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2020 US tax year end planning

As we approach the end of 2020, we consider the impact that the US president-elect Biden will have and look at some important year end planning points to consider for US taxpayers living outside the US.

Last updated: 1 December 2020

The 2020 US tax year ends on 31 December 2020, so now is a good time to consider whether there is anything that you can do to minimise your US tax exposure for 2020 and to begin preparing for 2021.

Any tax planning opportunities should always include the US and local tax implications for an American living abroad, and any decisions taken in relation to buying or selling/gifting of assets should take account of both the investment as well as the tax consequences of doing so.

About the author

Allan Wilkinson

+852 3192 7083
wilkinsona@buzzacott.hk
LinkedIn

Last updated: 1 December 2020

The 2020 US tax year ends on 31 December 2020, so now is a good time to consider whether there is anything that you can do to minimise your US tax exposure for 2020 and to begin preparing for 2021.

Any tax planning opportunities should always include the US and local tax implications for an American living abroad, and any decisions taken in relation to buying or selling/gifting of assets should take account of both the investment as well as the tax consequences of doing so.

Planning with uncertainty

Joe Biden became the president-elect of the US following the 2020 election and is due to be inaugurated in January 2021. President Trump has been slow to concede the election, which is likely to make the transition difficult. In addition, the Senate doesn’t currently have one party in control, and so we await January 2021 to see how difficult it could be for Joe Biden to push through any significant tax reform from 2021. As there will continue to be uncertainty into the beginning of 2021, if you’re already considering tax planning moves such as making gifts or selling assets, you may want to accelerate these to lock in the certainty of the current rules.  

It seems unlikely that changes to income taxes can be brought in so rapidly as to be retroactive for all of 2021, particularly if the Republicans control the Senate. However, transaction based taxes, such as capital gains and estate and gifts taxes could be made effective from a specific date, although anything significant requiring congressional approval is likely to take a while to be approved or may not happen at all.

Ordinary income tax rates

Assuming no retroactive income tax changes are made to 1 January 2021, the top federal tax rates are unchanged from the previous year, with a top rate of 37%. This rate applies to individuals with Adjusted Gross Income (AGI) in excess of: 

Filing status    

2020

2021 (projected)

Married Filing Jointly (MFJ)

$622,050

$628,300

Head of Household (HoH)                                      

$518,400

$523,600

Single

$518,400

$523,600

Married Filing Separately (MFS)

$311,025

$314,150

Opportunities before year end

So what opportunities could you take advantage of in the run-up to the end of 2020? Below we’ve summarised a few for you to consider. Click the banners to view the opportunities and what you should do for each, and click the banner again to close that section.

Utilising unused 2021 allowances or deferring income to 2022

Spreading income over two tax years

Depending on your tax bracket, the tax rate on long term capital gains and qualified dividends ranges from 0% - 20%. The tax rates on ordinary income range from 0% - 37%. You can deduct losses up to $3,000 with any excess loss carried forward. Should you wish to reinvest in the same stock, either it’s best to do so 30 days before or 30 days after the sale to avoid wash sale rules, which would disallow the loss.

The modified proposal is to keep the top income tax rate at 37% but introduce surtaxes for high earners. Current proposals are to have a 5% surtax for Married Filing Jointly (MFJ) taxpayers with Modified Adjusted Gross Income (MAGI) of over $10 million, plus a 3% surtax for MFJ taxpayers with MAGI of over $25 million. So for the highest earners this means a top rate of federal income tax of 45%. In terms of capital gains, Biden had proposed an increase to long-term capital gains rates to 25% beginning midway through 2021, however the modified bill has removed this increase.

What should you do?

By spreading capital gains/income between tax years, you can abstain from incurring spikes in income, which may push gains/income into the higher tax brackets. This may help minimise the total tax paid for those tax years. You may also want to consider realising some capital losses to reduce tax on other investment income and gains. 

As there is a potential chance of tax rates increasing, particularly for higher income earners, you may want to consider accelerating income in 2021. An investment decision should also be made, and there is the possibility of disposing of and reacquiring an asset, but we advise that you seek advice tailored to your unique circumstances.

Net Investment Income Tax (NIIT)

You may continue to incur an additional tax of 3.8% on unearned investment income, where your Modified Adjusted Gross Income (MAGI) exceeds the following thresholds:

Filing status

Threshold amount

Married Filing Jointly (MFJ)

$250,000

Married Filing Separately (MFS)

$125,000

Single

$200,000

Head of Household (HoH) with qualifying person

$200,000

Qualifying widow(er) with dependent child

$250,000

What should you do?

By spreading investment income across a number of years or offsetting it by above the line deductions, you can prevent the requirement of paying the additional 3.8% NIIT by keeping your total income under the NIIT thresholds. To do this, you could consider paying a dividend or realising capital losses.

Estate and gift tax

For the estate of a US citizen or domicile who makes taxable gifts or passes away in the 2021 calendar year, the lifetime exclusion amount is $11.7million for determining the amount of credit against estate or gift tax. This creates opportunities for gifting/estate planning in 2021. 

The uncertainty with 2022 is whether the lifetime exclusion amount will be reduced. There are other proposals such as the potential of there being no step up in basis of assets held at death. If such laws are enacted in 2022, many estate planning strategies may need to be reviewed.

What should you do?

There’s potential for you to make tax efficient gifts before the 2021 year end. For example, you could make a gift of up to $15,000, per donee, per donor, and not use up the current $11.7million estate tax threshold. 

You may want to follow through with tax planning that involves using up the lifetime exemption amount, knowing that with the tax reform, the rate is expected to be reduced at some point in the future.

US pensions

If you hold a traditional Individual Retirement Account (IRA) or 401(k) plan, you continue to be able to convert it to a Roth IRA. Converting your traditional IRA to a Roth IRA will, for some taxpayers, create long-term tax benefits as generally subsequent withdrawals are not taxable, and no minimum distribution is required each year after reaching age 72 (unlike for traditional IRAs). Conversions are taxable in the US at ordinary income tax rates and so will create a tax charge for 2021 that must be met by other sources of cash. However, given the flexibility that a Roth may bring, if you’re more suited to a Roth IRA from an investment perspective, you may wish to consider making the conversion now. 

Where contributions into the 401(k) plan or traditional IRA also involve a period of foreign service, available foreign tax credits may be used to reduce the liability. No Net Investment Income Tax (NIIT) is due on any distribution, conversion or rollover to/from a Roth IRA account.

What should you do?

Consider transferring your traditional IRA/401(k) plan into a Roth IRA before the end of 2021 if you’re more suited to it from an investment perspective.

Mortgage redemptions

If you have a mortgage denominated in a currency other than the US dollar and you’re about to sell your property and redeem the mortgage, beware of a possible tax trap. This includes US taxpayers with non-US mortgages who have a mortgage contract about to expire (e.g. a two-year fixed rate deal) and are considering transferring to a different mortgage.

If the mortgage currency is down against the dollar compared with the exchange rate at the time the mortgage was agreed, it will cost less in dollars to redeem the mortgage than its original US dollar value. The IRS (Inland Revenue Service) unfortunately taxes this dollar ‘gain’ as income, which can surprise a lot of people, especially when the actual value of the property may have gone down in dollar terms as a result of the relative devaluation of the local currency. It’s possible to harvest excess foreign tax credits in such a situation, so we encourage you to seek advice and plan against any nasty surprises.

What should you do?

Consider the foreign exchange position before changing mortgage contracts.

Foreign tax payments timed before or after 31 December 2021

If you pay tax in another jurisdiction and are on the ‘paid’ basis of accounting for foreign tax credits, it’s important that you consider paying your local tax liability by 31 December 2021, even if the tax on the income is not due until a later date. This will ensure that a corresponding foreign tax credit may be taken against any federal tax due on foreign income realised in 2021, and reported on your 2021 US tax return. This is especially true for self-employed individuals with rising profits or if a capital gain has been realised in 2021. Note that it is not always possible to make payments early so it will depend on how tax is assessed in the local jurisdiction.

Experience tells us that making payments before the festive season avoids last-minute problems and ensures you have the available tax credit.

Conversely, if you have plenty of excess foreign tax credits carried forward from the previous 10 years, you may want to consider utilising these by deferring a foreign tax payment to next year, if it is possible to do so without incurring penalties for late payment. This is because after 10 years, unused foreign tax credits are wasted. Unused foreign tax credits are utilised in a year with a shortfall of foreign tax credits on a first in first out basis, so intentionally creating a shortfall in 2021 would allow you to utilise credits going back to 2011.

There were proposals to reduce the excess foreign tax credit carry forward period to five years, and to repeal the one year carry back period. These proposals were included in Biden's initial tax bill but only the repeal of the one year carry back period was included in the modified bill, to apply from 2023. 

What should you do?

If you’ve realised any capital gains in 2021, or your income that is not taxed at source has increased, consider making a prepayment of foreign (non-US) personal or corporation tax before 31 December 2021. If you have large carried forward unused credits, and can delay a payment that is due without incurring penalties, consider paying it in January 2022.

Residency

When looking to move to a new country, it’s important that tax advice is taken well ahead of the move to allow for the most efficient tax planning. If you’re a green card holder, the beginning of the new 2022 tax year will mean another year is added to the number of years considered under the eight out of 15 year expatriation tax charge regime. 

What should you do?

If you’re considering a move to a new country, get in touch with our experts first to allow adequate planning. If you’re approaching the eight-year green card holding period, you may wish to take advice as to whether there would be any advantage in surrendering your green card this calendar year.

Key deadlines

There are other upcoming deadlines that you may need to be aware of, but here are some of the key US tax deadlines to consider over the next few months.

15 January 2021

Final instalments of 2020 US estimated taxes due.

16 March 2021

US partnership and trust returns deadline. Extension can also apply to 15 September.

15 April 2021

Foreign Bank Account Reports (FBAR)/FinCen Form 114 – these are automatically extended to 15 October 2021.

Individual income tax return filing deadline (automatic two month extension to 15 June 2021 applies to taxpayers living overseas). Extension can also apply.

First instalment of 2021 US estimated taxes due.

Speak to an expert

We recommend that you seek professional advice where appropriate before taking any action so please contact Allan or fill out the form below if you have any questions. 

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