LEVATUS Tax and Estate | Revisiting an Uncertain Tax Landscape
The outlook for tax policy in 2021 remains fluid. Planning should reflect this.
Photo by Philip Jahn
Looking forward to 2021, the outlook for tax policy remains fluid. Working with a wealth advisor to establish specific options for potential outcomes and keeping long term objectives in mind are two important ways to maintain control and keep strategy heading in the right direction.
Overlaying a menu of options with some big picture perspective blends planning with reality. The US government has spent a lot of money in its efforts to stabilize the economy during COVID. They are likely to spend more. At some point taxes will likely have to go higher to pay off this debt. At the same time the economy continues to face significant pandemic related headwinds. In the near term, taxes of any kind would only add to this so the timing of tax increases may be more open to debate than some might think. In addition, split branches of government would likely impact the degree and timing of any tax changes as well.
We wrote recently about the most significant potential changes from an estate tax perspective. Even with all the questions on likelihood and timing, other potential tax related policy shifts are worth thinking through as well, especially where there are practical action items that may make sense if changes do occur. Below are a few of the more significant topics that create interesting and actionable tax planning opportunities.
1 Income tax rates
Income tax rates are currently low by historic standards. The tax overhaul that brought tax rates down expires in 2025. What happens after that is very unpredictable. President-elect Joe Biden released a tax proposal earlier this year that begins by increasing taxes on people who earn over $400,000 per year and implies other tax increases as well.
Some practical steps worth considering, especially if you find yourself in a low tax bracket currently, include a review of assets in traditional IRA accounts that have required minimum distributions upon retirement. The cost of doing a ROTH conversion is diminished when tax rates are low. While income tax would be due upon conversion, required minimum distributions (which are taxable as income) do not apply to ROTH accounts. Assets in a ROTH account can grow tax sheltered and avoid taxes in the future. This is something worth discussing with your accountant or advisor given the current low tax rates, especially if you are young.
2. long term capital gains rate
Long term capital gains tax rates are as low as they have been in a long time. The current federal maximum long-term capital gains tax rate for 2020 is 20% plus 3.8% net investment income tax. This applies to individuals earning more than $441,451 in taxable income or $496,601 for married couples filing jointly. People in lower tax brackets may qualify for 0% or 15% long-term capital gains rates.
Even without any political consideration, changing debt dynamics may impact rates in the medium term. President-elect Biden has proposed higher taxes on capital gains, potentially bring them up to the same level as the higher income and short-term capital gains tax rates. This would mean a significant increase for high income earners.
A practical plan of action under a scenario in which long term capital gains rates go higher should include thinking about strategy around any concentrated positions. If the expectation is that at some point in the next few years the position will be reduced in order to diversify, it may be wise to consider accelerating at least some part of that plan at the current tax rates.
The same analysis and planning should be undertaken with other holdings that are not expected to be held for the long term. Importantly, however, investment decisions should first and foremost be made on the long-term merits of the investment.
3. cost basis step up rules
Joe Biden’s team has proposed a repeal of the stepped-up basis at death tax rule. Currently, an individual may hold an asset for many years, during which the asset typically appreciates in value. The current rule says that when the asset is inherited the ‘cost basis’ is moved up to the price of the security on the date of death. If the inheritor sold it the next day there would likely be no capital gains tax. The appreciation from the original purchase price is not taxed. Elimination of stepped-up basis will result in increased capital gains taxes for those that inherit the assets.
Some practical planning for the two potential outcomes is worth-while. If an individual has been holding an asset specifically to capture the cost basis step up, and does not have any other reason to hold the asset, considering a diversification strategy now versus later is definitely worth discussing with your accountant or advisor. Even without the change in rule, developing a strategy around low conviction long term holdings makes sense.
4. charitable donation limits
It is possible that 2020 may be the last year that large or unlimited charitable contributions can be applied as itemized deductions for tax purposes. Currently every dollar of charitable contribution over the standard deduction amount can be itemized as a deduction. If historic standards return, ‘means-testing’ could cap the amount of the charitable contribution that can be deducted.
As with all of these, the outcome is uncertain but lining up a plan that takes into account possible changes brings a level of control in uncertain times. Practical planning options include contributions to Donor Advised Fund or foundation before December 31. This would allow taxpayers to take the entire tax write off this year. While the tax benefit would apply to this tax year gifts from the donor advised fund could be made over time. Qualified charitable distributions are another option for people over 72 with a qualifying IRA. Here distributions from an IRA can be redirected to a charity of your choice, rather than a personal account. For amounts under $100,000 the charitable contribution has tax benefit against the normal ordinary income tax rate making this an option worth discussing with an advisor.
walking that tax tightrope …
Many things could change in the coming years. The bottom line - make sure to think about what makes sense from a personal and investment perspective first, and remember that the timing of tax code changes could be fluid. The fragile economic backdrop creates near term hurdles to big tax increases while the long-term debt dynamic created by pandemic related spending could mean that taxes will need to rise at some point down the road regardless of politics. A thoughtful plan that balances all these factors is just what is needed to reduce anxiety and increase control.
Tax, estate, investment
The LEVATUS approach to planning integrates personal priorities with rigorous process.
