In addition to some tax changes related to the COVID-19 pandemic, results of the US Presidential, Congressional, and Senate elections will affect tax planning beyond 2020. Ahead are tax planning tips for this year and a look at some of the proposed changes that would come under a Biden administration.
Payroll and Withholding
Many taxpayers, and certainly many physicians, saw payroll changes during the COVID-19 shutdowns. Therefore, it may be more important this year than in years past to review your projected 2020 income, your withholding, and your estimated tax payments. If you were taking a reduced paycheck or no paycheck during the shutdown but were counting on a certain amount of tax withholding to keep you safe from underpayment penalties, you still have time to make any necessary adjustments. Withheld taxes are considered to be paid evenly throughout the year, whereas estimated payments are considered paid on the actual payment date. If you find that you have underpaid, it may be better to increase withholding rather than to increase your fourth quarter estimated payment.
Joe Biden’s tax plan proposes to return the top tax rate to 39.6 percent from the current 37 percent. Mr. Biden has also proposed imposing the 12.4 percent Social Security payroll tax on wages and self-employment income that is higher than $400,000. The 12.4 percent tax would be split between employers and employees. Because this tax is not currently imposed on wages and self-employment earnings above $137,700, Mr. Biden’s plan would create a gap in the Social Security payroll tax, so wages between $137,700 and $400,000 would not be taxed.
A lack of paychecks, distributions, and revenue caused many physicians to stop or reduce funding of their retirement plans during the shutdown. You may maximize your retirement account contributions before year’s end. The 2020 limits for 401(k) salary deferrals are $19,500 for taxpayers who are 49 years of age or younger and $26,000 for those who are 50 years of age or older. If you are over the age of 70.5 or have a parent over that age, the CARES Act waived required minimum distributions for 2020 both for account owners and for beneficiaries who inherited a retirement account.
Taxpayers who are eligible for Health Savings Account contributions have time to maximize those, as well. A Health Savings Account allows you to use pretax dollars to pay for health care expenses. If your family is covered under your plan, you may contribute up to $7,100 in 2020 plus an extra $1,000 if you are 55 years of age or older.
With the current limitations on deductions for state and local income and property taxes ($10,000 maximum deduction) and the increased standard deduction for taxpayers, many taxpayers are taking the standard deduction instead of itemizing. You may want to consider bunching two years’ worth of charitable contributions into one tax year in order to itemize one year and take the standard deduction the next year. You may also do this if you have medical expenses that approach but don’t quite meet the adjusted gross income threshold for deductibility each year. In this situation, try to bunch the medical expenses into one year to gain some tax benefit.
Mr. Biden reportedly is in favor of removing the cap on federal deductions for state and local taxes, as are Speaker of the US House of Representatives Nancy Pelosi and US Senate Minority Leader Charles Schumer. Mr. Biden has proposed capping the value of all itemized deductions at 28 percent for taxpayers in the top tax bracket. He has also proposed restoring the Pease limitation on itemized deductions for those with more than $400,000 in taxable income. The Pease limitation required taxpayers to subtract three percent of certain itemized deductions (including mortgage interest, state and local taxes, and charitable contributions) if adjusted gross income was above certain thresholds.
Harvesting Capital Losses Against Gains
Harvesting capital losses is a strategy in which you sell investment assets at a loss in order to offset capital gains income in the same tax year. Doing so allows you to reduce the capital gains tax you owe. In 2020, you might have sold investment assets when the market was at a low point during the COVID-19 pandemic. If so, keep in mind the following if capital losses exceed capital gains for this year: You may only deduct $3,000 in losses against noncapital gains income, and any remaining capital losses will be carried forward to future tax years.
Mr. Biden’s tax proposal includes taxing capital gains at ordinary income tax rates for those earning more than $1 million. The current top capital gains tax rate for those in the highest tax bracket is 23.8 percent. Biden has proposed restoring the 39.6 percent top individual income tax rate that was in effect prior to the 2017 Tax Cuts and Jobs Act.
Qualified Business Income Deduction
A physician’s practice is considered to be a specified service trade or business (SSTB) and thus is generally excluded from taking the Section 199A pass-through income deduction. Because this deduction is taken at the individual level, however, some physicians are able to take the deduction against practice income. Individual taxpayers with less than $326,600 (married) or $163,300 (single) of taxable income may claim a 20 percent Section 199A deduction even if the income is from an SSTB. The deduction is phased out until it goes away completely for specified service business income once taxable income reaches $426,600 (married) or $213,300 (single). You may have other non-SSTB pass-through income that qualifies for the deduction. In addition, if you are above the threshold amount, qualified plan contributions and increased charitable contributions may enable you to reduce taxable income to below the threshold amount.
Mr. Biden’s proposal would phase out the Section 199A deduction for taxpayers earning more than $400,000 per year. This deduction is currently scheduled to expire after 2025.
If your practice is taxed as a C corporation, the owners are likely reducing corporate taxable income by paying themselves reasonable compensation in the form of W-2 wages and bonuses. The current tax rate for C corporations is 21 percent. Mr. Biden has proposed increasing that rate to 28 percent, which remains below the previous 35 percent top rate.
Plan for Future Unknowns
Review your 2020 taxable income, deductions, withholding, and estimated payments so you know where you stand. If COVID-19 shutdowns or other factors reduced your income in 2020 but you expect it to increase next year, you may want to push some of your deductions into 2021. Educated planning is often the best defense against future unknowns.
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently; accordingly, information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.