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Twelve end-of-year tax tips: How COVID-19 could lower your tax bite


 

If you are someone to whom the additional Medicare tax or NIIT no longer applies for 2020, you might consider generating income this year in order to realize the lower tax rates. You could consider selling highly appreciated investments in your taxable portfolio and reinvest the proceeds by repurchasing the same securities, thereby receiving a step-up in cost basis. Remember, when you go to sell securities in retirement, you are only taxed on the gain on the security over your cost basis. By bringing the cost basis up to today’s fair market value, you could be greatly reducing the future tax applied on a sale.

For those with IRA or inherited IRA accounts who also have required minimum distributions (RMDs), you might consider making voluntary withdrawals this year and then reinvesting the proceeds into a savings or taxable account for when you need it. Keep in mind that under the CARES Act, you are no longer required to take RMDs for 2020. However, this action would help avoid being forced to withdraw the amount when you may be at a higher tax bracket. You would need to do this before Dec. 31.

3. Build Roth assets strategies

With reduced incomes and lower marginal tax rates applying to the last dollar of income this year, physicians should carefully consider how to take advantage of current tax rates by building Roth assets. There are a few strategies, including switching 401(k) or 457 contributions from pretax to Roth or performing a backdoor Roth IRA contribution. However, neither is as powerful as converting IRA assets to Roth assets because there is no restriction on conversion amount or income cutoffs.

The goal is to convert enough assets to fill up lower applicable marginal tax brackets while avoiding tax surcharges, where possible. Roth IRA conversions can get you in trouble if you don’t know what to expect, so it’s best to work with a financial advisor or tax professional to give you guidance. For example, Roth conversions can trigger some tax surprises, such as the phaseout for the 199A qualified business income deduction, increased taxation on your Social Security benefits, or higher Income-Related Monthly Adjustment Amount surcharges on Medicare Part B and Part D premiums.

Bear in mind that Roth conversions generate taxable income and cannot be undone once completed. However, paying the lower marginal tax rate today may be a big win when RMDs could push physicians into tax brackets as high as or higher than during their working years.

4. Coronavirus-related distributions

New this year is a penalty-free way to withdraw qualified retirement plan funds for those who are not yet eligible to make penalty-free withdrawals.

Congress introduced the Coronavirus-Related Distribution under the CARES Act. It allows individuals who have been affected by the pandemic to withdraw up to $100,000 before Dec. 31, 2020, without paying the 10% early withdrawal penalty. If you are considering an early retirement because of the pandemic, it may make sense to take this withdrawal while the option lasts and keep the cash available to help fund the gap before the remainder of your retirement plan assets are available penalty free. Keep in mind that this withdrawal generates taxable ordinary income, even though the early withdrawal penalty does not apply. Taking this withdrawal can boost your taxable income bracket, so calculate carefully before you do this.

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