retire. When capturing losses, we usually use the funds and reinvest them immediately, so you do not miss a market move. Rebalancing your entire portfolio should be part of this process. You may also want to consider harvesting capital gains if you think are in a 0% tax bracket for capital gains, especially if you anticipate being in a higher bracket in the future or if you believe capital gains rates will be higher.

Third, Take advantage of Lower Income. If you are in a lower tax bracket, and in fact many people are when they retire and they are not taking social security (in many cases we recommend delaying the start) until they are 70; you could be in a 10% marginal bracket. For those years, it probably makes sense to consider partial Roth conversions each year to “use” up the lower brackets. You are now converting a taxable asset to a permanently tax-free asset. We have seen projections that indicate this “tax” arbitrage strategy can increase your net worth years down the line since you are reducing your RMD’s by reducing the value of your traditional IRA and increasing your net “after tax” net worth. You may also want to consider selling lost cost basis investments, in your taxable accounts since your capital gains tax rate may be 0% in retirement!

Fourth, Make a gift to charity. If you make gifts to charity every year and you are withdrawing money from your IRA why not consider making the gift directly from your IRA? If you are 70 ½ you can gift money directly from the IRA to the charity meaning your gift will be made without the need for declaring income on an IRA distribution. You can donate up to 100,000 without it being considered a taxable withdrawal. There is a caveat, you will not be able to declare the contribution as an itemized deduction. Another option to consider is contributing to a donor advised fund (DAF). You can contribute cash or highly appreciated property to such a fund. So instead of selling a stock, one perhaps you are over-allocated to which has a low-cost basis why not donate it to a DAF and get the entire charitable deduction in one year, then sell the stock within the DAF avoiding capital gains taxes. You can decide whenever you want, how much to give to various charities and the timing. With the standard deduction for married couples so high now ($24,800 for 2020 and $25,100 for 2021) you may not see the “value” of your charitable contributions as a deduction. So why not make one large contribution in one year to “bunch” up several years’ worth of deductions so you actually see a benefit from it on your tax return? Under the Cares act RMD’s are not required for 2020 but that does not mean that you cannot withdraw any amount you like from your IRA. You may want to still consider making a withdrawal even if it is not meant for charity if you are in a low tax bracket since you do not need to make the RMD.  So, let us summarize three potential choices:

  1. If you will not itemize deductions your charitable contributions may not really “matter” since the total of your deductions with a gift will not exceed the standard deduction, then consider a DAF.
  2. If  you do itemize and you are also taking RMD’s why not donate directly from your IRA?
  3. If you do not itemize and you are not required to take RMD’s the CARE act allows anyone who gives to charity an additional $300 deduction for cash gifts.

Fifth, Make a gift to a family member. If you have a highly appreciated asset for example stock with a low-cost basis it might make sense to gift that stock to your children or grandchildren if they are in a lower tax bracket than you. You may be in a 23.8% total capital gains bracket (20% capital gains plus an additional 3.8% “net investment tax”) They may pay capital gains tax at a 0% rate or a 15% rate. Keep in mind that your cost basis in an investment carries over to the person who receives the asset. The tradeoff is that at your death they would receive a step-up in basis, in effect the cost basis becomes the value of the asset at your death. Right now, you can gift up to $11.5M per person without gift tax liability. (There is some concern about the IRS “clawing back” gifts that may exceed the amount the exclusion may drop to in 2026, we have heard conflicting opinions).

The Bonus Move

Back Door Roth IRAThe “Bonus Move” is the so-called back door Roth. If you do not qualify for either a traditional IRA (income over $105,000 for a married couple filing jointly) or a Roth because of your income (over $206,000 for a married couple filing jointly) you can actually contribute to a traditional non-deductible IRA using post tax dollars (no income limit) and then convert those funds to a Roth, since the funds were post tax and because they most likely did not earn much over the months you waited to make the conversion little additional tax would be incurred based on the taxable earnings. Now suddenly you have a Roth an asset that will be tax free forever. You can do this every year. This is not specifically sanctioned by the IRS, but it is also not disallowed. This strategy may not make sense if you have significant sums in traditional IRA’s since the IRS requires you to prorate the conversion meaning some of it will be taxable. We suggest you contact us if you are considering this strategy.

If you are considering any of these strategies, we recommend you discuss them with us first, we can make very detailed tax projections using our advanced systems. We also want to make sure any strategy that involves gifting money or assets does not impact your lifestyle in the future.

If you would like to watch our video on this topic on our YouTube Channel click on the link below:

Five Smart End of Year Tax Moves


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