Update on the Enhanced Child Tax Credit

Earlier this year in April, I wrote about the changes Congress made to the child tax credit that will benefit many taxpayers. As part of the American Rescue Plan Act that was enacted in March 2021, the child tax credit:

  • Amount has increased for certain taxpayers
  • Is fully refundable (meaning you can receive it even if you don’t owe the IRS any taxes)
  • May be partially received in monthly payments

The new law also raised the age of qualifying children to 17 from 16, meaning that more families will be able to take advantage of the credit for at least one year longer.

The IRS will pay half the credit in the form of advance monthly payments beginning July 15. Taxpayers will then claim the other half when they file their 2021 income tax return.

Though these tax changes are temporary and only apply to the 2021 tax year, they may present important cash flow and financial planning opportunities today. It is also important to note that the monthly advance of the child tax credit is a significant change. The credit is normally part of your income tax return and would reduce your tax liability. The choice to have the child tax credit advanced will affect your refund or amount due when you file your return. To avoid any surprises, please get in touch with us if you’re concerned.

Qualifications and how much to expect

The child tax credit and advance payments are based on several factors, including the age of your children and your income.

  • The credit for children ages five and younger is up to $3,600 –– with up to $300 received in monthly payments.
  • The credit for children ages six to 17 is up to $3,000 –– with up to $250 received in monthly payments.

To qualify for the child tax credit monthly payments, you (and your spouse if you file a joint tax return) must have:

  • Filed a 2019 or 2020 tax return and claimed the child tax credit or given the IRS your information using the non-filer tool
  • A main home in the U.S. for more than half the year or file a joint return with a spouse who has a main home in the U.S. for more than half the year
  • A qualifying child who is under age 18 at the end of 2021 and who has a valid Social Security number
  • Income less than certain limits (see below)

You can take full advantage of the credit if your income (specifically, your modified adjusted gross income) is less than $75,000 for single filers, $150,000 for married filing jointly filers and $112,500 for head of household filers. The credit begins to phase out above those thresholds.

Higher-income families (e.g., married filing jointly couples with $400,000 or less in income or other filers with $200,000 or less in income) will generally get the same credit as prior law (generally $2,000 per qualifying child) but may also choose to receive monthly payments.

Taxpayers generally won’t need to do anything to receive any advance payments as the IRS will use the information it has on file to start issuing the payments.

IRS’ child tax credit update portal

Using the IRS’ child tax credit and update portal, taxpayers can update their information to reflect any new information that might impact their child tax credit amount, such as filing status or number of children. Parents may also use the online portal to elect out of the advance payments or check on the status of payments.

The IRS also has a non-filer portal to use for certain situations.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Inflation: Transitory or Here to Stay?

From leading indicators to business surveys to initial unemployment claims, the economic message is clear: The 2020 COVID-19 recession is over! Although the NBER (National Bureau of Economic Research) has yet to make their official announcement, my bet is that the recession ending point is backdated all the way to last autumn, or even earlier. That’s how economics often works… with perfect 20/20 hindsight.

As the economy’s emergence from pandemic restrictions exceeds widespread forecasts and expectations, so do underlying pressures in other areas vital to the stock market’s outlook. And with the combination of a potential valuation bubble on Wall Street and corresponding housing bubble on Main Street, investor sensitivity to interest rates has never been higher.

In April 2021, the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.8%, the largest one-month increase since August 2012. Over the previous 12 months, the increase was 4.2%, the highest year-over-year inflation rate since September 2008 (4.9% over prior 12 months). By contrast, inflation in 2020 was just 1.4%. (1)

The annual increase in CPI-U — often called headline inflation — was due in part to the fact that the index dropped in March 2020, the beginning of the U.S. economic shutdown in the face of the COVID-19 pandemic. Thus, the current 12-month comparison is to an unusual low point in prices. The index dropped even further in April 2020, and this “base effect” will continue to skew annual data through June. (2)

The monthly April increase, which followed a substantial 0.6% increase in March, is more indicative of the current situation. Economists expect inflation numbers to rise for some time. The question is whether they represent a temporary anomaly or the beginning of a more worrisome inflationary trend.

Measuring Prices

In considering the prospects for inflation, it’s important to understand some of the measures that economists use.

CPI-U measures the price of a fixed market basket of goods and services. As such, it is a good measure of prices consumers pay if they buy the same items over time, but it does not reflect changes in consumer behavior and can be unduly influenced by extreme increases in specific categories.

In setting economic policy, the Federal Reserve prefers a different inflation measure called the Personal Consumption Expenditures (PCE) Price Index, which is even broader than the CPI and adjusts for changes in consumer behavior — i.e. when consumers shift to purchase a different item because the preferred item is too expensive. More specifically, the Fed looks at core PCE, which rose 0.7% in April and 3.6% for the previous 12 months, slightly lower than core CPI but much higher than the Fed’s target of 2% for healthy economic growth. (3)

A Hot Economy

Based on the core numbers, inflation is not yet running high, but there are clear inflationary pressures on the U.S. economy. Loose monetary policies by the central bank and trillions of dollars in government stimulus could create excess money supply as the economy reopens. Pent-up consumer demand for goods and services is likely to rise quickly, fueled by stimulus payments and healthy savings accounts built by those who worked through the pandemic with little opportunity to spend their earnings. Businesses that shut down or cut back when the economy was closed may not be able to ramp up quickly enough to meet demand. Supply-chain disruptions and higher costs for raw materials, transportation, and labor have already led some businesses to raise prices. (4)

According to the April Wall Street Journal Economic Forecasting Survey, gross domestic product (GDP) is expected to increase at an annualized rate of 8.4% in the second quarter of 2021 and by 6.4% for the year — a torrid annual growth rate that would be the highest since 1984. As with the base effect for inflation, it’s important to keep in mind that this follows a 3.5% GDP decline in 2020. Even so, the expectation is for a hot economy through the end of the year, followed by solid 3.2% growth in 2022 before slowing down to 2.4% in 2023. (5)(6)

Three Scenarios

As investors have become increasingly concerned about inflation, the Federal Reserve has given countless reassurances that current pricing pressures will be “transitory” and short-lived. Yet mounting evidence has seemingly turned this debate into the Fed versus the World.

Will the economy get too hot to handle? Though all economists expect inflation numbers to rise in the near term, there are three different views on the potential long-term effects.

The most sanguine perspective, held by many economic policymakers including Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen, is that the impact will be short-lived and due primarily to the base effect with little or no long-term consequences. (7) Inflation has been abnormally low since the Great Recession, consistently lagging the Fed’s 2% target. In August 2020, the Federal Open Market Committee (FOMC) announced that it would allow inflation to run moderately above 2% for some time in order to create a 2% average over the longer term. Given this policy, the FOMC is unlikely to raise interest rates unless core PCE inflation runs well above 2% for an extended period. (8) The mid-March FOMC projection sees core PCE inflation at just 2.2% by the end of 2021, and the benchmark federal funds rate remaining at 0.0% to 0.25% through the end of 2023. (9)

The second view believes that inflation may last longer, with potentially wider consequences, but that any effects will be temporary and reversible.

The third perspective is that inflation could become a more extended problem that may be difficult to control. Both camps project that the base effects will be amplified by “demand-pull” inflation, where demand exceeds supply and pushes prices upward. The more extreme view believes this might lead to a “cost-push” effect and inflationary feedback loop where businesses, faced with less competition and higher costs, would raise prices preemptively, and workers would demand higher wages in response. (10)

Is Current Inflation “Transitory?

Dual surveys from the Institute for Supply Management (ISM) are ringing alarm bells, as the ISM Manufacturing Prices Paid Index has surged to one of its highest readings on record, led by widespread commodity price increases. As stated by one respondent to the ISM survey, “In 35 years of purchasing, I’ve never seen anything like these extended lead times and rising prices – from colors, film, corrugate to resins, they’re all up.” Likewise, even in the Service Sector the Prices Paid Index shot higher and is nearing a 25-year high.

Low inventories among companies that produce goods will undoubtedly keep price pressures high as companies scramble to replenish their depleted inventory and meet the unexpectedly high demand.” And prices have, indeed, continued to rise, while restocking efforts have been unable to prevent customer inventories from falling to a record low.

Central to the Fed’s “transitory inflation” argument is the belief that supply/demand pressures will quickly subside as inventories rebound. My concern is that broader evidence suggests inflation could be far stickier than the Fed expects.

From groceries to lumber to cars and even chickens, inflation pressures are being felt by consumers and businesses. The widespread nature of today’s inflation is one of the factors that suggest pricing pressures may be more deep-rooted than the Fed believes.

Perhaps most importantly, business owners are also facing higher wage costs as qualified labor is becoming an increasingly rare commodity. The National Federation of Independent Business (NFIB) reports that a record 44% of small businesses have unfilled positions, and over half of those with job openings reported that there were few or no qualified applicants.

Historically, wage inflation can be notoriously sticky, and the disparity between the NFIB Job Openings and reported Wage Inflation is a gap that will almost certainly be closed in the year ahead. This casts further doubt on the Fed’s narrative that inflation will surely be “transitory.” And unfortunately for the Fed, wage inflation–once ingrained–can typically only be reversed by a recession.

As businesses are facing higher input expenses, they are already making plans to pass these costs on to their customers. The National Federation of Small Business’ survey of small businesses shows that plans to raise selling prices have reached the second highest level since 1981 – a time when inflation was running near 10%.

Maintaining Perspective

Although it’s too early to tell whether current inflation numbers will lead to a longer-term shift, you can expect higher prices for some items as the economy reopens. Consumers don’t like higher prices, but it’s important to keep these increases in perspective. Gasoline, jet fuel, and other petroleum prices are rising after being deeply depressed during the pandemic. Airline ticket prices are increasing but remain below their pre-pandemic level. Used cars and trucks are more expensive than before the pandemic, but clothing is still cheaper. (11) Food is up 3.5% over the last 12 months, a significant increase but not extreme for prices that tend to be volatile. (12)

Anyone who has tried to buy or build a home in the past six months is aware of the rising stresses in the housing market. Home prices are soaring, not only here in the U.S. but on a global basis as well.

History has shown that it will be difficult, if not impossible, for the Federal Reserve to dampen or halt the imminent impact of the red-hot labor and housing market on the economy. Any cost surprises will undoubtedly be to the upside in the months and year ahead, and that does not bode well for inflation news OR for the Fed’s reassurance of “transitory” inflation.

For now, it may be helpful to remember that “headline inflation” does not always represent the larger economy. And with interest rates near zero, the Federal Reserve has plenty of room to make any necessary adjustments to monetary policy.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Projections are based on current conditions, are subject to change, and may not come to pass.

1, 12) U.S. Bureau of Labor Statistics, 2021

2, 4) The Wall Street Journal, April 13, 2021

3, 6) U.S. Bureau of Economic Analysis, 2021

5) The Wall Street Journal Economic Forecasting Survey, April 2021

7, 10) Bloomberg, March 29, 2021

8) The Wall Street Journal, April 14, 2021

9) Federal Reserve, 2021

11) The New York Times, April 13, 2021

Enhanced Child Tax Credit for 2021

The American Rescue Plan Act of 2021 (ARPA) ushered in several tax changes that we highlighted in this post last month. One of those tax changes involves the Enhanced Child Tax Credit.

If you have qualifying children under the age of 18, you may be able to claim a child tax credit (You may also be able to claim a partial credit for certain other dependents who are not qualifying children.) The American Rescue Plan Act of 2021 makes substantial and temporary improvements to the child tax credit for 2021, which may increase the amount you might receive.

Ages of qualifying children

The legislation makes 17-year-olds eligible as qualifying children in 2021. Thus, children age 17 and younger are eligible as qualifying children in 2021.

Increase in credit amount

For 2021, the child tax credit amount increases from $2,000 to $3,000 per qualifying child ($3,600 per qualifying child under age 6). The partial credit for other dependents who are not qualifying children remains at $500 per dependent.

Phaseout of credit

The combined child tax credit (the sum of your child tax credits and credits for other dependents) is subject to phaseout based on modified adjusted gross income (MAGI), which for most people, is your total income subject to taxes (this may differ from your taxable income shown on the tax return if you have certain adjustments). Special rules start phasing out the increased portion of the child tax credit in 2021 at much lower thresholds than under pre-existing rules. The credit, as reduced under the special rules for 2021, is then subject to phaseout under the pre-existing phaseout rules.

The following table summarizes the effect of the phaseouts on the child tax credit in 2021, based on MAGI.

Single/Married filing separatelyMarried filing jointlyHead of householdCombined credit
Up to $75,000Up to $150,000Up to $112,500No reduction in credit
$75,001 to $200,000$150,001 to $400,000$112,501 to $200,000Credit can be reduced to $2,000 per qualifying child, $500 per other dependent
More than $200,000More than $400,000More than $200,000Credit can be reduced to $0

Enhanced Child Tax Credit is Refundable

The aggregate amount of nonrefundable credits allowed is limited to your tax liability. With refundable credits, a taxpayer may receive a tax refund at tax time even if they exceed their tax liability.

For most taxpayers, the child tax credit is fully refundable for 2021. To qualify for a full refund, the taxpayer (or either spouse for joint returns) must generally reside in the United States for more than half of the taxable year. Otherwise,  under the pre-existing rules, a partial refund of up to $1,400 per qualifying child may be available. The credit for other dependents is not refundable.

Advance payments

Eligible taxpayers may receive periodic advance payments for up to half of the refundable child tax credit during 2021, generally based on 2020 tax returns.  The U.S. Treasury will make the payments between July and December 2021. For example, monthly payments could be up to $250 per qualifying child ($300 per qualifying child under age 6). Due to correspondence backlogs and under-staffing at the IRS, it remains to be seen if they can make good on sending out those payments on a timely basis this year.

If you would like to review your current investment portfolio, discuss any other financial planning or tax matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Should You Hit the Pause Button on Filing Your 2020 Tax Returns?

Note: Since the original publication of this article, the IRS announced that the federal income tax filing due date for individuals for the 2020 tax year is automatically extended until May 17, 2021.

As you likely know, President Joe Biden signed his sweeping $1.9 trillion Covid-19 economic relief package into law on Thursday afternoon March 11, 2021. Included in this package were several tax provisions that increase child tax credits and exempt certain 2020 unemployment benefits from taxation for lower income taxpayers.

Passing retroactive tax legislation just five weeks before the regular 1040 tax deadline of April 15, 2021, is virtually unprecedented, and has left the IRS and tax preparation software vendors scrambling to update calculations, guidance, tax forms, publications and program logic.

Add to the foregoing the IRS’ backlog of taxpayer correspondence and flood of erroneous taxpayer notices and you can understand that this has prompted the American Association of CPA’s to urge the IRS to extend the tax deadline for filing and payment until June 15, 2021, or at least provide guidance to taxpayers on their thinking about whether they are considering extending the tax deadline.

I was notified today that my own tax preparation vendor, Thomson Reuters, “highly recommends that no returns be filed at this time” due to the preliminary draft nature of several forms (which are based on 2019 forms and not yet approved for filing by the IRS) and the last minute passage of tax legislation. Make no mistake, updating the form calculations and logic is no small feat, especially considering that the IRS has issued scant guidance given that the legislation is still a “newborn”.

I imagine that things will look better in a couple of weeks, but if you’re anxious to file your returns in hopes of receiving a higher stimulus check, I can only advise you to cool your heels and, if applicable, save yourself a fee to have an amended return prepared. Eventually, you’ll receive every penny of stimulus you’re entitled to, albeit perhaps on next year’s tax return. Given that stimulus payments are due to start arriving this weekend, rushing to file your return will have virtually no effect on the amount of the stimulus check you’ll receive over the next month.

If you filed your return early, only your tax preparer can advise you if you’ll need to amend that return to take into account the most recent tax changes. If you have a very simple return (Form W-2 and no deductions), my guess is that you’re OK. If you received unemployment compensation in 2020, then you may need to file an amended return to claim a refund of overpaid taxes.

My standard advice to clients is not to file prior to March 15 each year (because of last minute issuance and changes to 1099s), and it appears that will now extend until at least March 31. I highly recommend that you do the same.

If you would like to review your current investment portfolio or discuss your 2020 tax return, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Making Your Money Last In Retirement

Quick Questions: How much can you safely withdraw each year from your retirement portfolio without the risk of running out of money before you run out of life? How much should you withdraw if you don’t want to leave too much money behind when you die?

If you’re as perplexed about answering these questions as many financial planners are, then this article will help update you on the latest research in this area of retirement planning. Saving for retirement is not easy, but using your retirement savings wisely can be just as challenging. Withdraw too much and you run the risk of running out of money. Withdraw too little and you may miss out on a more comfortable retirement lifestyle.

For more than 25 years, the most common guideline has been the “4% rule,” which suggests that a yearly withdrawal equal to 4% of the initial portfolio value, with annual increases for inflation, is sustainable over a 30-year retirement. This guideline can be helpful in projecting a savings goal and providing a realistic picture of the annual income your savings might provide. For example, a $1 million portfolio could provide $40,000 of income in the first year, with inflation-adjusted withdrawals in succeeding years.

The 4% rule has stimulated a great deal of discussion over the years, with some experts saying that 4% is too low, and others saying it’s too high. The most recent analysis comes from the man who studied it, financial professional William Bengen (widely considered in the financial planning profession as the “father of the safe withdrawal rate”), who believes the rule has been misunderstood and offers new insights based on new research.

Original Research

Bengen first published his findings in 1994, based on analyzing data for retirements beginning in 51 different years, from 1926 to 1976. He considered a hypothetical, conservative portfolio comprised of 50% large-cap stocks and 50% intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. A 4% inflation-adjusted withdrawal was the highest sustainable rate in the worst-case scenario — retirement in October 1968, the beginning of a bear market, and a long period of high inflation. All other retirement years had higher sustainable rates, some as high as 10% or more (1).

Of course, no one can predict the future, which is why Bengen suggested that the worst-case scenario as a sustainable rate. He later adjusted it slightly upward to 4.5%, based on a more diverse portfolio comprised of 30% large-cap stocks, 20% small-cap stocks, and 50% intermediate-term Treasuries (2).

New Research

In October 2020, Bengen published new research that attempts to project a sustainable withdrawal rate based on two key factors at the time of retirement: stock market valuation and inflation (the annual change in the Consumer Price Index). In theory, when the market is expensive, it has less potential to grow, and sustaining increased withdrawals over time may be more difficult. On the other hand, lower inflation means lower inflation-adjusted withdrawals, allowing for a higher initial rate. For example, a $40,000 first-year withdrawal becomes an $84,000 withdrawal after 20 years with a 4% annual inflation increase, but just $58,000 with a 2% annual increase.

To measure market valuation, Bengen used the Shiller CAPE, a cyclically adjusted price-earnings ratio for the S&P 500 index developed by Nobel laureate Robert Shiller. The price-earnings (P/E) ratio of a stock is the share price divided by its earnings per share for the previous 12 months. For example, if a stock is priced at $100 and the earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE divides the total share price of stocks in the S&P 500 index by average inflation-adjusted earnings over 10 years.

5% rule?

Again using historical data — for retirement dates from 1926 to 1990 — Bengen found a clear correlation between market valuation and inflation at the time of retirement and the maximum sustainable withdrawal rate. Historically, rates ranged from as low as 4.5% to as high as 13%, but the scenarios that supported high rates were unusual, with very low market valuations and/or deflation rather than inflation (3).

For most of the last 25 years, the United States has experienced high market valuations, and inflation has been low since the Great Recession (4)(5). In a high-valuation, low-inflation scenario at the time of retirement, Bengen found that a 5% initial withdrawal rate was sustainable over 30 years (6). While not a big difference from the 4% rule, this suggests retirees could make larger initial withdrawals, particularly in a low-inflation environment.

One caveat is that current market valuation is extremely high: The S&P 500 index had a CAPE of 34.19 at the end of 2020, a level only reached (and exceeded) during the late-1990s dot-com boom and higher than any of the scenarios in Bengen’s research (7).  His range for a 5% withdrawal rate is a CAPE of 23 or higher, with inflation between 0% and 2.5% (8) (Inflation was 1.2% in November 2020 (9)). Bengen’s research suggests that if market valuation drops near the historical mean of 16.77, a withdrawal rate of 6% might be sustainable as long as inflation is 5% or lower. On the other hand, if valuation remains high and inflation surpasses 2.5%, the maximum sustainable rate might be 4.5% (10).

It’s important to keep in mind that these projections are based on historical scenarios and a hypothetical portfolio, and there is no guarantee that your portfolio will perform in a similar manner. Also remember that these calculations are based on annual inflation-adjusted withdrawals, and you might choose not to increase withdrawals in some years or use other criteria to make adjustments, such as market performance. For example, some retirees, in an effort to reduce withdrawals after a “down” year in the market, forego taking an inflation-based increase for the following year.

Although there is no assurance that working with a financial professional will improve your investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, including your withdrawal strategy.

If you would like to review your current investment portfolio or discuss your current or upcoming withdrawal rate, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

(1)(2) Forbes Advisor, October 12, 2020
(3)(4)(6)(8,)(10) Financial Advisor, October 2020
(5)(9) U.S. Bureau of Labor Statistics, 2020
(7) multpl.com, December 31, 2020

Disclaimer: All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Asset allocation and diversification are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss. Rebalancing involves selling some investments in order to buy others; selling investments in a taxable account could result in a tax liability.

The S&P 500 index is an unmanaged group of securities considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.

GameStop-Shop, Chop or Slop?

By now, I’m sure you’ve heard or read about the whole GameStop stock market story in the news or online this past week.  I realize a lot of ink has already been spilled on this topic and I am not sure I can add much value or color to the discussion. Nonetheless, perhaps my added value can be to try and explain, in the simplest terms that I can muster, this craziness in the stock and derivatives market.

Let me say that the GameStop “short squeeze” debacle has had little effect on the individual investor, because we, and the majority of registered investment advisors I know, do not short-sell stocks in client portfolios. We typically only invest in blue-chip quality and solid value or growth companies, index funds, and actively managed funds. Short selling is more the domain of large hedge funds, who both buy stocks and sell stocks short. We also don’t invest in companies that were already circling the “bankruptcy drain” such as GameStop and AMC Theatres (GameStop stock traded as low as $2.57 last June).  

So what is short selling?
Short selling is betting that a stock price will go down instead of up (the exact opposite of what everyday stock investors do). To do this, traders ask their broker/dealer if they have any shares that can be borrowed from someone else’s owned shares in the broker’s inventory. If shares are available to borrow, you proceed to sell those shares (short) in the markets at their prevailing price, in hopes that their price/value goes down. Your objective is to subsequently buy them back at a lower price, and “re-pay” your borrowed shares.

Imagine this being done with millions of shares of GameStop, where so many people were already betting that the stock was going down, but instead, the stock went up these past few weeks, and went up a lot. In fact, as unbelievable as it is, more shares were sold short than the entire number of outstanding shares issued by the company (164% to be exact, so many out there were loaning shares they didn’t even have). If you’re short the shares, and they go up in price, you are said to be getting “squeezed”, and your only option is to buy back the shares at much higher prices before your broker/dealer decides that you can no longer afford to stay short, buys them back on your behalf, and charges your account for the losses (the difference between the price you sold them for and the price you paid to buy them back). Imagine selling your shares short for $65.00 per share on Friday, January 22, only to be forced to buy them back at $313 on Friday, January 29 (GameStop traded as high as $483 last week). That’s a loss of 4.8X your money (or if you were lucky and instead bought the shares, you made 4.8X your money).

What we saw this past week was a concerted effort by members of a Reddit subgroup known as Wall Street Bets (WSB) to force these short shareholders to “cover” their short positions. The whole rush to cover short shares is like tinder for a fire because the higher the shares go, the more the short shareholders have to pay to buy them back in a negative “feedback loop” for their positions. Momentum traders and other investors who see this kind of short squeeze also pile on to try and capture or “scalp” some profits.

While some large hedge fund who do/did hold short shares in client accounts lost a lot of money over the past few weeks, the majority of investment advisors and their clients were largely unaffected, other than the fact that these same hedge funds, in an attempt to ride out the short squeeze, used and sold other blue chip stocks (such as Microsoft, Apple, Johnson and Johnson) to cover their losses on the short sales. That’s why you saw the price of those stocks go down last week.

This kind of thing shall pass, and although this may be the first time you’ve heard about this type of “squeeze”, it has happened a lot in the past and will likely happen again. This type of activity tends to crop up when you have a lot of people receiving government checks who have nowhere to go and have nothing better to do (and therefore nothing to lose), so they might as well risk that money in the markets. The current COVID environment has created the perfect stock market storm. I believe that this is more media hype than substance, and will be out of the news cycle in a short time. Cries for regulating or investigating all of this are misplaced in my opinion.

In other words, it’s business as usual in the stock market, unless you owned or shorted the stocks of AMC Theatres, GameStop, Bed, Bath & Beyond, and a few others. As in other newsworthy stock markets “mania’s”, when the dust settles, the majority of the players will likely lose their money because risk management and profit protection isn’t a regular part of their stock trading discipline. If you’re a long term investor, you should grab some popcorn and enjoy the “show” from a distance, and resist the temptation to jump in and risk your hard earned money. Because when the music stops, I believe that GameStop shares will be back to trading in the low-double, if not single-digits once again.

If you would like to review your current investment portfolio or discuss short-selling, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

IRA and Retirement Plan Limits for 2021

As the year comes to and end, it is good to know the limits for 2021 contributions to IRA’s and employer retirement plans.  Many IRA and retirement plan limits are indexed for inflation each year. While some of the limits remain unchanged for 2021, other key numbers have increased.

IRA contribution limits

The maximum amount you can contribute to a traditional IRA or a Roth IRA in 2021 is $6,000 (or 100% of your earned income, if less), unchanged from 2020. The maximum catch-up contribution for those age 50 or older remains $1,000. You can contribute to both a traditional IRA and a Roth IRA in 2021, but your total contributions cannot exceed these annual limits.

Income limits for deducting traditional IRA contributions

If you (or if you’re married, both you and your spouse) are not covered by an employer retirement plan, your contributions to a traditional IRA are generally fully tax deductible. If you’re married, filing jointly, and you’re not covered by an employer plan but your spouse is, your deduction is limited if your modified adjusted gross income (MAGI) is between $198,000 and $208,000 (up from $196,000 and $206,000 in 2020), and eliminated if your MAGI is $208,000 or more (up from $206,000 in 2020).

For those who are covered by an employer plan, deductibility depends on your income and filing status.

If your 2021 federal income tax  filing status is: Your IRA deduction is limited if your MAGI is  between: Your deduction is eliminated if your MAGI is:
Single or head of household $66,000 and $76,000 $76,000 or more
Married filing jointly or qualifying  widow(er) $105,000 and $125,000 (combined) $125,000 or more  (combined)
Married filing separately $0  and $10,000 $10,000 or more

If your filing status is single or head of household, you can fully deduct your IRA contribution up to $6,000 ($7,000 if you are age 50 or older) in 2021 if your MAGI is $66,000 or less (up from $65,000 in 2020). If you’re married and filing a joint return, you can fully deduct up to $6,000 ($7,000 if you are age 50 or older) if your MAGI is $105,000 or less (up from $104,000 in 2020).

Income limits for contributing to a Roth IRA

The income limits for determining how much you can contribute to a Roth IRA have also increased.

If your 2021 federal income tax  filing status is: Your Roth IRA contribution is limited if your MAGI  is: You cannot contribute to a Roth IRA if your MAGI is:
Single or head of household More than $125,000 but less than $140,000 $140,000 or more
Married filing jointly or qualifying  widow(er) More than $198,000 but less than $208,000  (combined) $208,000 or more (combined)
Married filing separately More  than $0 but less than $10,000 $10,000 or more

If your filing status is single or head of household, you can contribute the full $6,000 ($7,000 if you are age 50 or older) to a Roth IRA if your MAGI is $125,000 or less (up from $124,000 in 2020). And if you’re married and filing a joint return, you can make a full contribution if your MAGI is $198,000 or less (up from $196,000 in 2020). Again, contributions can’t exceed 100% of your earned income.

Employer retirement plan limits

Most of the significant employer retirement plan limits for 2021 remain unchanged from 2020. The maximum amount you can contribute (your “elective deferrals”) to a 401(k) plan remains $19,500 in 2021. This limit also applies to 403(b) and 457(b) plans, as well as the Federal Thrift Plan. If you’re age 50 or older, you can also make catch-up contributions of up to $6,500 to these plans in 2021. [Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.]

The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) remains $13,500 in 2021, and the catch-up limit for those age 50 or older remains $3,000.

Plan type: Annual dollar limit: Catch-up limit:
401(k), 403(b), governmental 457(b),  Federal Thrift Plan $19,500 $6,500
SIMPLE  plans $13,500 $3,000

Note: Contributions can’t exceed 100% of your earned income.

If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit ($19,500 in 2021 plus any applicable catch-up contributions). Deferrals to 401(k) plans, 403(b) plans, and SIMPLE plans are included in this aggregate limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and a 457(b) plan, you can defer the full dollar limit to each plan — a total of $39,000 in 2021 (plus any catch-up contributions).

The maximum amount that can be allocated to your account in a defined contribution plan [for example, a 401(k) plan or profit-sharing plan] in 2021 is $58,000 (up from $57,000 in 2020) plus age 50 or older catch-up contributions. This includes both your contributions and your employer’s contributions. Special rules apply if your employer sponsors more than one retirement plan.

Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans in 2021 is $290,000 (up from $285,000 in 2020), and the dollar threshold for determining highly compensated employees (when 2021 is the look-back year) remains $130,000 (unchanged from 2020).

If you would like to review your current investment portfolio or discuss 2021 IRA contributions, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Year-End Tax Planning for 2020 (Business)

In December of 2019, the Further Consolidated Appropriations Act, 2020, was signed into law. Included in that new law was the SECURE Act of 2019, which not only extended certain expiring tax credits, such as the employer credit for paid family and medical leave, it also made favorable changes to certain provisions relating to employer-provided retirement plans.

In 2020, the first piece of COVID-19 legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, payroll tax credits for leave required to be paid under the newly enacted Emergency Paid Sick Leave Act (EPSLA) and Emergency Family and Medical Leave Expansion Act (EFMLEA). The Families First Act was followed by the biggest piece of legislation for the year – the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Included in the CARES Act was the Paycheck Protection Program (PPP), a program authorized by the Small Business Administration (SBA) to guarantee $349 billion in new loans to eligible businesses and nonprofits affected by coronavirus/COVID-19. Such loans may also qualify for tax-free loan forgiveness. We need to evaluate the changes made by the CARES Act, as well as subsequent coronavirus-related legislation, to determine their impact on your business’s tax liability. The following are some of the considerations we need to review when deciding what year-end actions may be appropriate to reap the most benefit to you and your business’s bottom line.

Depreciation Deductions

Among the many changes made by the CARES Act, the one which may have the most impact is the correction of a technical error made in the Tax Cuts and Jobs Act of 2017 (TCJA). That error resulted in the 15-year recovery period that applied to qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property being eliminated for such property placed in service after 2017. After the TCJA, the depreciation period for such property, now referred to as “qualified improvement property,” was 39 years and, as a result, did not meet the requirements for additional first-year depreciation (i.e., bonus depreciation). Under the CARES Act, qualified improvement property is now depreciated over a 15-year life and meets the criteria for taking bonus depreciation. The change is effective as if it were included in the TCJA. Thus, if your business is affected by this change, we can file amended returns to claim refunds for the deductions that should have been available to you had the technical error not happened.

Relaxed Rules for Deducting Net Operating Losses

The CARES Act also temporarily removed the 80 percent limitation on taxable income for deducting net operating losses (NOLs) for 2020. In addition, the CARES Act amended the rules for NOLs to provide for a five-year carryback of any NOL arising in 2018, 2019, and 2020. As a result, if applicable, your business can take such NOLs into account in the earliest tax year in the carryback period and carry forward unused amounts to each succeeding tax year. Alternatively, you can waive this carryback period and instead carry forward any NOLs to offset income in future years. Depending on expected tax rates and cash flow in future years, this waiver option may make more sense than carrying back any NOLs.

Reduction in Business Interest Limitation

The CARES Act reduced the limitation on the deductibility of business interest. For tax years beginning in 2019 or 2020, 50 percent of a business’s adjusted taxable income, rather than 30 percent, is used to determine the business interest limitation. A special rule is provided for partnerships. Under this special rule, the increase in the limitation to 50 percent of adjusted taxable income in determining the business interest limitation does not apply to a partnership for 2019, subject to certain rules relating to allocations to the partners. There is also an election under which a business can substitute its adjusted taxable income for its last tax year beginning in 2019 for its adjusted taxable income for 2020 in calculating the business interest limitation for 2020. Keep in mind that the business interest deduction limitation only applies if the gross receipts of your business exceed $26 million in 2019 and 2020; Additionally, certain types of businesses are exempt from the limitation.

Modification of Excess Business Loss Limitation Rules

The CARES Act eliminated certain limitations on excess farm losses of a business other than a corporation. This change applies to any tax year beginning after December 31, 2017, and before January 1, 2026. Thus, if you had such losses that were limited in 2018 and/or 2019, we may be able to obtain tax refunds with respect to those years. Further, excess business losses, previously disallowed for tax years beginning after December 31, 2017, and before January 1, 2026, are now allowed for tax years beginning after 2017 and before January 1, 2021. This also presents an opportunity for amended tax returns if it applies to your business.

Minimum Tax Credit Refund

The CARES Act modified the rules for the minimum tax credit for alternative minimum tax (AMT) incurred by a corporation in a prior tax year. Under this provision, the limitation on the credit for prior year minimum tax liability does not apply to a corporation’s 2020 and 2021 tax years and the AMT refundable credit amount is 100 percent, rather than 50 percent, for tax years beginning in 2019. In addition, a corporation can elect to take the entire refundable credit amount in 2018. A corporation can apply for a tentative refund of any amount for which a refund is due by reason of this new election and, within 90 days, the IRS is required to review the application, determine the amount of the overpayment, and apply, credit, or refund the overpayment.

Retirement Plans and Other Employee Benefits

You can reap substantial tax benefits, as well as non-tax benefits, by offering a retirement plan and/or other fringe benefits to employees. Businesses that offer such benefits have a better chance of attracting and retaining talented workers. This, in turn, reduces the costs of searching for and training new employees. Contributions made to retirement plans on behalf of employees are deductible and you may be eligible for a tax credit for setting up a qualified plan. In addition, business owners can take advantage of the retirement plan themselves, as can their spouse. Where a spouse is not currently on the payroll of a business, consideration should be given to adding the spouse as an employee and paying a salary up to the maximum amount that can be deferred into a retirement plan. So, for example, if your spouse is 50 years old or over and receives a salary of $25,000, all of it could go into a 401(k), leaving him or her with a retirement account but no taxable income.

To help employees with medical expenses, your business might consider setting up a high deductible health plan paired with a health savings account (HSA). The benefits to a business include savings on health insurance premiums that would otherwise be paid to traditional health insurance companies and having employee wage contributions to the plan not being counted as wages and thus neither the employer nor the employee is subject to FICA taxes on the payroll contributions. As for employees, they can reap a tax deduction for funds contributed to the HSA, which they can invest the funds for future medical costs because there is no use-it-or-lose-it limit like there is for most flexible spending accounts; thus the funds can grow tax free and be used in retirement.

Your business might also consider establishing a flexible spending arrangement (FSA) which allows employees to be reimbursed for medical expenses and is usually funded through voluntary salary reduction agreements with the employer. The employer has the option of making or not making contributions to the FSA. Some of the benefits of an FSA include the fact that contributions made by the business can be excluded from the employee’s gross income, no employment or federal income taxes are deducted from the contributions, reimbursements to the employee are tax free if used for qualified medical expenses, and the FSA can be used to pay qualified medical expenses even if the employer or employee haven’t yet placed the funds in the account.

In addition, the SECURE Act made substantial changes to retirement plan-related provisions from which your business may benefit. For one, it increased the credit available for small employer pension plan startup costs. The credit is available for qualified startup costs of an eligible small employer that adopts a new qualified retirement plan, SIMPLE IRA plan, or SEP, provided that the plan covers at least one non-highly compensated employee. Qualified startup costs are expenses connected with the establishment or administration of the plan or retirement-related education for employees with respect to the plan. The credit, which applies for up to three years, was increased to the lesser of (1) a flat dollar amount of $500 per year, or (2) 50 percent of the qualified startup costs.

The SECURE Act also extended through 2020 an employer credit for paid family and medical leave. The credit allows eligible employers to claim a general business credit equal to an applicable percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave, provided that the rate of payment under the program is at least 50 percent of the wages normally paid to an employee.

The SECURE Act also extended the work opportunity credit through 2020. Under this provision, an employer can take a 40 percent credit for qualified first-year wages paid or incurred with respect to employees who are members of a targeted group of employees.

Qualified Business Income Deduction

If you participate in a business as sole proprietor, a partner in a partnership, a member in an LLC taxed as a partnership, or as a shareholder in an S corporation, you may be eligible for the qualified business income (QBI) deduction. The QBI deduction is generally 20 percent of qualifying business income from a qualified trade or business. A W-2 wage limitation amount may apply to limit the amount of the deduction. The W-2 wage limitation amount must be calculated for taxpayers with a taxable income that exceeds a statutorily-defined amount (i.e., the threshold amount). For any tax year beginning in 2020, the threshold amount is $326,600 for married filing joint returns, $163,300 for married filing separate returns, and $163,300 for all other returns.

The QBI deduction reduces taxable income, and is not used in computing adjusted gross income. Thus, it does not affect limitations based on adjusted gross income. The QBI deduction does not apply to a “specified service trade or business,” which is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.

Some of the categories and fields listed as a specified service trade or business are fairly clear in their meaning. Others – such as “consulting” and “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees” – are more vague. If your business could be considered a specified service trade or business, we will need to document why it should not be considered such a business and is thus eligible for the QBI deduction.

Employee Payroll Tax Deferrals

In a Payroll Tax Memorandum issued in August, President Trump directed Treasury Secretary Mnuchin to use his authority to defer the withholding, deposit, and payment of employee social security taxes, as well as taxes imposed under the Railroad Retirement Tax Act (RRTA) on railroad employees, for the period of September 1, 2020, through December 31, 2020. Because these taxes are not forgiven, and must be repaid at the end of the year, such a deferral could result in numerous practical challenges, such as what happens if an employee leaves before he or she repays the payroll taxes. If you have deferred an employee’s payroll taxes under this Presidential directive, we need to discuss your options.

Extension of Time to Pay Employment Taxes

Under the CARES Act, a business can delay payment of applicable employment taxes for the period beginning on March 27, 2020, and ending before January 1, 2021 (i.e., the payroll tax deferral period). Generally, under this provision, the business is treated as having timely made all deposits of applicable employment taxes that would otherwise be required during the payroll tax deferral period if all such deposits are made not later than the “applicable date,” which is (1) December 31, 2021, with respect to 50 percent of the amounts due, and (2) December 31, 2022, with respect to the remaining amounts. For self-employed taxpayers, the payment for 50 percent of the self-employment taxes for the payroll tax deferral period is not due before the applicable date. For purposes of applying the penalty for underpayment of estimated income taxes to any tax year which includes any part of the payroll tax deferral period, 50 percent of the self-employment taxes for the payroll tax deferral period are not treated as taxes to which that penalty applies.

PPP Loan

If your business obtained funds through the PPP program, we should discuss the steps and documentation necessary to ensure that your loan is fully forgiven.

Impact of Future Tax Legislation

Because it is unclear what, if any, tax legislation may be coming next year, we’ll need to base our year-end planning on existing law.

If you would like to review your current investment portfolio or discuss any other financial or tax planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

2020 Year-End Tax Planning Tips & Traps

It’s that time of year again! Well, yes, it’s that magical holiday time of year too, but year-end tax planning season is upon us.

Because of uncertainty surrounding the two vacant Georgia Senate seats scheduled for a runoff election on January 5, 2021, it’s unclear whether any of presumed President-elect Biden’s tax proposals (increases) will become law in 2021. If the Republicans can capture at least one of the two Georgia Senate seats and maintain control of the Senate, then tax increases in 2021 will be harder to pass under a split Congress.

Due to the coronavirus pandemic (COVID-19) and the enactment of legislation to offset the economic burden wrought by COVID-19, as well as a legislation passed at the end of 2019, there is a lot to consider when reviewing year-end tax planning options that may be available to reduce your 2020 or 2021 tax liability.

In December of 2019, the SECURE Act was signed into law. This legislation extended several expiring deductions and tax credits and provided some taxpayer-friendly changes to retirement-related rules. In 2020, the first piece of COVID-19 tax-related legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, four types of tax credits for employers and self-employed individuals.

The Families First Act was followed by the biggest piece of legislation for the year – the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act, as well as subsequent coronavirus-related legislation, will most likely impact your tax return in some way. The following are some of the considerations we should explore when discussing the tax breaks from which you may benefit, as well as the strategies we can employ to help minimize your taxable income and resulting federal tax liability.

Effect of CARES Act Rebate on Your 2020 Tax Return

Under the CARES Act, individuals with income under a certain level are entitled to a recovery rebate tax credit. These are direct payments (sometimes referred to as “stimulus checks”) to individuals by the government. Most, but not all, of these stimulus checks have already been sent out to eligible individuals during 2020.

Single individuals and joint filers are entitled to a payment of $1,200 or $2,400, respectively, plus $500 for each qualifying child. The term “qualifying child” has the same meaning that it does for the child tax credit. Thus, a qualifying child can be no older than 16 on the last day of the tax year (December 31, 2020). The amount of the recovery rebate phases out for income over a certain level. The rebate is reduced by 5 percent of the amount by which the taxpayer’s adjusted gross income exceeds (1) $150,000 in the case of a joint return, (2) $112,500 in the case of a head of household, and (3) $75,000 in the case of a single taxpayer or a taxpayer with a filing status of married filing separately.

The government issued the rebates based on 2019 income tax returns, or 2018 returns for individuals who had not yet filed their 2019 tax return. The calculation for the correct amount of the rebate will be part of your 2020 tax return. If your 2020 tax return indicates a rebate larger than your stimulus check (because, for example, your income went down or you had another child), any additional amount can be claimed as a credit against your 2020 tax bill. In an unusual twist in the legislation, if the 2020 rebate calculation shows an amount in excess of what you were entitled to, you do not have to repay that excess.

Filing Status

Your tax return filing status can impact the amount of taxes you pay. For example, if you qualify for head-of-household (HOH) filing status, you are entitled to a higher standard deduction and more favorable tax rates. To qualify as HOH, you must be unmarried or considered unmarried (i.e., legally separated or living apart from a spouse) and provide a home for certain other persons. If you are in such a situation, you need to review whether you qualify for HOH filing status.

If you are married, you’ll either be filing your return using the married filing jointly or married filing separately filing status. Generally, married filing separately is not beneficial for tax purposes, but in some unique cases, such as when one party earns substantially less or when one party may be subject to IRS penalties for issues relating to their tax reporting, it may be advantageous to file as married filing separately. Additionally, if one spouse was not a full-year U.S. resident, an election is available to file a joint tax return where such joint filing status would otherwise not apply, and this may help reduce a couple’s tax liability.

Note that once you file your return jointly, you cannot subsequently go back and amend your return to file separately, but you can switch status from married filing separately to married filing jointly.

Income, Deductions, and Credits

Income from Repayment of Student Loan Debt: The CARES Act excludes from income certain student loan debt repaid by an individual’s employer. Thus, if an employer repaid some or all of your student loan debt after March 27, 2020, and before 2021, that repayment, which would otherwise be taxable income to you, is not includible in your income.

Standard Deduction versus Itemized Deductions: The Tax Cuts and Jobs Act of 2017 (TCJA) substantially increased the standard deduction amounts, thus making itemized deductions less attractive for many individuals. For 2020, the standard deduction amounts are: $12,400 (single); $18,650 (head of household); $24,800 (married filing jointly); and $12,400 (married filing separately).

If the total of your itemized deductions in 2020 will be close to your standard deduction amount, you should evaluate whether alternating between bunching itemized deductions into 2020 and taking the standard deduction in 2021 (or vice versa) could provide a net-tax benefit over the two-year period. For example, you might consider doubling up this year on your charitable contributions rather than spreading the contributions over a two-year period (or look into setting up a Donor Advised Fund). If these contributions, along with your mortgage interest, medical expenses (discussed below), and state/local income and property taxes (subject to the $10,000 deduction limitation on such taxes that applies to both single individuals and married couples filing jointly; and the $5,000 limitation on such expenses for married filing separately returns), exceed your standard deduction, then itemizing such expenses this year and taking the standard deduction next year may be appropriate.

Medical Expenses Health Savings Accounts, and Flexible Savings Accounts: For 2020, your medical expenses are deductible as an itemized deduction to the extent that they exceed 7.5 percent of your adjusted gross income. To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They don’t include expenses that are merely beneficial to general health, such as vitamins or a vacation.

Deductible expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract. Depending on what your taxable income is expected to be in 2020 and 2021, and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2020 or defer them until 2021. The right approach depends on your income for each year, expected medical expenses, as well as your other itemized deductions.

You may also want to consider health saving accounts (HSAs) if you don’t already have one. These are tax-advantaged accounts which help individuals who have high-deductible health plans (HDHPs). If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. These contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax free to the extent that they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2020, the annual contribution limits are $3,550 for an individual with self-only coverage and $7,100 for an individual with family coverage.

In addition, if you are not already doing so and your employer offers a Flexible Spending Account (FSA), consider setting aside some of your earnings tax free in such an account so you can pay medical and dental bills with pre-tax money. The maximum amount that the IRS will allow to be set aside in 2021 is expected to be $2,750. Since you don’t pay taxes on this money, you’ll save an amount equal to the taxes you would have paid on the money that you set aside. FSA funds can be used to pay deductibles and co-payments, but not for insurance premiums. You can also spend FSA funds on prescription medications, as well as over-the-counter medicines, generally with a doctor’s prescription. Reimbursements for insulin are allowed without a prescription. And finally, FSAs may also be used to cover costs of medical equipment like crutches, supplies like bandages, contact lenses and diagnostic devices like blood sugar test kits.

Several CARES Act provisions affect health care related rules. For example, under the CARES Act, an HDHP temporarily can cover tele-health and other remote care services without a deductible, or with a deductible below the minimum annual deductible otherwise required by law. The CARES Act also modified the rules that apply to various tax-advantaged health-related accounts so that additional health-related items are “qualified medical expenses” that may be reimbursed from those accounts. Under the new rules, which apply to amounts paid after 2019, over-the-counter products and medications are now reimbursable without a prescription.

Charitable Contributions: While the tax benefits of making charitable contributions and taking an itemized deduction for such contributions were tamped down as a result of the increase in the standard deduction in the TCJA, the CARES Act modified the charitable contribution rules for 2020 tax returns. As a result, an eligible individual can claim an above-the-line deduction of up to $300 for qualified charitable contributions made during 2020. The above-the-line deduction is not available for contributions made after 2020. An eligible individual is an individual who does not elect to itemize deductions. Thus, absent this provision, anyone taking the standard deduction would be ineligible to take a charitable contribution deduction. A qualified charitable contribution is a cash contribution paid in 2020 to an eligible charitable organization. Contributions of non-cash property, such as securities, are not qualified contributions.

In addition, if you are itemizing your deductions and have substantial charitable contributions, the CARES Act modified the percentage limitation rules that could otherwise limit your charitable contribution deduction. Under the provision, for charitable contributions made during 2020, any qualified contribution is allowed as a deduction to the extent that the aggregate of such contributions does not exceed the excess of your charitable contribution base over the amount of all other charitable contributions. Excess contributions are eligible for a five-year carryover.

As in prior years, you can reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles you to a charitable contribution deduction but also helps you avoid the capital gains tax that would otherwise be due if you sold your stock.

For example, if you own stock with a fair market value of $1,000 that was purchased for $250 and your capital gains tax rate is 15 percent, the capital gains tax you would owe is $113 ($750 gain x 15%). If you donate that stock instead of selling it, and are in the 24 percent tax bracket, your ordinary income deduction is worth $240 ($1,000 FMV x 24% tax rate). You also save the $113 in capital gains tax that you would otherwise pay if you sold the stock; that amount goes to the charity. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 – $240 – $113) compared to the after tax cost of a donation of $1,000 cash which would be $760 ($1,000 – $240). However, it’s important to also keep in mind that tax deductions for contributions of appreciated long-term capital gain property may be limited to a certain percentage of your adjusted gross income depending on the amount of the deduction.

Finally, if you have an individual retirement account and are 70 1/2 years old and older, you are eligible to make a charitable contribution directly from your IRA (even though the age for required minimum distributions is now age 72). This is more advantageous than taking a distribution and making a donation to the charity that may or may not be deductible as an itemized deduction. If your itemized deductions, including the contribution, are less than your standard deduction, then you receive no tax benefit from making the donation in this manner. By making the donation directly from your IRA to a charity, you eliminate having the IRA distribution included in your income. This in turn reduces your adjusted gross income (AGI).

And because various tax-related items, such as the medical expense deduction, the taxability of social security income, or the 3.8 percent net investment income tax are calculated based on your AGI, a reduced AGI can potentially increase your medical expense deduction, reduce the taxes on social security income, and reduce any net investment income tax.

Expenses Incurred While Working from Home: Although more people have been working from home this year due to the pandemic, related expenses are not deductible if you are an employee. The TCJA eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was available before 2018. However, if you are self-employed and worked from home during the year, tax deductions are still available. Thus, if you have been working from home as an independent contractor, some office in the home expenses you have incurred might reduce your taxable income.

Mortgage Interest Deduction: If you sold your principal residence during the year and acquired a new principal residence, the deduction for any interest on your acquisition indebtedness (i.e., your mortgage) could be limited. The mortgage interest deduction on mortgages of more than $750,000 obtained after December 14, 2017, is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). If you have a mortgage on a principle residence acquired before December 15, 2017, the limitation applies to mortgages of $1,000,000 ($500,000 in the case of married taxpayers filing separately) or less. However, if you operate a business from your home, an allocable portion of your mortgage interest is not subject to these limitations.

Interest on Home Equity Indebtedness: You can potentially deduct interest paid on home equity indebtedness, but only if you used the debt to buy, build, or substantially improve your home. Thus, for example, interest on a home equity loan used to build an addition to your existing home is typically deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, is not.

Sale of a Home: If you sold your home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of your home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if you rented part of your home or otherwise used it for business, the loss attributable to that portion of the home may be deductible.

Discharge of Qualified Principal Residence Indebtedness: If you had any qualified principal residence indebtedness which was discharged in 2020, it is not includible in gross income.

Deductions for Mortgage Insurance Premiums: You may be entitled to treat amounts paid during the year for any qualified mortgage insurance as deductible qualified residence interest, if the insurance was obtained in connection with acquisition debt for a qualified residence.

Deductions for Excess Business Losses: The CARES Act removed the loss limitation deduction applicable to non-corporate taxpayers who incurred excess business losses in 2018, 2019, and 2020. An excess business loss for the tax year is the excess of aggregate deductions attributable to your trades or businesses over the sum of your aggregate gross income or gain plus a threshold amount. The threshold amount for 2020 is $259,000 or $518,000 for joint returns. If this provision affects you, you can file amended returns and claim refunds for the years affected.

Qualified Business Income Passthrough Tax Break: Under the qualified business income tax break, a 20 percent deduction is allowed for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and nonitemizers, it is taken on your individual tax return as a reduction to taxable income. This tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below $163,300 ($326,600 for joint filers; $163,300 for married individuals filing separately) are simpler and more permissive than the ones that apply above those thresholds.

Child and Dependent Tax Credit: For 2020, you may claim as much as a $2,000 credit for each child under age 17. The amount of the credit is reduced for taxpayers with modified adjusted income over $200,000 ($400,000 for married filing jointly) and eliminated in full for taxpayers with modified adjusted gross income over $240,000 ($440,000 for married filing jointly). In addition, you may be eligible for a $500 credit for certain dependents. The $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed (because, for example, you do not have a social security number for that child), and (2) certain qualifying relatives.

Education-Related Deductions and Credits: Certain education-related tax deductions, credits, and exclusions from income may apply for 2020. Tax-free distributions from a qualified tuition program, also referred to as a Section 529 plan, of up to $10,000 are allowed for qualified higher education expenses. Qualified higher education expenses for this purpose include tuition expenses in connection with a designated beneficiary’s enrollment or attendance at an elementary or secondary public, private, or religious school, i.e. kindergarten through grade 12. It also includes expenses for fees, books, supplies, and equipment required for the participation in certain apprenticeship programs and qualified education loan repayments in limited amounts.

A special rule allows tax-free distributions to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister). As a result, a 529 account holder can make a student loan distribution to a sibling of the designated beneficiary without changing the designated beneficiary of the account. In addition, if your modified adjusted gross income level is below certain thresholds, the following are also available for 2020: a deduction of up to $4,000 for qualified tuition and related expenses, an exclusion from income for education savings bond interest received; a deduction for student loan interest; and a lifetime learning credit of up to $2,000 for tuition and fees paid for the enrollment or attendance of yourself, your spouse, or your dependents for courses of instruction at an eligible educational institution.

Credit for Sick Leave for Self-Employed Individuals: Under the Families First Act, if you are considered an eligible self-employed individual, you may be eligible for an income tax credit for a qualified sick leave equivalent amount. You are an eligible self-employed individual if you regularly carry on any trade or business and would be entitled to receive paid leave during the tax year under the Emergency Paid Sick Leave Act added by the Families First Act.

The calculation of the qualified sick leave equivalent amount is quite complicated but is generally equal to the number of days during the tax year that you could not perform services for which you would have been entitled to sick leave, multiplied by the lesser of two amounts: (1) $511, or (2) 100 percent of your average daily self-employment income. The number of days taken into account in determining the qualified sick leave equivalent amount may not generally exceed 10 days. Your average daily self-employment income under this provision is an amount equal to the net earnings from self-employment for the year divided by 260. In addition, if you have appropriate documentation, the credit is refundable.

Credit for Family Leave for Certain Self-Employed Individuals: Another income tax credit that may be available to you under the Families First Act is a credit for a qualified family leave equivalent amount. The qualified family leave equivalent amount is an amount equal to the number of days (up to 50) during the tax year that you could not perform services for which you would be entitled, if you were employed by an employer, to paid leave under the Emergency Family and Medical Leave Expansion Act, which was added by the Families First Act, multiplied by the lesser of two amounts: (1) 67 percent of your average daily self-employment income for the tax year, or (2) $200. Your average daily self-employment income under the provision is an amount equal to your net earnings from self-employment for the year divided by 260. This credit is also refundable.

Retirement Planning

CARES Act and SECURE Act Changes. Several taxpayer-favorable changes were made in the CARES Act and the SECURE Act with respect to retirement plans and distributions from those plans including the following:

(1) The required minimum distribution rules for 2020 are waived so no one is required to take such a distribution and include it in taxable income in 2020.

(2) The age limit for making contributions to a traditional individual retirement account (IRA), previously 70 ½ years old, was repealed in 2020. Thus, anyone who is otherwise eligible may make a contribution to a traditional IRA.

(3) A new type of retirement plan distribution was added to the list of early distributions that are excepted from the 10-percent penalty for early withdrawals. You can now receive a distribution from an applicable eligible retirement plan of up to $5,000 without penalty if the distribution is either a qualified birth or adoption distribution.

(4) Taxpayers impacted by the coronavirus (which is essentially anyone) can withdraw up to $100,000 from a retirement plan without penalty and is generally includible in income over a three-year period and, to the extent the distribution is eligible for tax-free rollover treatment and is contributed to an eligible retirement plan within a three-year period, is not includible in income.

(5) The required beginning date for required minimum distributions has been increased to 72 years old from 70 ½ years old. The former rules apply to employees and IRA owners who attained age 70½ prior to January 1, 2020. The new provision is effective for distributions required to be made after December 31, 2019, with respect to individuals who attain age 70½ after December 31, 2019.

Retirement Plan Contributions: If you can afford to do so, investing the maximum amount allowable in a qualified retirement plan will yield a large tax benefit. If your employer has a 401(k) plan and you are under age 50, you can defer up to $19,500 of income into that plan for 2020. Catch-up contributions of $6,500 are allowed if you are 50 or over. If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2020 is $13,500. That amount increases to $16,500 if you are 50 or older. The maximum IRA deductible contribution for 2020 is $6,000 and that amount increases to $7,000 if you are 50 or over.

Life Events

Life events can have a significant impact on your tax liability. For example, if you are eligible to use head of household or surviving spouse filing status for 2019, but will change to a filing tax status of single for 2020, your tax rate will go up. If you married or divorced during the year and changed your name, you need to notify the Social Security Administration (SSA). Similarly, the SSA should be notified if you have a dependent whose name has been changed. A mismatch between the name shown on the tax return and the SSA records can cause problems in the processing of tax returns and may even delay tax refunds. Let me know if you have been impacted by a life event, such as a birth or death in your family, the loss of a job or a change in jobs, or a retirement during the year. All of these can affect you tax situation.

Impact of Future Legislation

Because it is unclear what, if any, tax legislation may be coming next year, you’ll need to base your year-end planning on existing tax law. Be sure to check themoneygeek.com for updates on any potential law changes.

An article on business tax planning will be posted next week, so be sure to return and read those tips if you own or run a business.

If you would like to review your current investment portfolio or discuss any other financial or tax planning matters, please don’t hesitate to contact us or visit our website at ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

Election Confusion Designed to Steal Your Data and Assets

Criminals are using election confusion to attempt to steal your data and assets. Don’t become a victim!

As we near the end of the year, we’re all reminded once again that fraud attempts tend to spike during the holiday season. But this year’s fourth quarter offers additional reasons for concern—not only due to the ongoing global pandemic, but also because of tensions surrounding the U.S. presidential election.

Fraudsters are already doing their best to take advantage of voters’ confusion about how, where and when they can cast their ballots in a disorienting and seemingly unpredictable environment. For example, there are already reports of fraudulent websites that are offering inaccurate mail-in voting guidelines, as well as fallacious robocalls purporting to be from presidential candidates.

We anticipate that, as election day approaches, fraudsters will try not only the techniques mentioned above, but also phishing campaigns and other scams designed to steal your personal and account information, infect your devices with malware, and gain access to your email and financial accounts.

Be sure that you are aware of these threats and are ready to defend against them. Here are some tips:

  • Always pause and ask additional questions when something doesn’t seem right.
  • Hang up on strangers who call you asking personal questions
  • Never open an e-mail attachment that you’re not 100% sure is legitimate or you were not expecting.

As a firm, we are doing everything we can to help prevent fraud, among others by verifying money movement between client internal and external accounts. We will always verbally verify wire transfers before approving them and will do our best to flag unusual activity with the help of our custodian.

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