It's end-of-year tax planning time. As you get further along in your financial independence journey, there are likely more end-of-year tax planning items you'll need to be aware of. Having a checklist to review annually is useful.
It's been an unusual year and December is that time to begin making end-of-year tax considerations. In addition to the normal checklist, there may be additional items to consider in this remarkably different year.
Sean Mullaney says unique to 2020 are Roth conversions. While Roth conversions should be on the checklist every year, this year there was a much greater chance of diminished income which may provide the opportunity to make Roth conversions in a lower marginal income tax bracket.
In any year when income is much lower than it normally is, Roth conversions would be at the top of your mind. The deadline is December 31 and there are no extensions.
While complex situations may benefit from professional consultations, anyone with mostly W2 income can find their tax brackets online. If your income has dropped from 22-24% to 10-12%, locking in a Roth conversation at that lower rate is effective tax planning.
A Roth conversion is when you go into a traditional IRA account and convert it to a Roth IRA. This is a taxable event, but you are intentionally choosing it because you are in a lower tax bracket for the year rather than convert or withdraw funds in a letter year when your income is higher and the taxes will be higher.
How much money should be converted to a Roth IRA? Sean says he has never encountered a client who has had too much money in a Roth IRA. While the action is irrevocable, there is no penalty for converting too much. If a portion of the conversation is taxed at 22%, it is not the most efficient conversion, but your future self will likely still be quite happy that you did it.
Some employers allow for Roth conversions within their 401K plans.
The deadlines for completing some of these end-of-year tax planning checklist times vary. Solo 401Ks and qualified business income tax deductions should be completed as soon as possible.
In addition to Roth conversions, another item with a Dec 31 deadline is charitable contributions.
Checklist items with an April 15 deadline are traditional IRA, Roth IRA, and health savings account contributions.
A good rule of thumb is individual tax accounts have a tax return deadline, not an end-of-year deadline.
The reason solo 401Ks have an “as soon as possible” deadline is that unlike IRAs, solo 401Ks require more time and paperwork to do. It may not be necessary to have it funded by Dec 31, but you'll want it set up and have a well-documented game plan. S-corps do have to fund the employee-side by the end of the year.
The first item on Sean‘s checklist is charitable contributions. With that category are two options to consider, a donor-advised fund if you plan to itemize deductions this year, or regular year-end charitable contributions.
If you don't plan on itemizing, in 2020 up to $300 per tax return make be taken as a charitable contribution against your adjusted gross income.
Another checklist item to be completed by the year's end are small business expenses since they are deducted when paid for, not when accrued. Businesses who have had a good 2020 may want to accelerate these payments to get the deduction this year. While businesses that have struggled in 2020 may want to hold off making payments until 2021.
In response to a question from Brad regarding credit cards, Sean confirmed that credit cards work on a cash basis so the deduction takes place in the same in which the credit card was used, not when the credit card bill was paid.
Paying bills with a check becomes a little trickier as you may need to prove to the IRS that the check was written and mailed on a business day prior to Dec 31 even if the vendor does not deposit the check until January of the following year.
A backdoor Roth IRA applies when your income is too high to contribute to a regular Roth IRA. If you've done a backdoor Roth IRA in 2020, don't roll over any 401Ks, 403Bs, or 457s into tractional IRAs before Dec 31, wait until Jan 1 so it's not complicated by the pro-rata rule.
To clean your investments up before leveraging the backdoor Roth technique, try and roll traditional IRA accounts into a new employer's 401K plan. Then implement the backdoor Roth IRA which may be done by April 15.
Sean has a blog post describing the process to get clean with traditional IRAs before doing a backdoor Roth IRA.
Tax-gain and tax-loss harvesting are also both Dec 31 deadlines. The stocks need to be sold by the end of the year. With tax-loss harvesting, you may not repurchase those securities within 30 days before or after the sale to comply with the wash sale rule.
If you're in the 12% marginal federal income tax rate or lower, the capital gains rate today is 0%. You may want to sell stocks to diversify your portfolio or sell and rebuy the same stock to realize the large capital gain and reset your basis without paying federal income tax. Unlike tax-loss harvesting, there are no timing considerations to make when repurchasing the same stock with tax-gain harvesting.
State income taxes may not favor capital gains in the same way the federal tax does.
Keeping all of the rules and impacts of buying and selling straight can be confusing and time-consuming. It is helpful to keep your tax records as clean as possible by doing everything in a specific account for this purpose. Sean states that tax-loss harvesting should be a tactic and not a goal occurring only in years where you are down.
State tax considerations to be mindful of are fourth quarter estimated tax payments and deduction planning. In California for example, it may be beneficial to take the standard federal deduction and itemize to take advantage of the state property deduction, possibly even pre-paying on property taxes.
A FI framework allows you to play from a position of strength. The financial independence community can take advantage of timing their payments for certain things and make strategic decisions because they don't have the same issues with cashflow that people on a traditional path might have.
While many in the financial independence community may be too young to think about required minimum distributions (RMD), it's good information to review for future planning.
RMDs apply to all retirement accounts except Roth IRAs. Starting at age 72, minimum distributions will be required by Dec 31 or there is a penalty. However, in 2020, they have been canceled and you may want to convert it into a Roth.
When you inherit an IRA, it doesn't matter how old you are. You are subject to an RMD or a 10-year rule. It would be wise to consult a tax professional when inheriting a sizable IRA.
With an inherited Roth IRA, the account will have to be emptied within 10 years following the death of the original owner. Different rules may apply to eligible designated beneficiaries who may have RMDs instead.
An adult who inherits a traditional IRA has a tax issue and probably will need professional assistance wit
The year-end is a good time to update beneficiary designation forms. Financial institution accounts are governed by the beneficiary designation forms, not wills or trusts, so it's important to ensure these are up-t0-date.
Year-end tax planning is great, but Sean likes long-term strategic tax planning to minimize your total tax over your lifetime. January is a great time to start long-term planning.

As always, the discussion is general and educational in nature and does not constitute tax, investment, legal, or financial advice with respect to any particular taxpayer. Please consult your own advisors regarding your own unique situation.

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Sean Mullaney's 2020 Year-End Tax Planning article
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274 | Tax Planning 2020 | Sean Mullaney