The Ultimate 2020 Tax Planning Guide

Hey, Reader: Don't get confused! This article's about 2020 taxes, which you won't have to file until 2021. For 2019 tax planning, check out this guide. And if you're looking for more info on filing your taxes -- including the recently changed filing deadline -- check out this article.

2020 could be a momentous year for many reasons. But if you're trying to do tax planning for 2020, it doesn't look like this year is going to bring much in the way of massive changes to tax laws. No matter what happens in the 2020 elections, any changes in the White House or control of Congress won't take effect until 2021, and so this year is likely to continue the gridlock that has kept current tax laws largely unchanged since 2018's tax reform efforts.

Even without major tax law changes, every year brings a host of smaller amendments to existing provisions. They include the following:

• New tax brackets for ordinary income as well as qualified dividends and long-term capital gains
• Higher standard deductions
• Changes to key provisions for popular tax credits
• Qualifications for common tax deductions
• Contribution limits and income thresholds for retirement accounts
• Increases in other tax-favored accounts for healthcare and education
• Exemptions from gift and estate tax

Let's take a more comprehensive look at all of these tax issues to help you create a better tax plan for 2020.

What are the tax brackets for 2020?

Tax brackets define what percentage of your income you have to pay in tax. Under our progressive tax system, the more money someone makes, the higher the percentage of tax owed on each extra dollar of income -- also known as the marginal tax rate.

Image source: Getty Images.

However, you don't pay the marginal tax rate from your top tax bracket on every dollar you earn. Instead, you receive the benefit of lower tax rates for certain parts of your income, in a graduated manner.

The only changes to the income tax brackets for 2020 reflected the usual yearly inflation adjustments to the income amounts for each bracket. Apart from that, you can expect the same basic structure as 2019, with the same seven tax rates applying to the various brackets. The actual income amounts of the brackets depend on your tax filing status. Accordingly, you'll see five sets of 2019 tax brackets below.

If you file as a single taxpayer, the following brackets apply:

Data source: IRS.

Those who qualify as head of household have higher income thresholds apply to each tax bracket, resulting in lower tax. To qualify as a head of household, the requirements include that you be unmarried and provide both housing and financial support for a child, parent, or other relative who lives with you for greater than half of the year. The financial support you provide must generally be more than half of all support the child or other relative received during the year.

Data source: IRS.

Most married taxpayers file jointly. If you were married but your spouse passed away recently, then you're also allowed to use these brackets as a surviving spouse.

Data source: IRS.

Some married taxpayers choose to file separate returns. These are the brackets that apply.

Data source: IRS.

Finally, there are some trusts that get taxed as separate legal entities. The same is true of estates of someone who passes away. These brackets are also important for those whose children have enough unearned income to be subject to the kiddie tax.

Data source: IRS.

What's the 2020 tax rate on long-term capital gains and qualified dividends?

Investors enjoy a tax break on certain types of investment income. Dividends that certain stocks pay qualify for lower tax rates, as do the profits on investments that you sell after having held them for longer than a year. These qualified dividends and long-term capital gains are eligible to get taxed at 0%, 15%, or 20%, producing substantial savings.

A separate set of brackets applies to determine the maximum tax rate on qualified dividends and long-term capital gains, as seen below.

 Data source: IRS.

To take advantage of these lower rates, taxpayers should ensure that they meet the requirements for qualified dividend income and long-term capital gains. Most dividends that U.S. stocks pay qualifies, but any dividends that don't qualify get taxed at higher ordinary income tax rates. Selling an investment you've held for a year or less makes any gain short-term rather than long-term, and short-term capital gains also get taxed at ordinary tax rates. If you pick good dividend stocks and hold your investments for the long run, the tax laws reward you with lower rates.

What is the standard deduction for 2020?

The vast majority of taxpayers take the standard deduction. The current amounts are high enough that only a few taxpayers get enough extra benefit to justify itemizing their deductions instead.

Annual inflation adjustments brought a modest rise in standard deductions for 2020, as seen below.

Source: IRS.

In addition to these base amounts, those who are 65 or older or are blind get to take additional amounts as a standard deduction. For those who are married, the added amount is $1,300, while singles get to add $1,650. These added amounts are the same for 2020 as they were in 2019. If you're 65 or older and blind, then you can boost your standard deduction by double the relevant amount. Moreover, for joint filers, each spouse has an opportunity to get these added amounts. So married couples in which both spouses are over 65 and are blind would see their standard deduction increase by $5,200 -- or $1,300 times four.

Most minor children don't have to file taxes at all, but if they have income from a job or from investments held in their name, then it's possible that they will need to file. If so, they typically aren't allowed to claim the full standard deduction. Instead, they're subject to reduced standard deductions. For them, a standard deduction of at least $1,100 is available. Those who have earned income from a job or other source get a standard deduction of at least their total earned income plus $350 more, until that amount rises above the regular standard deduction shown in the table above. These numbers are the same for 2020 as they were in 2019.

What are the most popular tax credits for 2020?

Tax credits are extremely valuable breaks for taxpayers. Credits lead to a greater reduction in tax than deductions because they are directly applied to your tax bill in a dollar-for-dollar manner. For instance, a $1,000 credit would cut your tax bill by $1,000, but a $1,000 deduction would reduce your taxes by less than $1,000 -- more specifically, typically somewhere between $100 and $370 under current tax law. In particular, the following tax credits are among the most common and can produce significant savings. 

The earned income tax credit gives sizable reductions in taxes to workers with low- or mid-level incomes. The credit amount varies by family size and income, with maximums of $6,660 for those with three or more children, $5,920 for those with two children, $3,584 for those with one child, or $538 for those with no children. The income limits below indicate which taxpayers are eligible for at least some of the earned income credit, but bear in mind that the top credit amount phases out gradually over a large portion of the income range.

Data Source: IRS.

A special thing about the earned income tax credit is that even if you don't owe anything in taxes, you can still get the credit amount back from the IRS in the form of a refund. As you can imagine from the chart, a credit of several thousand dollars for workers earning less than $56,000 -- in some cases, much less -- can make a big financial difference for families struggling to make ends meet.

The child tax credit is a simple provision, paying $2,000 for each eligible child. To qualify, children must be 16 or younger at the end of the tax year, and the person claiming the credit must live with the child for more than half the year and provide at least half of the child's financial support. Also, to get the full credit, your income must be no greater than the amounts below.

Data source: IRS.

If you make more than these thresholds, then you'll lose $50 in credits for every $1,000 you make above the relevant income amount.

Two different tax credits give those paying educational costs some relief. The American Opportunity tax credit pays 100% of eligible tuition and required fees up to $2,000, and another 25% of the next $2,000, making for a total maximum credit of $2,500 per year. It's available for four years of undergraduate education, and taxpayers can claim the full credit if they make up to $80,000 for singles or $160,000 for joint filers. Reduced amounts are available for incomes up to $90,000 for singles or $180,000 for joint filers.

Meanwhile, the Lifetime Learning tax credit offers additional educational tax breaks even beyond traditional college. A 20% credit on up to $10,000 in eligible expenses every year is available to taxpayers making less than $59,000 if they're single or $118,000 if they're filing jointly, with reduced credits available up to $69,000 in income for singles and $138,000 for joint filers. This credit is available for graduate school, vocational training, and certain other nontraditional educational expenses.

Finally, the Saver's tax credit pays as much as $1,000 per person to encourage retirement contributions. Depending on your income, you can get a credit for 10%, 20%, or 50% of up to $2,000 in contributions to an IRA, 401(k), or similar retirement account. The following income limitations apply.

Data source: IRS.

No credit is available above those top amounts, showing that the Saver's credit is generally intended for low- to middle-income taxpayers.

What are the most popular tax deductions for 2020?

Deductions aren't as valuable as tax credits, because they don't produce dollar-for-dollar reductions in tax.

For every $1 you're allowed to deduct from taxable income, you'll save a percentage equal to your marginal tax rate. So if you're in the 24% tax bracket, then a $1 deduction will save you $0.24 in tax. Yet even though those amounts are smaller than what you get from a tax credit, deductions are nothing to sneeze at.

The deductions below are only available if you itemize deductions. Those taking the larger standard deduction won't get any extra benefit from these deductible items, and with the standard deduction continuing to rise for inflation, fewer taxpayers are likely to have enough itemized deductions to go above the standard deduction amount.

These are the most popular deductions for 2020:

• The mortgage interest deduction allows homeowners to deduct interest on up to $750,000 of mortgage debt, with higher grandfathered deductions on up to $1 million in debt applying to those who had such mortgages outstanding before the beginning of 2018. Certain home equity loans used to purchase, build, or improve your home also qualify for the interest deduction.
• Donations to qualified charities are eligible for a deduction as well. Cash and check donations are deductible and full, and most gifts of property are also deductible up to their fair market value. The key to claiming charitable deductions is to make sure you get the appropriate acknowledgment from the charity that you made the gift, because you'll need that documentation in order to support your deduction in case you're audited.
• The state and local tax (SALT) deduction was limited by tax reform, but it hasn't disappeared entirely. In 2019, you'll be allowed to deduct up to $10,000 for money you pay to state and local governments in tax. Property tax is always allowed, and you can elect either income or sales tax depending on which amount is higher.

What's changing in retirement tax planning for 2020?

Managing retirement accounts is an important part of tax planning. Not only do some retirement plan contributions earn you valuable deductions right now, but you also get a chance to put off paying taxes on the income produced by your retirement savings for years until you take money out in retirement.

Each year, the contribution amounts and income limitations change on IRAs, 401(k)s, and other retirement plans. It's critical to keep up to date on these annual changes in order to make the most of these valuable tax benefits. If you miss an annual change, then you might save less than you could have.

IRA contribution limits remain the same in 2020, at $6,000 for those younger than 50 and $7,000 for those 50 or older.

There are two different types of IRAs -- traditional and Roth -- and different income-related limits apply to each. For Roth IRAs, contributions are prohibited if you make more than a certain amount of income, and the maximum contribution amount is reduced if your income falls into the phaseout range in the chart below.

For traditional IRAs, contributions are always allowed, but if you or your spouse is also covered by an employer-sponsored plan at work, you can only deduct those contributions if your income falls within certain ranges. If your income falls into the phaseout ranges below, you can only deduct a portion of the contributed amount.

Data source: IRS.

401(k) contribution limits are rising in 2020. Those younger than 50 can contribute up to $19,500 toward a 401(k) or similar plan in 2020, up $500 from last year's $19,000. Those 50 or older get to put up to $26,000 into a 401(k), up $1,000. With no income limits applying to 401(k)s, those whose employers offer these plans can save a lot toward retirement.

Some employers offer different alternatives for workers. For instance, the SIMPLE IRA is easier to administer than a 401(k), making it a popular choice among small businesses. Yet employees can still set aside substantial amounts in a SIMPLE IRA -- up to $13,500 if you're younger than 50 or $16,500 if your 50 or older in 2020. Those numbers are up $500 from last year.

What other tax-favored accounts are available in 2020?

Beyond retirement savings vehicles, there are other tax-favored accounts you can use to save for your financial future, including the following:

• 529 plans let you set aside money toward educational costs in accounts that generate tax-free income. As long as you use the money for qualifying expenses, then you'll never pay tax on the money. With generous contribution limits that in most states are well into six figures, these accounts offer a substantial amount of flexibility with no income-based restrictions on their use.
• Coverdell ESAs have similar features to 529 plans, offering tax-free growth on investments toward educational costs. However, Coverdells have advantages and disadvantages compared to 529 plans. You're free to invest Coverdell money in nearly any type of investment you want, but annual contributions are limited to $2,000. Moreover, income limits of $95,000 to $110,000 for single filers and $190,000 to $220,000 for joint filers apply to reduce or eliminate the ability to make Coverdell contributions.
• Health savings accounts are available to those who have high-deductible health insurance coverage and who want to set money aside to cover healthcare costs. Contribution amounts of up to $3,550 for those with self-only policies or $7,100 for family policies apply in 2020, with minimum annual deductibles of $1,400 or $2,800 respectively required to qualify for high-deductible health plan status. Catch-up contributions of $1,000 are available if you're 55 or older, but a qualifying plan must have maximum out-of-pocket expenses of $6,900 for self-only policies or $13,800 for family coverage.

What are estate taxes in 2020?

Finally, a few aspects of gift and estate tax planning will see some changes in 2019. The federal estate tax lifetime exclusion amount will rise to $11.58 million in 2020, up from $11.4 million in 2019. However, annual gift tax exclusion amounts of $15,000 remain in place and unchanged for 2020, and the traditional exemptions from gift and estate tax -- including transfers to spouses and charities as well as amounts paid toward educational or medical costs -- are also still available.

Get your tax planning done right in 2020

As long as this guide might seem, it still only scratches the surface of some of the most important tax issues for taxpayers. For example, if you're self-employed or own a business, then there are many other issues to consider. That's a topic that would take its own guide to cover, and there are several situations that deserve similar planning considerations.

No matter how complicated or simple your personal situation is, it's never too early to think about tax planning for the coming year. By getting an early start on the 2020 tax year and using and referring to this guide to 2020 taxes throughout the year, you'll be in much better shape to take advantage of all the favorable provisions that can result in a lower tax bill this year and beyond.