After this year, 20/20 hindsight, 20/20 foresight, and 20/20 vision will all have a double meaning for me. Whenever I hear these phrases, I will think about what they mean but always think about 2020. It has certainly been a stressful year, and we all need a little encouragement. I truly believe that by enduring this adversity, we will all be in a more grateful place. After all, one must fly into the wind to get enough resistance beneath their wings to soar. And now, with the elections and 2020 almost behind us, this issue of The Financierge focuses on the exciting topic of year-end tax planning.
Taxes Will Likely Stay the Same
The 2020 elections now favor a balanced government with Joe Biden as our 46th President, the Senate controlled by the Republicans, and the House controlled by the Democrats. But of course, this is 2020, and anything can happen! So, although our planning favors taxes staying the same, we will plan with caution.
How Would Biden’s Tax Plan Affect You?
Although I don’t think we will feel the effects of a Biden Tax Plan right away, I thought it might be important to understand should the Democrats win control of the government. According to the Tax Policy Center, those earning more than $790,000 a year will see their taxes increase an estimated 16% for an average of $265,000. For those earning between $400,000 and $790,000, it is estimated that their tax will increase by 2.4% for an average amount of $9,000. For those earning under $400,000, the combination of tax increases and tax credit increases would reduce taxes for most Americans. For example, a family earning between $88,000 and $160,000 would get an average reduction of $540, while a family earning between $50,000 and $90,000 would get an average reduction of $920. Should the Democrats win, we may recommend that certain high earning individuals consider accelerating income and reducing deductions to take advantage of lower taxes.
Year-End Tax Planning Strategies
Considering that our current tax structure will stay the same, here are several common year-end tax planning strategies you might want to consider.
Reduce Income, Maximize Deductions
In 2017, the Tax Cuts and Jobs Act (TCJA) reduced wages, business income, and interest income from 39.6% to 37%. Under the progressive U.S. Tax system, we pay higher rates as our income increases. For 2020 those rates are 10%, 12%, 22%, 24%, 32%, 35% and 37%. It might be advantageous for tax planning to reduce income and maximize deductions to decrease your taxable income. Some common examples include reducing income from tax-inefficient mutual funds that create short-term capital gains, donating up to $100,000 of your required minimum distribution to charity if you are age 70 1/2, replacing taxable bonds with tax-free municipal bonds, and maximizing retirements savings and itemize deductions. (Planning Note: Under a Biden Plan, the 37% rate would increase to 39.6% for single taxpayers with income over $520,000 and married taxpayers with income over $620,000.)
Contribute to Tax-Advantaged Accounts
To reduce income, you can make a retirement plan contribution to 401(k) plans, IRAs, and defined benefit plans. You can also contribute to 529 education plans and health savings accounts (HSAs). These vehicles may offer tax deductions, tax-free growth, and tax-free distributions. If you are age 50 this year, you can make a $6,500 catch-up contribution to your 401(k) and a $1,000 catch-up contribution to your IRA. You can also make contributions early to take advantage of tax-free growth. The following chart shows income limits for IRA contributions.
Use Itemized Deductions
You can deduct the greater of the standard deduction or itemized deductions. Itemized deductions include mortgage interest, medical expenses, state and local income and property taxes, and charitable contributions. For 2020, the standard deduction is $12,400 for single taxpayers and $24,800 for married couples. For itemized deductions, there is no longer an overall limitation on itemized deductions with a few exceptions, such as a $10,000 limit on state and local income and property taxes. (Planning Note: Under a Biden Plan, the Pease Limitation would be reinstated, and total itemized deductions would be reduced by 3% for every dollar that income exceeds $400,000. In addition, there would be a limit on the benefit of itemized deductions at a 28% rate for taxpayers earning more than $400,000.)
Tax Loss Harvesting
Long-term capital gains and qualified dividends are currently taxed at 20%, 15%, or 0%, depending on your tax bracket. Tax-loss harvesting is used to sell securities with losses to offset gains. (Planning Note: Biden’s Plan would increase the top rate on long-term capital gains and qualified dividends from 20% to 39.6% for taxpayers earning more than $1 million. Also, there will be a net investment income tax of 3.8% for a total capital gains rate of 43.4%)
Consider Using the Estate Tax Exemption
For 2020, if you die, the value of your estate over $11.58 million per person is taxed at a rate of 40%. If your estate is over $11.58 million per person, it would be worthwhile to discuss planning strategies to reduce tax on multigenerational wealth transfer. Also, keep in mind that this exemption will increase with inflation every year and sunset on December 31, 2025, to an estimated inflation-adjusted $6 million per person. (Planning Note: Under a Biden plan, the estate tax rate would rise to 45%, the exemption would reduce to $3.5 million, and there would be no step-up in cost basis at death, and appreciated assets would be taxed.
Use Your Annual Gift Tax Exemption
Don’t forget to consider using your annual gift exclusion. This allows you to make gifts each year of up to $15,000 (or $30,000 for a married couple) in cash or property to an unlimited number of individuals without incurring any gift taxes or reducing your lifetime exemption from gift tax.
For 2021, the Internal Revenue Service has released its annual inflation adjustments. Here are some highlights:
- The estate exclusion amount (and generation-skipping tax exemption) will increase from $11.58 to $11.7 million for decedents dying in 2021.
- The annual gift tax exclusion amount remains $15,000.
- The annual gift tax exclusion for a non-citizen spouse will be $159,000, up from $157,000.
- The standard deduction will increase to $25,100 for married individuals filing jointly and $12,550 for single taxpayers and married individuals filing separately, and $18,800 for heads of household.
- The top tax rate will remain 37% for individual single taxpayers with incomes higher than $523,600 ($628,300 for married couples filing jointly).
- There is no personal exemption for 2021.
- There is no limitation on itemized deductions.
- Children under age 19 and college students under age 24 must pay taxes on unearned income. For 2021, the standard deduction for unearned income subject to tax is $1,100.
- The top (37%) income tax bracket for estates and trusts will begin at $13,051.
- The alternative minimum tax exemption for estates and trusts, adjusted for inflation, will be $25,700, and the phaseout of the exemption will start at $85,650.
- The foreign earned income exclusion amount is $108,700.
- The qualified business income threshold under Internal Revenue Code Section 199A will increase to $329,800 for married individuals filing joint returns and to $164,925 for married individuals filing separate returns, and to $164,900 for single individuals and heads of household.
The Bottom Line
Tax planning is an important part of your overall family wealth management strategy. Please meet with your tax advisor to discuss your goals, circumstances, and strategies to reduce taxes for 2020 and 2021.
Please reach out to me at firstname.lastname@example.org if you have any questions, or I can serve you in any way. Thank you, and may you and your family be blessed with health, prosperity, and wisdom.
Warm and best regards,
Don B. Saulic, CPA, CFP®