Tax Planning After the CARES Act: Three Ways Investors Can Reduce their Tax Burdens for 2020

Investors at every income level have experienced an exceptionally unpredictable year in the markets. The passage of the CARES Act, however, presents with some creative tax planning strategies worth considering for offsetting any losses investors may have incurred over the past 12 months. Read on for three ways you can potentially reduce your tax burden while also preparing for retirement.

Required Minimum Distributions are Waived, and Investors Have Options

One of the most notable parts of the CARES Act is the waiver of Required Minimum Distributions (RMDs) for taxpayers. Normally, if you have reached the age of 72 years old and inherited money or have investment accounts, the IRS requires you to take a required minimum distribution (RMD) from those accounts every year and pay taxes on it. If you do not, you face a penalty.

Under the CARES Act, RMDs are waived for 2020 for IRA, 401 (k), 403(b) and 457(b) plans. RMD amounts are calculated using the balance of one's retirement account on December 31 of the prior year, so values are based on equity markets at that time. Without the CARES Act, some investors may have found themselves taking an RMD based on much higher account values, which would have left them paying a disproportionate amount of taxes based on a higher percentage of their IRA. Investors who decide to take an RMD this year may want to consider IRA or 401(k) Roth conversions or tax loss harvesting.

Revisit a Roth IRA and Consider a Roth IRA Conversion

Based on the performance of your portfolio or other factors, you may want to make a Roth IRA conversion in 2020. The main differences between a Roth IRA and a traditional IRA lie in the tax implications and income limits, but rules for these accounts also differ. Where Roth IRAs can offer tax-free growth, traditional IRAs allow investors to defer taxes until they withdraw the money in retirement. Investors can also start taking tax-and-penalty-free distributions from Roth accounts at age 59½. RMDs are never required of original Roth IRA account owners at age 72; in fact, the money can stay invested until the death of the original account owner. Roth IRAs can also be passed on to heirs tax-free with some limitations.

Based on your filing status and modified adjusted gross income, you may have missed the opportunity to open a Roth IRA if you were a high income earner early on in your career. As of January 1, 2020, you cannot open or contribute to this type of account if you make more than $139,000+ if you're single and $206,000+ if you're married.

In 2018, however, Congress lifted income restrictions for Roth IRA conversions as part of the Tax Cuts and Jobs Act (TCJA). For this reason, converting a traditional IRA to a Roth IRA using the backdoor method has become an attractive method for putting money away. Although investors must pay income taxes on the funds converted from a traditional IRA to a Roth up front, the results pay off later, as assets continue to grow long-term and can be withdrawn decades later without being taxed.

Depending on your portfolio, this conversion may be worth it for you. Still, it is important to know that Roth IRAs, similar to opening a new Roth IRA, are subject to a five-year rule, which means that if an investor converts an IRA to a Roth, they are not permitted to make any withdrawals without penalty during the first five years of the existence of the account.

Convert Your 401(k) to a Roth IRA

Converting your 401(k) to a Roth is another possibility, but certain rules apply for these types of conversions, as well. Because traditional 401(k) accounts are funded with your pre-tax salary and come from your gross income, you don't pay taxes on the money you deposit, or on the profit earned, until you withdraw the funds later in retirement. Like a traditional IRA conversion, you'll owe income taxes in the year you make this conversion, so you'll want to make sure you consider the tax burden (and pay attention to your tax bracket).

Investors can also make a series of conversions over time, rather than all at once, if desired. Bob Cellucci and Jason Beard, B. Riley Wealth Management financial advisors in Philadelphia, add an example. "Let's say a married couple with $200,000 in taxable income this year would like to make a Roth IRA conversion while remaining in the 24 percent income tax bracket. We would advise them to convert no more than $126,600. Anything above that amount would be taxed at the next-highest bracket, which starts at $326,600. In layman's terms, that means that the first $126,600 of the rollover would be taxed at 24 percent, and every dollar thereafter would be graduated to a 32 percent tax rate. To avoid this, we suggest doing a similar calculation again next year to convert another portion. By segmenting the tax years, we can limit the tax burden of the rollover dollars."

Ask Your Financial Advisor about Tax Loss Harvesting

Tax loss harvesting is another way for investors to manage losses in a year of market volatility. Through this technique, investors can sell off a losing position in an investment account to offset any current or future capital gains taxes. A shorter-term gain from securities owned for less than one year would be taxed at the investor's regular income tax rate, while gains from securities held for longer than one year would be taxed at a rate of 15-20 percent.

Investors are permitted to use any losses to offset any capital gains, plus, if they have an overall net loss, they can deduct up to an additional $3,000 against their ordinary earned income. However, because investors can only reduce their ordinary taxable income by $3,000, it is worth noting that any unused capital losses may be carried forward for additional years. If you sustained a significant loss this year, it is a good idea to work with your financial advisor and tax planner to help you decide whether you want to carry over additional losses to next year based on your anticipated tax bracket. If you'll earn more income next year, it may be a good idea to wait; otherwise, you may want to incur the loss in 2020.

Beard and Cellucci provide a simple hypothetical example. "If an investor had a $10,000 gain in securities, he or she would need to sell $10,000 in losses to offset the taxes from the initial gain. If that same investor had $13,000 in losses, they would still be able to offset their gain of $10,000, but in addition, they would also be able to deduct an additional $3,000 from their ordinary earned income for 2020."

It cannot be overstated that there are stringent rules governing the sale of investments and tax loss harvesting, including the wash sale rule, and this type of movement should not be done without the assistance of your financial advisor.

Tax planning based on the CARES Act can get complicated quickly, and no moves should be made without directly consulting with your financial advisor or tax preparer. Need advice? Do not hesitate to reach out to your financial advisor, or contact

We know that the CARES Act may leave you with questions, and we welcome the opportunity to work with you and your legal and tax professionals to determine how these changes impact your retirement and estate planning goals. This material is provided for informational purposes only. It is based on tax information and legislation as of March 2020. Investors need to make their own decisions based on their specific investment objectives, financial circumstances, and tolerance for risk. Our firm is not a tax or legal advisor. Investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.