With the end of the year quickly approaching, there are some important financial planning measures we can take to reduce our taxes and improve our financial position. This year poses a bit of a challenge while the control of the Senate remains uncertain, but there are measures we can implement that will be beneficial no matter the change in policy.
Many tax and financial planning deadlines are based on a calendar cycle – complete them after December 31st and lose the benefit for that year. Outlined below are some of the most common planning that can be implemented:
- Contributing to Your 401(k) or 403(b) and/or 457(b).
- Tax loss harvesting – Short and long-term losses must be used first to offset gains of the same type. If your losses of one type exceed your gains of the same type, then you can apply the excess to the other type. Net losses of up to $3,000 a year reduce ordinary income. Amounts in excess of $3,000 can be used in future years.
- Contributing to your state-sponsored 529 Plan (dependent on the state rules).
- Paying your Medical Expenses and Long Term Care insurance premiums from your Health Savings Account (tax free distribution).
- Strategize Charitable giving with a Donor Advised Fund.
- Push property taxes into 2021 (dependent on state and local tax position in 2020 and change in tax policy – advice will vary per individual).
The breakdown of seats in the Senate, and the fate of Democrats’ plans to raise taxes on high income earners and high net worth individuals/families, likely will not be known until Georgia conducts a special election for its two senators on Jan. 5. If the Democrats win both Georgia Senate seats, the Senate will be divided 50-50, which would give Democrats control of the Senate because the vice president has the constitutional power to break ties. Through the reconciliation process, Democrats would be able to enact tax reforms President-elect Joe Biden proposed in his campaign platform. On the other hand, if the Republicans win either of the Georgia Senate seats, they will be able to block Biden’s tax proposals. With that being said, there remains uncertainty around the planning based on the Biden Tax Proposal, but let’s take a look at the facts, and then you can weigh the risks associated with any type of implementation on your financial plan.
KEY PROPOSALS IN PRESIDENT-ELECT BIDEN’S PLATFORM
Ordinary Income
- Proposed top tax bracket of 39.6%, same level as before the Tax Cuts & Jobs Act (TCJA).
- Proposed ordinary income tax rate increase for taxpayers with income > $400,000.
- Elimination of the Qualified Business Income (QBI) deduction for taxpayers with > $400,000 of income.
Itemized Deductions
- Potential cap on the maximum benefit of itemized deductions would be tied to the 28% tax bracket.
- The cap would limit the value of itemized deductions (i.e. if taxpayers were in the 33%, 35%, or 37% tax bracket, they would only receive a 28% break on their itemized deductions)
Capital Gains
- Proposed change to long-term capital gain rates for taxpayers with income of > $1,000,000. At this threshold, long-term capital gains would lose preferential treatment, and therefore LTCG’s realized above this level would be taxed at ordinary income tax rates.
Estate Planning
- Proposed changes include eliminating the step-up in basis of capital assets upon death.
- Under current law, the appeal of not selling and triggering long-term capital gains is the potential to permanently avoid realizing gains to get step-up treatment at death.
- This proposal would rapidly change the favorable step-up at death, to an undesirable one which could push capital gains to be realized all in one year, potentially at higher rates.
Estate Tax Threshold
- Proposed Biden platform outlines returning the estate tax exemption to $5.85 million/person, or pre-TCJA levels ($5 million indexed for inflation).
- IRS has stated that any future reduction in estate/gift tax exemption transfers today, in excess of the future exemption, will not be subject to clawback.
YEAR-END CONSIDERATIONS
Advice in each of these categories will vary on an individual client basis, but based on what we know, here are some year-end considerations with the facts and information we currently have.
- Roth conversions are still a productive strategy to accelerate income, but no ‘take-backs’ due to the elimination of Roth recharacterizations.
- Cash-basis business owners may benefit from planning around revenue billing and expense payments, to accelerate business income in 2020.
- Even if tax rates stay the same next year, there’s limited downside to accelerating income for those who are otherwise pegged to the top tax bracket.
- Harvesting income can be thought of as “buying tax insurance” or paying a price (current tax rates) today that may or may not turn out to be a good deal, in exchange for a guarantee that minimizes additional cost.
- TVM (time value of money) would need to be calculated in order to determine the break-even point as well as the potential upside vs. the downside consideration.
- High-income taxpayers with income above the 28% tax bracket who already itemize may benefit from accelerating additional itemized deductions before year-end 2020 as the proposed 28% cap would limit future itemized deductions above this threshold.
Our team remains available to you to assist in any questions you may have surrounding these and other topics. Please don’t hesitate to reach out if we can help.
We wish you and yours a healthy and happy end of 2020.
The Legacy Financial Group Team