James Royal: 5 unusual year-end tax strategies for investors

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Taxpayers have any number of deductions and credits that they can take to reduce their tax burden, but those looking to get a break for their investing activities have a more limited menu of choices. If you’re an investor, you’ll want to optimize your tax situation with strategies beyond the traditional ones – earned income credits, interest write-offs and the like. And the deadlines for making these moves are key to remember if you want to lock in your tax break for this year.

Here are five unusual year-end tax strategies for investors to reduce what they owe.

Strategies to slash your taxes

The traditional 401(k) and the traditional IRA are both well-known ways to save for retirement and reduce your taxes (though the traditional IRA does have some limitations.) Certainly these are great moves for investors to make if they haven’t already done so, and those looking for the best and easiest ways to reduce their tax bill will get the most mileage from these strategies.

But if you’ve taken advantage of these avenues fully, here are some more unusual ways to beat the tax man, including one that’s new in 2020.

Check out a donor-advised fund. A donor-advised fund is a great way to work around the relatively high standard deduction on taxes, which may limit your ability to gain additional write-offs for your charitable contributions.

By making a charitable contribution to a donor-advised fund (before year end), you’re able to deduct that amount from your taxes this year. Meanwhile, you can distribute the funds in later years, and the money can even grow tax-free in the fund, providing more benefit to the charity.

“From the perspective of the organizations you support, nothing changes, but the donor-advised fund allows you to control the timing and amount of your charitable tax deduction,” said Mark Brown, CFP and managing partner at Brown and Co. in the Denver area.

The donor-advised fund has many advantages, including flexibility and simplicity.

Give directly from your IRA. A donor-advised fund is optimal if you’re able to exceed the standard deduction, but if you’re not able to reach that threshold and want to give anyway, then you can give straight from your IRA.

“For those who are of required minimum distribution age and might not be itemizing taxes, qualified charitable contributions are a great way to give directly to the charity from your IRA,” said Michael Kojonen, founder and owner of Principal Preservation Services in St. Croix County, Wisconsin.

Normally, investors with a traditional IRA and subject to a required minimum distribution, or RMD, could use the qualified charitable contributions rule to exempt their distributions from tax.

Although the RMD was suspended this year as part of the CARES Act, investors can still donate the money and claim the deduction, says Kojonen.

You’ll need to take care of your charitable giving by the end of the calendar year.

Convert your traditional IRA to a Roth IRA. And if you’re able to get out of a required minimum distribution from your traditional IRA, it may be a good time to convert that fund to a Roth IRA. You can save on taxes that you might otherwise have paid if you converted in a normal year. The calendar year that you make the conversion will determine when you’re taxed.

“Some retirees may have an unusually low tax rate this year, since their RMDs are subject to ordinary income tax rates and can often be a big source of taxation in retirement,” Brown said. He suggested that if you’re in a lower bracket it may make sense to convert a portion of your traditional IRA into a Roth, reducing the tax liability that usually accompanies the conversion.

The Roth IRA remains one of the most popular retirement plans because of its tax-free benefits.

Look into trusts. Trusts can be an effective way to achieve all kinds of goals when you’re planning your estate. Given a relatively favorable tax regime – and the potential that the Biden administration may make it less favorable – it might make sense to establish a trust to sidestep future tax increases.

With the lifetime gift exemption amount at a historically high $11.58 million per person (in 2020), Brown suspects the amount will decline in the future.

“It makes sense to consider strategies like grantor retained annuity trusts and intentionally defective grantor trusts,” Brown said. “The intention is to get future capital appreciation out of your estate and avoid estate taxes.”

“The current low interest rate environment can make these wealth transfer strategies even more appealing,” Brown said.

Older workers can still contribute to an IRA. While contributing to an IRA is a typical game plan to reduce your taxes – and you have until April 15 of the subsequent calendar year to do so – this year saw something new for older workers. The SECURE Act removed the maximum age for contributing to a traditional IRA.

“It allows those over (age) 70½ who are still earning income to contribute to a traditional IRA,” said Morgan Hill, CEO and owner of Hill & Hill Financial in Woodstock, Georgia. “This has never happened before and for many, could be a good tax strategy to take advantage of.”

You can also contribute to a Roth IRA, but it won’t reduce your taxable income. Regardless of which type of IRA you contribute to, you have until tax day to deposit your money.

Bottom line

When prepping your taxes, it’s important to begin before the calendar year ends, because some tax moves must be made before the new year. Meanwhile, others can wait until Tax Day. It’s key to know which moves can be made when and then act fast to get them done by the deadline.