Fortunately for all of us, 2020 will soon draw to a close. Before it does, though, it's probably a good idea to look at your personal tax situation and make sure you're at least considering what you can do to optimize it. After all, when the calendar year ends, many of these opportunities do, too.
With that in mind, these five tax moves are ones you should look at making now -- before 2020 ends and the windows to leverage them snap shut. In some cases, you'll get a new window to make adjustments in 2021, but in others, now is your last chance to make these adjustments to avoid a world of pain later.
1. Adjust your withholdings to get within safe harbor
The IRS does not require you to get your taxes perfect before the April 15 filing deadline. It does, however, require you to pay close to what you owe before the deadline and then true up any differences by that date.
What it views as close enough is based on three safe harbor tests. As long as you pass any one of them, you're viewed as being close enough until that final deadline comes around. If you're not within safe harbor, you'll likely see penalties tacked on to your tax bill.
The safe harbor tests are as follows:
- You've paid to within $1,000 of what you owe for the year
- You've paid at least 90% of what you owe for the year
- You've paid at least 100% of what you owed for last year (or 110% if you're considered high income)
If you're coming up short, you can adjust the tax withholdings from your paycheck or from withdrawals from your retirement account to help close the gap. The IRS views any withholdings on or before Dec. 31 to be timely for 2020, so time is running out to get yourself close enough using this method.
2. Top off your contributions to your employer-sponsored retirement plan
The IRS places annual limits on the amount you can contribute to your 401(k), 403(b), TSP, or other employer-sponsored retirement plan. In 2020, if you're under age 50, that limit is $19,500 per year, and it's $26,000 if you're aged 50 or older. In order for that money to qualify for the 2020 limits, you need to have it withdrawn from your paycheck on or before Dec. 31.
Typically, your employer or retirement plan administrator has an online form you'll need to fill out to adjust your contribution amount. That form usually needs to be received and processed before payroll runs (which may be a few days before payday itself) in order to have the contribution reflected in your upcoming paycheck. As a result, if you'd like to get this done for any December paychecks you may be expecting, now is a great time to look into it.
3. Take capital losses to offset your gains
Even the best investors don't always pick only winners. If you have an investment that looks like it will result in a capital loss, you generally need to close that investment before the end of the year in order to claim the loss on your current year's taxes. If they're large enough, your capital losses can completely offset your capital gains and even potentially as much as $3,000 of ordinary income above and beyond those gains.
If you are considering taking capital losses, though, be sure to take the losses only on investments that you no longer want to hold. If you buy back the shares within 30 days of selling them, you have what is known as a "wash sale", which effectively means you can't immediately deduct the losses. Since the market can move substantially in the space of a month, it doesn't make sense to sell to take the loss, only to hope you can buy back the same company at a similar price later.
4. Take long-term capital gains to raise your basis
On the flip side, if your overall income is low enough, you may want to consider taking long-term capital gains to raise the basis cost on your investments. Unlike for capital losses, you face no worry of wash sales when taking capital gains. For 2020, if you're married filing jointly and your net taxable income is below $80,000, you face a 0% long-term capital gains tax rate at the federal level. That may give you the chance to sell some investments for a gain, immediately buy them back, and not face taxes on them.
Say that you're married, your ordinary taxable income is $50,000, and you own shares in an ordinary investment account that you bought a few years ago for $5,000 that are now worth $20,000. If you sell those shares and immediately rebuy them, you will face a $15,000 capital gain. If that capital gain is the only income you have beyond that $50,000, it brings your total taxable income to $65,000, which is below that $80,000 limit so you won't face any federal capital gains tax.
The advantage of this move is that it would raise your basis price of your shares to $20,000. That way, if you were to sell them later, you would likely owe less tax on them than had your basis been $5,000. Do note, however, that this move does reset your holding period, which means you need to hold those shares for over a year from that point on to again qualify for long-term capital gains rates.
5. Partially convert your traditional retirement accounts to Roth-style ones
One key advantage of Roth-style retirement accounts is that the money in those accounts can grow and compound completely tax free for your retirement. On the flip side, most withdrawals from traditional style plans are taxed as ordinary income in retirement, making every dollar in those accounts potentially a little less valuable than one in a Roth account.
If your overall tax bill is low in 2020, now is a great time to consider converting some of the money in your traditional-style retirement accounts into your Roth-style retirement accounts. You will pay ordinary income tax on the converted amount, but if you're in a low tax bracket, the relatively small amount of taxes you'll pay on the conversion could very well be worth it later.
After all, not only do those Roth accounts grow for potential tax free withdrawals, but Roth IRAs are also not subject to required minimum distributions in retirement. Those required minimum distributions force you to take money from your traditional retirement plans, likely subjecting that money to income taxes. In addition, if they drive your overall income high enough, those minimum distributions could also cause your Social Security benefits to be taxed and your Medicare Part B premiums to rise.
Time is ticking -- so act now
If you want to take advantage of these tax opportunities for 2020, your time is running out. On some of these, you need to take action by the time your last 2020 paycheck is processed by your employer. On others, you have until the end of the calendar year. In all cases, though, time is of the essence if you want to improve your tax situation in 2020. So get started now, and execute whichever of these five tax moves make sense for you to make before 2020 ends.