What You Should Do Now in Preparation for Tax Law Changes
It’s possible that major tax law changes will be coming, including the elimination of the preferential tax treatment given to long-term capital gains, a new wealth tax on households earning more than $50 million annually, and changes to taxation related to carried interest and estate planning. But it’s not too late to plan ahead to account for these possible tax law changes.
“There is probably time, as it is unlikely the changes will be retroactive to Jan. 1, 2021,” said Bill Smith, managing director for CBIZ MHM’s National Tax Office.
With this in mind, here’s what Smith and other financial experts say to do now to prepare for changes down the line.
Make Plans for Your Capital Investments
“Economists are saying that the increase in capital gains tax to 39.6% will only affect less than 1% of American households because it only applies if income is over $1 million. That being said, those same economists are saying it will be a tax loss unless coupled with the elimination of the step-up in basis at death,” Smith said. “Because the wealthy do not typically need the proceeds of their capital investments to live on, they can (1) sell now and take advantage of the current rates so any locked-in gain will receive favorable tax treatment; (2) hold it until the next Republican takeover of the House, Senate and White House and hope for tax cuts; or (3) if there is no elimination of the step-up in basis upon death, hold until they die. They can also use gifting strategies to get the gains into lower-income family members.”
Missed the Tax Deadline? Here’s What To Do
Defer Income If You Are a High-Income Earner
Under President Joe Biden’s proposed American Families Plan, the top income tax rate would be raised from 37% to 39.6%. To avoid having to pay higher taxes, high-income earners should be proactive about deferring income. Jennifer Marshall, director of tax services at Bryn Mawr Trust, suggests the following strategies:
- Invest in tax-exempt municipal securities over corporate bonds to reduce ordinary income. “Consider tax-advantaged investments such as cash value life insurance. If structured properly, money grows tax-free and can be distributed tax-free.”
- Perform a Roth IRA conversion. “Pay the tax now while it is lower and withdraw tax-free later.”
Reassess Your Corporate Stock Holdings
An increase in the corporate tax rate could have trickle-down effects on the individual, specifically when it comes to their investment portfolio.
“Individuals holding publicly traded corporate stock may want to choose growth companies over dividend-paying companies, assuming they (1) are not over the $1 million income threshold, or (2) can afford to hold on to the stock over time,” Smith said.
Minimize Estate Taxes Now
“There are several legislative proposals that have the potential to lower exemption rates, remove the step-up in basis for assets passing at death and eliminate some tax-efficient estate planning techniques,” said Michael Roberts, president of Arden Trust Company. “While it is always critical to have an updated estate plan to protect your beneficiaries and distribute assets according to your wishes, there are a number of steps individuals can consider now to minimize estate taxes before any potential legislative changes take effect.”
Here are the steps Roberts recommends:
- Maximize the annual gift exemption. “For 2021, the annual gift-tax exclusion is $15,000 per donor, per recipient. Individuals can give anyone up to $15,000 in assets a year, free of federal gift taxes. Spousal gifting doubles the annual tax-free gift allowance to $30,000 per recipient. Proposals under consideration would cap the yearly gift-tax exclusion to as little as $20,000 to $50,000 for all recipients.”
- Leverage the lifetime estate and gift tax exemption. “The current lifetime estate and gift tax exemption of $11.7 million is set to decrease to $5.3 million in 2026, and an even lower threshold could be on the horizon under the new administration. Gifting a piece of your estate to a trust fund for a spouse or an heir could help maximize the current exemption rate. By doing so, your gift may be grandfathered in at the higher exemption rate before any changes to tax law are enacted at year-end.”
- Fund a Grantor Retained Annuity Trust (GRAT). “For assets expected to appreciate, consider placing them in a GRAT. With this method, an irrevocable trust provides an annuity to its beneficiary that stems from the appreciating assets and is paid out on a yearly basis for a predetermined amount of time. Once the trust expires, the beneficiary receives the remaining assets tax-free.”
- Make charitable gifts. “With a Charitable Remainder Trust, a large sum of money can be placed into the trust that will then pay a fixed annuity each year, benefitting you or your loved ones while living. The remainder of your trust then passes onto the charity of your choice upon passing.”
“Complex estate planning takes time,” Roberts said. “While these legislative initiatives have not yet been passed, individuals are rushing to make gifts before potential tax law changes are implemented at the end of 2021. If these changes could affect you, don’t procrastinate on opportunistic planning.”
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