COVID-19 and 2020 will be forever known for its unprecedented challenges. But what about opportunities? Trust Officer, Ronald Glenn, M.A., CFP, discusses potential tax planning advantages to the unique characteristics we faced in 2020 and may still face in 2021.
While there were not significant changes in tax law from 2019 to 2020, there are changes that occur every year as rates adjust for inflation.
Standard Deduction - The standard deduction for 2021 will be $12,550 (up $150) for single taxpayers and $25,100 (up $300) for married couples filing jointly. If you are blind or over the age of 65, then these amounts will be increased by $1,350. These amounts will again influence the number of taxpayers that itemize their deductions.
Income Tax Rates - The 2020 tax brackets are the same as the rates in effect for the 2019 tax year: 10%, 12%, 22%, 24%, 32%, 35% and 37%. However, the amounts that fall into each bracket are adjusted every year. That means you could wind up in a different tax bracket when you file your 2020 return than the bracket you were in before – which also means you'll be paying a different tax rate on some of your income.
|Tax Rate||Taxable Income (Single)||Taxable Income (MFJ)|
|10%||Up to $9,875||Up to $19,750|
|12%||$9,876 to $40,125||$19,751 to $80,250|
|22%||$40,126 to $85,525||$80,251 to $171,050|
|24%||$85,526 to $163,300||$171,051 to $326,600|
|32%||$163,301 to $207,350||$326,601 to $414,700|
|35%||$207,351 to $518,400||$414,701 to $622,050|
|37%||Over $518,400||Over $622,050|
Capital Gains Rates - Income on capital gains are taxed at lower rates than income taxes. However, the rate of the tax depends on your taxable income.
|Long Term Capital Gain Tax Rate||Taxable Income (Single)||Taxable Income (MFJ)|
|0%||Up to $40,400||Up to $80,800|
|15%||$40,401 to $445,850||$80,801 to $501,600|
|22%||Over $445,850||Over $501,600|
There are a lot of reasons that a person may have earned less income in 2020 (or even 2021). The economy slowed down and many people were faced with unemployment or reduced wages. Additionally, with the passage of the CARES Act, Congress suspended Required Minimum Distributions (RMDs) for 2020. This came after the SECURE Act which modified IRA distribution rules and extended the time to take RMDs to 72, so some will delay the onset of RMDs. Therefore, many people will have less taxable income and smaller tax bills as a result. Here are some ways that you can use the lower taxable income to your advantage.
Distributions - Because there is no set RMD amount in 2020, you can take an IRA withdrawal by either taking the money or moving to an investment account within the above-referenced tax brackets if you are typically in a higher bracket. However, be aware that distributions before age 59½ are subject to a 10% early withdrawal penalty.
Convert Traditional IRA Funds into a Roth IRA - With lower tax rates, you may wish to consider converting some or all of your traditional IRA into a Roth IRA. When you convert your traditional IRA to a Roth IRA, you must pay taxes on the amount converted. If you have less income in a given year, this will result in a lower tax rate and provide you with an opportunity to convert to a Roth IRA at a lower tax amount.
Defer Deductions - If you are able to overcome the standard deduction and itemize your deductions, you may wish to put off the deductions to future years where your income may be higher and take the standard deduction this year.
Zero Capital Gains Rate - As noted above, there is a 0% capital gains rate for those taxpayers whose taxable income is lower. If the lack of RMDs makes for a lower capital gains rate, it may be a good idea to sell some appreciated securities that you have owned for more than a year and pay no or very little tax on the gain.
You may not be able to take advantage of all these strategies in 2020 or 2021. Indeed, it is typically better to make more money in a given year. However, you may have a year with lower income or high deductions. Often with the right planning, people can take advantage of those years through their taxes. We are all looking forward to better times in 2021.