Auburn University accounting professor offers tax tips on year-end financial and tax planning

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Auburn University Professor Kimberly Key provides advice on year-end financial and tax planning, including circumstances due to COVID-19. She serves as the PWC Professor of Accounting in Auburn University’s Harbert College of Business.

What do you recommend when it comes to year-end financial and tax planning?

Ideally, taxpayers consider tax planning throughout the year, maintain complete and accurate records and “fine tune” at the end. However, “ideal” is hard to do. Nonetheless, even if taxes have been on the backburner during 2020, the last few weeks of December allow for some financial review and decisions.

A good framework for tax planning is to put it in the broader context of personal financial planning. An important question is, “How will or might this year and next year be different?” Are any life changes on the horizon (like retirement, getting married or having a child start or finish college)? Are any one-time financial windfalls or costs expected? These sorts of events can change someone’s tax position, and those changes often provide opportunities to implement strategic tax planning. For example, if someone is anticipating a higher tax rate next year, the person might accelerate income to this year by taking IRA withdrawals in December instead of early in 2021.

I strongly recommend two popular tax-favored savings and investment options: voluntary contributions to an employer-sponsored retirement plan that are matched and 529 plans for K-12 private school and college savings. Most employers match employee contributions to some extent. Auburn University matches up to $1,650. It is a financial mistake for any employee to be passing up this 100% match.

Parents or grandparents can set up a 529 savings plan. As long as the money eventually pays for qualified education expenses, the earnings escape taxation. A second tax benefit in Alabama is that the state allows an income tax deduction for contributions to the account (up to a maximum). Small, monthly investments add up significantly over time in either of these savings vehicles.

What do you recommend when it comes to specific year-end tax deductions?

Individual Retirement Accounts (IRAs) are worth considering. 2020 contributions can be made as late as April 15, 2021, which gives taxpayers a chance to review their tax position and then decide if they want to make and designate contributions as 2020. Depending on taxpayer income, the IRA contributions could be deductible, reducing 2020 taxable income and tax.

The IRS estimates that only 10% of filers itemize their deductions as opposed to taking a standard deduction. For that 10%, the main year-end choice is whether to make charitable contributions in 2020 or to wait and make them in 2021. The possible tax rate difference between the two years and whether the taxpayer itemizes in both or only one of the years affects the decision.

Are there any new deductions or developments that would affect late-year tax planning or spending in general?

This year, tax law was stable, but one 2020 change affected many retirees. Congress enacted a one-year waiver of retirement account required minimum distributions (RMDs). Retirees who wanted to take advantage of the waiver should have already done so, so there is not a direct year-end strategy for RMDs. However, anyone who used the waiver should remember that taxable income this year will be lower than usual … and that 2021 taxable income will be higher than 2020. The difference can affect the best timing of income and deductions under the taxpayer’s control.

Are there any tax issues due to COVID-19?

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), passed in late March, included stimulus payments to many taxpayers. The maximum amount was $1,200 per person and $500 per qualifying dependent. The payments are technically 2020 tax credits sent to taxpayers in 2019. Taxpayers will need to report their stimulus payment amounts to file their 2020 tax returns, but no one will have to pay back any stimulus if it turns out they received more than the amounts based on 2020 tax data. Some taxpayers will receive additional stimulus payments. For example, someone whose income was higher in 2018 or 2019 than it is in 2020 could be affected. Second, taxpayers who welcomed a baby in 2020 are eligible to receive up to the $500 maximum for that new dependent. Stimulus calculations are based on taxpayer income, so even in these situations, some taxpayers will receive less than the maximum and possibly $0.

COVID-19 increased the number of taxpayers who need to be aware of two possible issues: unemployment compensation received and work-from-home (WFH) locations. Unemployment compensation is taxable. Taxpayers who receive it and do not have any taxes withheld could find themselves paying tax or receiving a smaller refund than usual.

Employees who live in one state and used to cross a state border to go to an employer’s onsite work location have probably dealt with two state tax returns in the past. States can tax a non-resident’s wages when the person performs work within the state. The state of residency can also tax the wages. To prevent double taxation of the income, the residency state typically allows a credit for taxes paid to another state. Changes to work locations (home versus employer site) could lower state income in one location and increase it in another. A second WFH scenario applies to people who used to live and work in the same state but who chose a WFH location outside that state. The state where they set themselves up to work may tax the income earned while in that state.

Finally, home improvements are on track to hit a record high in 2020. Taxpayers financing improvements with a home equity loan may deduct the interest along with mortgage interest. The deduction is an itemized deduction.

About Kimberly Key:
Kimberly Key serves as the PWC Professor of Accounting in the School of Accountancy in Auburn University’s Harbert College of Business. Her research interests are primarily in the areas of earnings management, state taxation and the effect of taxes on asset prices. Her work has been published in the Journal of Accounting and Economics, Journal of the American Taxation Association, Issues in Accounting Education, Journal of Accounting Education and tax practice-related journals. She has received three School of Accountancy teaching awards and is an active member of the American Taxation Association.

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