2020 Tax Saving Strategies for Individuals

[Ashish Acharya]

@Account Closed and I have presented some, mostly non-googleable, high-level overview of some tax strategies. I understand this might be very technical for some of us. If these apply to you, please research more, reach out to me, or consult with your tax advisor.If this is helpful, I will share some tax strategies for Businesses and Real Estate Investments in the coming days

- Ashish Acharya, MAcc, CPA, CFP®, PFS

• Hiring Kids: If you have a kid under the age of 18 and you operate your business as a sole proprietor or as a spousal partnership, hiring your kid can have significant tax breaks:
  • First, your business gets the payroll expense deductions to save taxes at the parents level who are in a higher tax bracket.
  • Second, neither parent nor the child would pay payroll taxes (15.3%) on the child’s income.
  • Third, with a traditional IRA, the child can avoid all federal income taxes (around 11%) on up to $18,400 in income.

• IRAs: First, get a deduction for contributing to a Traditional IRA that can be easily established with most of the financial institutions.

          As this year has been tough and some people have experienced losses from investments and businesses,

• Converting Traditional IRA to ROTH IRA:
  • If the Taxpayer expects NOL in the year, the IRA conversion can be timed so that conversion income is not taxed. Tax-free Roth Conversion.

• When not to deduct traditional IRA and rather do ROTH IRA
  • If the taxpayer gets no tax benefit from the deduction (e.g., a taxpayer has a negative taxable income), it is better to treat the contribution as nondeductible and thus give the taxpayer basis in the IRA. There are scenarios where contributing to a Roth IRA is a better strategy even though a deduction is allowed for a contribution to a traditional IRA.

• Primary residence (Buying and selling home): Most people are either considering buying a house or upgrading to a bigger house because of historic low interest rates:
  • You don’t have to pay tax on $250k gain if single and $500k gain if married when you sell your primary residence. You must own and live 2 out of the last 5 years.
  • Instances when deductible points when buying a house should not be deducted: The deductible points may be, but are not required to be, deducted. In certain situations, for example, when a taxpayer's standard deduction for the year in which points are paid exceeds his or her total itemized deductions, taxpayers may find it more desirable to capitalize and amortize otherwise deductible points. This situation may be fairly common for couples purchasing their first home. Consequently, the deduction will not be wasted, and if the taxpayers pay off the loan early (for example, when buying a larger home), the unamortized points can be deducted at that time.
  • Repairs on the personal residence: Repairs on your home are generally not deductible but an individual may capitalize amounts paid for the repairs made if they are made as a part of remodeling improvements. This will increase your basis and lower your gain when you sell your house. This rule applies only to the part of the residence not used for a business.

• Highearner: If you are a high earner (Singles with modified AGIs over $200,000 and couples over $250,000), then take these steps to limit the sting of the 3.8% surtax on net investment income: taxable interest, dividends, gains, rents, annuities, royalties, passive income and such.
  • If selling property, use an installment sale to spread out a large gain.
  • Purchase municipal bonds. The tax-free interest is exempt from the 3.8% levy and doesn’t affect the owner’s AGI
  • And, if feasible, do a like-kind exchange of investment realty instead of a taxable sale to defer the gain (aka 1031).
  • Increase material participation to convert the passive income to non-passive income.

• Using self-charged income to generate portfolio income to be able to deduct investment interest expense:

• Taxpayers can also elect not to apply the self-charged rules. Electing out of the self-charged rules might be appropriate if the taxpayer has plenty of passive income but needs portfolio income to be able to deduct any investment interest expense.
• Loan to family members to provide Financial Gains for Both Parties. Parents who normally invest funds in CDs or other cash equivalents may actually enhance their investment returns by loaning the money to an adult child who is otherwise borrowing from an institutional lender. For instance, parents receiving 1% on CDs and a child paying 5% on a home mortgage can both benefit by entering into a loan with an interest rate between those amounts. This boosts the parents' interest income and reduces the child's borrowing cost. Of course, to ensure that the child can deduct the interest as mortgage interest, the loan must be secured by the residence. This also helps to deduct investment interest expenses.

• Combining both capital loss and passive activity strategy:
  • If you have a capital loss carryover into the year of a disposition of a passive activity, and if the disposition generates a capital gain, the capital loss carryover can offset the capital gain. So, by timing the gain on a sale of a passive activity in a year with a capital loss carryover and a suspended loss carryover from that activity, you get a double tax benefit. The disposition frees up both the capital loss carryover and the suspended passive losses. (Sorry if this sounds complicated, your CPA will understand if you hint this)

• Stock Transactions: If you don’t follow the strategy stated below, you will be paying taxes at 40.8% rather than the tax-favored rate of 23.8%.
  • Sell stocks where you offset short-term gains subject to a high tax rate such as 40.8% with the long-term losses (up to 23.8%). Meaning, offset the large tax gains with small tax losses.
  • Use long-term losses to create the $3,000 deduction allowed against ordinary income.
  • If you have huge capital losses/ carryovers, sell additional stocks, rental properties, and other assets to create offsetting capital gains. If you sell stocks to use the capital losses, you can immediately repurchase the stock after you sell it—there’s no wash-sale “gain” rule. See below.
  • Because of the wash sale rule on losses (bought and sold within a 61-day period (30 days before or 30 days after the date of sale), follow the steps below to maintain your investment position even after recognizing gain or loss on the stocks:

1. Double up. Buy more of the same stocks or bonds, then sell the original holding at least 31 days later. (There is a risk here of further downward price movement of the remaining stock that was not sold)
2. Sell the original holding and then buy the same securities at least 31 days later. (If you think the stock will perform better in the long run, you can follow this)
3. Sell the original holding and buy similar securities in different companies in the same line of business. This approach trades on the prospects of the industry as a whole, rather than the particular stock held.
4. In the case of mutual fund shares, sell the original holding and buy shares in another mutual fund that uses a similar investment strategy. The same approach can be used with Exchange Traded Funds.
5. The wash sale rules apply only when securities are sold at a loss. As a result, a taxpayer may recognize a paper gain on stock in 2020 for year-end planning purposes and then buy it back at any time without having to worry about the wash sale rules as mentioned above.

• Buy State Tax Credit: Taxpayers can buy the state tax credits for around 90 cents on a 1 dollar. For e.g. If your state tax liability is $10,000, then you would buy tax credits for $9,000. You instantly saved $1,000 instantly. Next year you have to recognize a gain of $1,000, but it can be sheltered with capital losses.

As this is getting longer than expected, the following are some other strategies that are not expanded in detail:

• 529 plan
• Retirement plans/HSA contributions
• Tax saving form real estate investments
• Transferring passive income to Kids with kiddie tax in mind.

There are many others. I would love to have other professionals share more.