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Year-End Tax Planning Opportunities Amid Tax Reform Uncertainty

By December 15, 2020July 1st, 2021No Comments

The elections are over, and it appears likely that we’ll have at least two years of divided government, with Joe Biden as president, a Democratic House, and a Republican Senate. Democrats’ failure to sweep all three contests, which pollsters had suggested was possible, is a big deal for investors and taxpayers. 

A sweep would have given Biden a leg up in raising tax rates and lowering exemption thresholds for wealthy families. With a divided government, major tax legislation will likely be delayed or watered down. The Democrats could conceivably take Senate control by winning the two Georgia Senate runoff elections in January, but that appears to be a long shot. The biggest risk to your wealth right now may be lowering your guard when it comes to tax planning. 

Here are three tax-saving strategies to consider sooner rather than later:

Accelerate charitable donations. 

If you are considering making a significant charitable contribution, you can enjoy an unusually generous tax break by doing so before year’s end. Prior to this year, charitable gift deductions were typically limited to 60% of adjusted gross income. Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, donations to qualifying organizations are tax-deductible up to 100% of AGI in 2020. Giving makes even more sense if you have unusually high taxable income this year. And with Covid-19 still raging, there’s certainly plenty of need for generosity. 

Bear in mind that there may be tax advantages to gifting long-term, appreciated securities rather than cash. Donating appreciated shares provides the same benefit to the charity as giving cash, while the giver not only receives a tax deduction for the gift’s full market value, but also avoids paying taxes on accrued capital gains. Yet another potential benefit of donating appreciated stock is that it can help rebalance an investment portfolio that’s become overweighted to equities due to market performance.

One final note: Gifts above AGI limits can be used as charitable carryforwards over five years.

Convert to a Roth IRA. 

Income tax rates are historically low right now, but with the federal budget deficit having tripled over the past year, it’s a good bet that lawmakers will look to raise rates in the next few years. If you have significant retirement assets in a traditional IRA or 401(k), and you think you’ll be in a high tax bracket in retirement, consider converting at least a portion to a Roth. 

While traditional retirement accounts are funded with pre-tax dollars and taxed as income upon withdrawal, Roths are taxed on the front end and provide tax-free retirement income. Simply put, Roth-ifying now is a hedge against paying higher rates later. And if your Roth assets end up being inherited, your named beneficiaries will receive a very tax-favorable asset.

Take into account that moving money from a traditional to a Roth account triggers a tax liability. The potential upside is that the conversion tax can effectively reduce the size of your taxable estate. Alternatively, it may be possible to neutralize the Roth-ification tax hit by using 2020’s higher deduction limits for charitable gifting. 

Finally, a Roth conversion may make particular sense for those who expect to receive unusually low total income in 2020, since they may be subject to a lower tax rate. 

Use the Lifetime Gift Tax Exemption (LGTE).

At $11.58 million per person, the Lifetime Gift Tax Exemption (LGTE) is currently at its highest threshold ever. But the current exemption limits, created by the Tax Cuts and Jobs Act of 2017, are set to expire after 2025. At that time, they’ll return to pre-2018 levels of $5 million per person plus inflation adjustments. But legislators may target the LGTE sooner as they look to raise badly needed revenue. If that possibility concerns you, and if you remain under the $11.58 million threshold, consider moving your gifting timetable forward. 

Part of the groundwork related to significant gifting is analyzing how much money you’ll likely need to support yourself throughout the remainder of your life. In addition, consider making any large gifts through trusts rather than directly to intended beneficiaries; doing so enables you to set up parameters and safeguards to ensure that the gift is used as intended. 

One issue that had caused some to delay taking full advantage of the current LGTE threshold was the fear of IRS “clawbacks” after the current exemption limit expires. Rest easy: The U.S. Treasury and IRS last year issued guidance clarifying that clawbacks won’t take place. 

The election may be over, but the tax man never rests. Don’t hesitate to contact us if you’d like to discuss strategies for keeping more of your wealth.