Spring Is in the Air but Your Tax Planning Shouldn’t Have to Be

For many, spring is one of the best times of the year – mostly because of melting snow and warm sunshine, and less so because of tax filing. Throughout 2020, Boardwalk actively adjusted tax recommendations for each of our clients’ specific needs in response to the CARES Act, portfolio tax-efficiency, and changes in income for many clients. We have included a brief overview of a few impactful changes for the 2020 tax season. And should you have any questions as you file your 2020 return, please don’t hesitate to reach out to Mike or John.

Along with more typical tax planning strategies, such as building your portfolio as tax-efficiently as possible or optimizing retirement savings, there were three areas impacted by the CARES Act (March) and the Emergency Coronavirus Relief Act (December) that we wanted to highlight: charitable giving, support for businesses, and economic impact payments (stimulus checks).

Charitable Giving: In response to a difficult economic environment and greater need for community support, Congress increased the deductibility of charitable giving for taxpayers that itemize their deductions as well as the vast majority of Americans who take the standard deduction. For taxpayers with enough mortgage interest, state or local taxes, or charitable giving to itemize their deductions, the CARES Act allows up to 100% of AGI to be deducted for cash charitable donations in 2020. Ordinarily, tax law limits deductions for charitable giving to 60% of AGI for cash donations and even less for non-cash gifts. If the standard deduction ($24,800 for married filing jointly under age 65) is taken, then there is a unique above-the-line deduction of $300 for charitable giving done in 2020. There is a $600 below the line charitable deduction for married tax filers in 2021 ($300 for single), but the law does not extend this deduction into future years.

For Boardwalk clients, we consider your tax situation to find the optimal strategy for charitable giving, including gifting appreciated securities, “bunching” deductions using a charitable “donor advised fund,” or donating directly from your IRA if you are required to take annual distributions.

Small Businesses: Faced with lockdowns and dramatic swings in consumer demand, the CARES Act and subsequent Emergency Coronavirus Relief Act provided small businesses with economic relief in the form of the Paycheck Protection Program (PPP). For many businesses, PPP loans are forgivable provided that the funds were used to cover payroll and other enumerated expenses. If forgiven, the loan is not taxable income and business expenses paid by PPP funds remain deductible.

As with other business-related tax law changes in years prior (like the Qualified Business Income deduction introduced in 2017), Boardwalk has advised on how to utilize these changes to help our small business owner clients.

Stimulus Checks: Economic Impact Payments last spring and at the turn of the calendar helped many Americans through a difficult year. Both the first round of stimulus checks at $1,200 per tax filer and the second round at $600 per filer were paid in full for joint (single) taxpayers with income of $150,000 ($75,000) or less on their 2019 tax returns. Higher income earners’ eligibility was phased out. For those above the phaseout points in 2019 but with qualifying income in 2020, the Recovery Rebate Credit will ensure that you receive a refundable tax credit for these missed stimulus payments. With passage of the American Rescue Plan Act expected today, families with income under $150,000 (phased out at $160,000) will receive $1,400 stimulus checks. Unlike the last two rounds where families only received money for dependent children, adult dependents (over age 17) are now eligible for checks as well. If you have already filed for 2020, your eligibility will be based on your 2020 tax return, with an opportunity to get additional amounts credited in 2021 if your income for that year is lower than 2020.

As with other tax credits, deductions, or retirement contributions, there is often an income limitation to consider and plan around if possible. More broadly, it is also important to manage income tax brackets when possible (including thresholds that increase capital gains rates or IRMAA charges). If flexibility exists in your recognition of income and deductions, we analyze tax projections to optimize your tax position.

Please reach out to Boardwalk with any questions you may have on these specific 2020 tax items or the usual tax planning items such as IRA contributions, Roth conversions, HSA contributions, or savings to 529 plans. We are keeping close tabs on how strategies for 2021 will impact our clients, especially in the event that any significant tax law changes are enacted.

How Much Does Your Attention Impact Your Finances?

Many of the most recent breakthroughs in financial research have been discovered by psychologists rather than economists or investment researchers.  The branch of study they’ve pioneered is known as “behavioral finance.”  This was evidenced in 2002, when the Nobel Prize in Economics was given to psychologist Daniel Kahneman.  The insights gained from research in behavioral finance reveal how our brains process decision making and how this can heavily impact our finances – in both helpful and harmful ways.  Of the many behavioral biases that we can have, many are rooted in how we apply our attention.

As humans, we tend to avoid “headline” risks (like those on the front page of the newspaper or widely discussed in public).  While this seems appropriate, this tendency often causes us to take on larger but lesser known risks.  A good example of this occurred in the aftermath of September 11, 2001.  Due to the “headline risk” of flying, more people opted to drive instead of fly even though air travel is much safer than driving – especially over long distances.  Professor Gerd Gigerenzer, the director of the Harding Center for Risk Literacy in Berlin, estimates that an extra 1,595 Americans died in car accidents in the year after the attacks due to this tendency.  Because of our poor understanding of danger, the maxim “out of the frying pan into the fire” often applies to our behavior.  This holds true in our financial decisions.  If the stock market crashes, it is understandable that many people don’t want their portfolios to suffer the same fate.  Avoiding this risk by holding excess bonds or cash in advance may accomplish that, but at a near certain risk of their portfolio failing to generate sufficient inflation-adjusted returns.  Even more, deciding amid a downturn to offload risk by selling stocks in favor of bonds or cash poses an even more significant risk to the portfolio’s recovery.  It matters where we focus our attention – are we just “seeing” headline risks or are we focused on our exposure to real risks and actively working on what we can control?

Just how it’s easy to focus on “headline” risks, we also tend to commit our attention to seeking complex solutions rather than embracing simple, powerful ones.  As a derivative of this behavioral bias, we often try to “outsmart” the system.  A study, “The Left Hemisphere’s Role in Hypothesis Formation,” published by The Journal of Neuroscience in 2000, examined how humans and animals “guess” when certain probabilities are in place.  In one experiment, 80% of the time a light would appear on the right.  The remainder of the time it was on the left, but the sequence was random.  Prior to each trial, the subject would predict which side the light would be on.  Rats, discovering that the light on the right would appear most times, continually selected that side.  On the other hand, humans tried to use frequency matching to guess when the left light would appear – with minimal success!   Human subjects chose a less optimal strategy than rats because of our desire to find patterns and outsmart the system.  Like in this study, we tend to overlook the simple solutions to investing intelligently.  Instead, we attempt to beat the rest of the market with exotic or complex solutions.

The simple but powerful index fund doesn’t have all the bells and whistles that actively managed mutual funds tout, but they have outperformed most active managers over the past decade.  According to S&P Dow Jones’s 2017 SPIVA (“S&P Indexes Vs. Active”) scorecard, 63.43% of actively managed funds invested in U.S. stocks underperformed their benchmark in 2017 – over a three-year period the number of underperforming funds jumps to 83.40% and at 10 years reaches 86.65%.  In some categories, like funds invested in U.S. “small-cap” stocks, less than 5% of actively managed funds outperform their benchmark over a period of 10 years.  Despite not offering all the expertise of fund managers and their bold predictions, a simple strategy for diversification – the index fund – almost always wins out.  Our human desire for complexities is seen even more in the appeal of hedge funds and the way pensions and endowment funds typically invest.  As a testimony to simple, powerful investing solutions, my alma mater, Carthage College, was featured in numerous articles for having better returns than Harvard’s $37 billion endowment fund over the 10-year period leading up to June 30, 2017.  When asked why reliance on indexing isn’t more common among the nation’s endowments, Carthage’s endowment manager replied, “Maybe it’s too simple.” 

At Boardwalk Financial Strategies, one of our goals is to help you focus your attention on the important things and not let behavioral biases negatively impact your wealth.  Where we focus attention often gets the better of us: humans focus on avoiding “headline risks” (even if we take on larger but lesser known risks) and overlook simple, powerful solutions because of our desire for complex solutions.  It can be hard at times to not let our impulses dictate how we invest money or handle financial decisions.  But we believe focusing our attention on the things we can control – like financial planning – and utilizing an academic, data-driven (though simple) investment philosophy are ways we can help you build wealth, remove financial stress, and find the time and peace to enjoy what matters most to you in life.