There have been so many tax changes this year! As you might expect, it is difficult to cover them all. We’ll try to highlight a handful of changes that we think will be most relevant to you as a tax professional.
We’ll skip over the changes that are compliance-related, and focus on the provisions from the Secure Act that we feel will be most helpful when it comes to developing tax planning or helping our clients make shifts in order to minimize their tax liability.
Auto-Enrollment Tax Credit
This is an easy, simple, free tax credit created by the Secure Act. This tax credit is for small employers who implement an automatic contribution arrangement for a qualified employer plan.
The law allows for a plan to automatically enroll employees. They can opt-out if they want, but the goal is obviously to encourage and promote automatic retirement contributions.
It’s simple: turn on this feature and you get a tax credit. The tax savings are $500 a year for up to three tax years. Both new and existing plans are eligible and it is effective for tax years beginning in 2020 (so you can get started right now!). If you’re interested in this tax credit as a nice little bonus, check out Notice 2020-68 for additional information.
Birth & Adoption Distributions
Not a lot of people are talking about the fact that the Secure Act created a new penalty exception for the 10% early withdrawal penalty on IRAs and qualified retirement plans. And this exception has one big bonus feature attached that makes it better than all of the others.
Here’s how it works. A child is born or an adoption is finalized on a specific date. Within one year of the birth or adoption date, each parent can take a qualifying distribution of up to $5,000 per child per parent. Let’s say a married couple has twins. Within one year of the birth, each parent can take up to $10,000 penalty-free from their retirement accounts. The children could have even been born in 2019, as long as the distribution was taken after 12/31/19.
Now there are a number of retirement penalty exceptions and we have seen a number of clients taking money out of their retirement due to pandemic-related financial stressors. But it is the repayment feature that makes this penalty exception special.
When a birth/adoption distribution is repaid, the applicable tax can be taken off the return! The statute of limitations on the refund is three years from the date the return was filed or two years from the date the tax was paid, whichever is later.
529 Plan Changes
Under the Secure Act, more expenses qualify for tax-free distributions from a 529 plan. There are two new types of qualified higher education expenses. First, certain apprenticeship program costs now apply (fees, books, supplies, and equipment). Second (and more interestingly), principal or interest payments on any qualified education loan of the designated beneficiary or their sibling also qualify. That means that taxpayers can take money out of their 529 plans to pay down their student loan and it qualifies as a tax-free distribution.
This is huge, but two quick caveats. First, there is a $10,000 lifetime maximum on the loan amount. Second, your student loan deduction will be reduced by the amount treated as a qualified higher education expense.
See Part 2 on our blog Saturday to read more tax-saving tips..