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Tax Planning

April 14, 2020

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UPDATE: On March 21, 2020, The Treasury Department and Internal Revenue Service announced that the federal income tax filing due date is automatically extended from April 15, 2020, to July 15, 2020.

Through the first five posts, we have walked through all the major sections of the Form 1040. We have looked at income, deductions, tax liability and credits. We have also talked about some of the major areas of everyday life (e.g., homeownership and retirement savings) that many taxpayers need to realize have major tax implications. We also spent some time talking about when, where and how to report your taxes each year.

With the major areas behind us, we conclude with a brief post that ties up some loose ends, adds a little advice and sends you off with a sense of confidence as you continue to manage your affairs with an eye toward tax consequences.

ANTICIPATING COMMON LIFE CHANGES

It is important to keep in mind that many of the big events in your life also have significant tax implications. We discuss a few of the common ones here.

First, if your marital status changes during the year, this will affect your filing status, whether from single/head of household to married filing jointly/separately or vice versa. Bringing children into your home can have major tax advantages as this may give you a more favorable filing status and qualify you for the child tax credit. Conversely, if you have teenagers in your home, you may soon find yourself losing the benefit of the child tax credit as they get older.

Next, remember that if you or someone in your family decides to go to college, or go back to college, the American Opportunity Credit and the Lifetime Learning Credit may help offset the cost of this education.

Further, know that most money received from an inheritance is tax-free to the recipient. However, there may be taxes on distributions from an IRA that is inherited. Also, keep in mind that the basis of inherited property will be adjusted to the value at the time of the decedent’s death. Gains in value after that will generally be taxable. If someone leaves you a house worth $300,000 at the time the person dies, you will generally be treated as if you bought the house for $300,000. Should you sell the house later for $400,000, you will only need to report $100,000 of taxable income ($400,000 sale price less $300,000 basis).

Finally, in the year that you die, your personal representative will have to file a final tax return in your name. Your spouse can file a joint return for that year if he or she so chooses. Depending on the size and composition of your assets, an estate tax return may also need to be filed.

BUNCHING TAX-DEDUCTIBLE EXPENSES

In an earlier post, we talked about the difference between a taxpayer’s standard deduction and itemized deductions. For example, in 2019, a married taxpayer who files a joint return with his/her spouse is entitled to deduct either $24,400 from their adjusted gross income or the amount of certain qualified expenditures (e.g., charitable donations, medical expenses, property taxes) if they total to a higher amount. With a little planning, taxpayers can take advantage of this rule in a way that reduces their tax liability across multiple years. The best way to illustrate this is by example:

John and Jane are married and file jointly each year. In both 2019 and 2020, they had $24,000 of itemized deductions. Since $24,000 is less than the standard deduction amounts of $24,400 in 2019 and $24,800 in 2020, they simply claimed the standard deduction each year.

As such, they have $48,000 worth of expenditures across two years and claim a total tax deduction of $49,200 ($24,400 + $24,800) for those years.

Now, suppose they were able to move some of their 2020 expenditures up to 2019. For example, maybe they paid their January 2020 mortgage interest in December 2019, or perhaps they made a cash gift to their church in December 2019 that they had planned to give in January 2020. To put numbers on it, let us say they moved enough expenditures up to December 2019 that now they had expended $30,000 in 2019 and $18,000 in 2020. Here, they will claim a $30,000 itemized deduction in 2019 (because it is greater than the $24,400 standard deduction), and they will claim the $24,800 standard deduction in 2020 (because it is greater than the $18,000 of actual expenditures).

As such, they still have $48,000 worth of expenditures across the two years, like before, but now they claim a total deduction of $54,800 ($30,000 + $24,800). Just by moving some expenditures up a few days from January to December, John and Jane were able to generate $5,000 worth of extra tax deductions.

IRS WITHHOLDING CALCULATOR

Employees use Form W-4 to calculate how much federal income tax they have withheld from each paycheck. Until recently, employees claimed “allowances” on this form, and the more they claimed, the less taxes they had withheld. In 2020, however, this system changed. Now, a taxpayer answers questions on the W-4 about things such as their filing status, their family income, the amount of tax deductions they plan to claim, and the number of children they have.

Calculating your withholding is a vitally important exercise, as it will prevent surprises the following April. To help you have more confidence in how to fill out the W-4, the Internal Revenue Service (IRS) has an online tool to help walk you through the process.

TAX AVOIDANCE VS. EVASION

Tax avoidance is the use of legal methods to reduce taxable income or tax owed. As the famous judge Learned Hand once said, “Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible.” Indeed, it is perfectly legal and logical to avoid paying more than what the law requires of you.

On the other hand, tax evasion is the use of illegal methods of concealing income or other information from the IRS. An innocent mistake on your tax return does not automatically turn you into a tax evader — intent is a factor. But if one did intend to evade taxes, here’s a taste of the penalties they could face: a felony on their record, five years jail time, fines of up to $250,000 or a bill for the cost of prosecuting them. Civil penalties can add up as well. Examples include failure-to-file penalties, underpayment penalties, accuracy-related penalties and interest on penalties owed.

DISCLAIMER

Dr. Benjamin Akins and Dr. James A. Weisel are faculty members in the Georgia Gwinnett College School of Business. The content of this blog should not serve as a substitute for legal advice from an attorney or accountant familiar with the facts and circumstances of your specific situation. If legal or accounting assistance is needed, we recommend that you seek the services of a qualified professional.