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End of Year Tax Planning- Part 2

Tommy Blackburn, CFP®, CPA, PFS & John M. Mason, CFP® 

Taxes are a critical part of each client’s financial plan.  Our job as financial planners is to look at the ENTIRE picture and make recommendations accordingly.  Unfortunately, most “financial planners” are only money managers or asset gathers and focus primarily on rate of return with little knowledge of the other areas of financial planning. A comprehensive financial plan, at a minimum, will address:

  1. Investment Planning / Portfolio Management
  2. Risk Management and Insurance Planning
  3. Tax Planning
  4. Retirement Savings and Income Planning
  5. Estate Planning
  6. Education Planning

Source: CFP Website

We can’t plan in a vacuum or plan in a silo.  The recommendations and actions throughout the financial planning process must complement and coordinate with each other.  The financial planners at Mason understand the importance of rate of return but we are passionate about serving our clients in the other areas where most “advisors” are too scared to venture.

Tax planning is a central focus of our firm.  Every dollar we can save our clients in taxes adds to their rate of return and increases their probability of having a successful retirement. In addition to general tax planning, such as recommendations of contributing to a Pre Tax 401k or Thrift Savings Plan vs a Roth, we advise in several other areas such as:

  1. Efficient charitable giving strategies
  2. Roth IRA Conversions
  3. Maximization of Federal and State Tax Credits
  4. Review withholdings on retirement pensions, earned income and Social Security
  5. Monitor income as it relates to Medicare Part B and D premiums
  6. Monitor income as it relates to taxation of Social Security Benefits
  7. Monitor income as it relates to the deductibility of medical expenses
  8. North Carolina Bailey Act
  9. Long term care state tax deduction
  10. Virginia disability subtraction
  11. Virginia age 65 deduction
  12. Virginia, and other state, 529 deductions
  13. Neighborhood assistance program (NAP) credits
  14. Efficient portfolio design

Part 1 of our End of Year Tax planning can be viewed here.  In this post, we discussed the increased standard deduction and how so few taxpayers are able to itemize.  The increased standard deduction resulted in most Americans receiving little to no tax benefit from their charitable contributions.  The fix for those over age 70 ½ is a qualified charitable distribution.  What’s the strategy for those who are charitably inclined but younger than age 70 ½?

Bunching of Itemized Deductions

This strategy is applicable for clients who are close to being able to itemize or those who are itemizing by a few thousand dollars.  These clients are basically receiving little, or no benefit, from their:

  1. Mortgage interest
  2. State Taxes Paid
  3. Charitable Contributions

They are receiving little to no benefit because the Standard Deduction is a free deduction where itemized deductions require you to spend money first. After the money is spent, the IRS provides the ability for some of these expenses to reduce your income. The only time you win with itemizing is if your itemized deductions exceed the standard by a significant amount.  It is only the amount of itemized deductions that exceed the standard that provide a financial benefit. If your itemized deductions are less than, equal to, or barely higher than the Standard, the Bunching of Itemized Deductions strategy must be considered. We also refer to this as charitable lumping because charitable donations are typically the kicker in determining if our clients itemize or take the standard deduction.


If charitably inclined, consider shifting two or more years of charitable giving into one year rather than spreading the donations over multiple tax returns.  The client in this example would have a large itemized deduction in the year where large gifts are made and would then revert back to the Standard Deduction until the next large charitable donation.  This strategy could be employed with other itemized deductions as well, such as medical expenses.  Alternatively, not bunching the deductions may result in either never itemizing or receiving reduced tax benefits for your itemized expenses. Remember, the only itemized expenses that provide a financial benefit are those expenses that exceed the standard deduction of $24,800 (2020 married filing jointly).

Donor Advised Fund

A donor advised fund allows you to efficiently set money aside (in a completed gift/donation) to a fund exclusively for charitable purposes.  Once the gift has been made, it is irrevocable, and the gift cannot come back to you. However the fund does not have to pass the donation to a charity immediately.  This is where the advised part comes in.  While you have given to the donor advised fund, the fund waits for you to advise where and when donations should be made to qualified charities.  Although the donation is a completed gift the year it is transferred to the DAF for tax purposes, the owner of the account is allowed to direct/advise the fund to make gifts over time.  Retaining control of how quickly the gifts are distributed to qualifying charities makes it easier to stomach gifts that are two or three times larger than the normal amount.

The funds can be in cash or invested in a diversified investment strategy that grows tax free. The growth on the original contributions can also be used to fund charitable goals.  Gifts to donor advised funds can be sourced from excess cash or appreciated securities (stocks, bonds, mutual funds, etc.). Gifting of highly appreciated securities is a strategy that provides clients with the potential to avoid long term capital gain taxes and also receive the benefits of a completed gift.  Donor Advised Funds must be considered for those who are charitably inclined and under the age of 70 ½.

Consider Roth Conversions:

Roth IRAs have a lot of positive tax attributes to them, one of which is tax-free distributions if certain qualifications are met.  In addition, Roth IRAs do not have RMDs, and do not impact the taxability of Social Security or the Medicare premiums you pay.  If you have IRAs or employer retirement plans (such as a TSP), it may make sense to convert some or all of those accounts into a Roth IRA. Roth conversions could substantially lower taxes paid over your lifetime. Remember, every dollar we can save in taxes adds to our rate of return.

Be cautious!  Conversions create taxable income and they are irrevocable. It’s important to think about your overall, long-term financial plan to determine if conversions make sense. For example, if your financial plan projects a low tax bracket for a protracted time, Roth conversions may not make sense.  Financial planning is an art and a science.  As financial planners, we help our clients make the best decisions possible with the information available to us.  In addition to the available information, we help our clients make educated assumptions of what the future may hold. We are in a historically low tax regime that is set to sunset in 2025.  After that, anything is possible.  Know your situation, both short and long-term, and work with a qualified financial advisor before venturing down the conversion path.

Max Out Tax Preferred Accounts:

Set a goal of maximizing as many tax referenced accounts as possible. Tax preferred accounts include IRAS, Roth IRAs, 401(k)s, TSP, HSAs, and FSAs to name a few.  The financial plan should highlight which tax preferred accounts to contribute to, and also help establish an order of precedence for funding.  

Further, your financial plan should go on to address your strategy for withdrawing retirement assets, as it is as important as your strategy for accumulating them.

Account for life changes:

Get married in 2019?  Add a child to the family?  Have a child turn 17?  Move, retire, or change jobs? Send a child to college?

All of these changes could impact your tax situation, not to mention your overall financial plan.  Be aware of the impacts they may have on your situation and plan accordingly.

Harvest Losses / Use Losses

No one enjoys losses. However, they can be useful from a tax perspective.  Capital losses (like those generated from investments) can be used to offset realized capital gains.

Realized capital gains occur when a security is sold at a higher price than it was purchased.  In addition to the trades that result in realized gains, mutual funds also distribute capital gains, regardless if the fund was sold by the investor.  Mutual fund companies are required to pass on capital gain distributions to investors. This means that a client may have to include a short or long term capital gain distribution as income, even if they didn’t sell anything themselves. Many mutual fund companies distribute capital gains at the end of the year.  If considering an investment in November or December, review the potential capital gain distributions and consider delaying your investment until after the capital gain has been distributed.  Most, if not all, mutual fund companies provide an estimate of potential gains to help individuals make investment decisions in the 4th quarter. American Funds posted their estimates in September.

Take a look at any unrealized capital losses, positions in securities that are worth less than the original purchase price, and consider selling them to realize the loss.  The realized loss can be used to offset the realized gains.  In addition, consider realizing capital losses and reinvesting the proceeds in similar but not identical investment. Your funds will be invested in an equivalent security to achieve stated investment objectives and provide a realized loss that can be used either now or later.

The great recession was over 10 years ago and we still see clients with carry forward losses from that event. The IRS allows taxpayers to use $3,000 per year of carry forward losses to reduce income which could take years if not decades to realize the full benefit.  The great recession was immediately followed by a great bull market.  The same clients with carry forward losses may also have positions with sizeable gains. If this sounds like you, it’s time to make a plan!

Do you have a tax plan? If not, you don’t have a financial plan.

Do you have a “financial plan”, but not a tax plan?  Ditto.

Reach out to the Mason financial planning team to start one today.