Five Tax Planning Questions to Answer Before Year End

11.11.2020 - Craig Richards, CPA/PFS, CFP

The election results mean the federal tax environment may remain uncertain for some time. While the Biden campaign proposals included several significant tax changes, a Biden presidency appears likely to face a divided Congress that may make it difficult to get his agenda passed. Yet at the same time, the January run-off elections for both Senate seats in Georgia preserve the possibility of a Democrat-controlled Congress, where the Biden tax proposals could more easily be pushed through to law. 

This uncertainty can present a quandary for taxpayers who would be impacted by the Biden proposals, such as high-income earners and those planning for large estates. Taking steps before year-end to benefit from the current rules could make sense if the proposed tax laws go into effect next year. But if there is a divided Congress, the need to act becomes less necessary or less urgent before year end. 

Making Informed Decisions Among Uncertain Tax Law Changes

The decision whether to act this year largely rests on factors personal to each situation. To help you determine the right actions for your circumstances, answering these five questions can help you make informed decisions as laws remain uncertain.     

1. Should I plan to update my estate plan?

The answer for many individuals is yes. This year has brought many changes that make updating your estate plan a priority, such as new rules for how you can leave your retirement accounts to your beneficiaries.

The pandemic has also put a spotlight on the gaps in estate plans. Gaps can range from not funding your revocable trust and having outdated specific bequests, to the need to review the details of your health care directive and ensure your plans for incapacity address the health care realities we’ve seen under COVID.

The high gift and estate tax exemption amount of $11.58 million per person in 2020 ($23.16 million for a married couple) has left many people thinking they do not need to worry about estate taxes. If the exemption amount decreases, whether under the Biden presidency or through the sunset of the current rules in 2026, more families and individuals will want to consider making gifts for tax purposes. Estate plans may also need to be updated to address transferring assets in ways that consider a lower threshold for tax.

These changes may not need to happen immediately. But the fluidity of our tax laws puts a premium on having a clear vision for your estate. You can start by confirming the goals for your estate plan, reviewing your balance sheet and considering whether gifting assets sooner rather than later may make sense for you. And of course, there are always the standard reasons to update your estate plan for major life events, like marriage, divorce and the birth of children or grandchildren.  

2. Should I make gifts to use my gift and estate tax exemption amount?

The Biden tax proposals have raised concerns about a decrease in the gift and estate tax exemption amount. The current exemption amount of $11.58 million is set to be reduced roughly by half after 2025. But the potential for legislative change may compress this timeframe, possibly as soon as the beginning of next year. 

Even if immediate tax changes do not materialize, if your estate is well in excess of the current exemption amounts, gifting before year-end should still be a priority to consider. Gifting will remove assets from your estate for estate tax purposes. And generally, the sooner that occurs, the better to maximize the appreciation potential in the hands of your beneficiaries. And, it’s possible that any changes to the estate tax exemption could be applied retroactively in 2021, so if you already know you would like to make large gifts, it makes sense not to wait.   

You always want to pay close attention to the type of property, and the cost basis of that property, that you give away. And, almost all gifts designed to use your exemption amount should be made in trust. There are several benefits trusts can provide, including tax benefits, providing creditor protection and assisting with family governance. Trusts also can be drafted to provide flexibility in the use of trust funds, whether preserving access for your spouse or detailing when funds may be available for your children or grandchildren.   

If your estate does not far exceed the exemption amount, gifting may still make sense in some cases. But there’s a definite need to crunch the numbers. With any gift, there are many factors that should play into your decisions, such as ensuring gifts don’t stress your personal finances and having a thoughtful plan so family members receiving the gifts are prepared to handle them responsibly. 

3. Should I sell securities or other significant assets to realize capital gains this year?

Biden’s campaign proposals would significantly increase the capital gain tax for taxpayers with income over $1 million. While details are not clear, the proposal could increase the 20% federal tax rate on long-term capital gains to nearly double at 39.6%. Given that a sale of a major asset could push your income over the $1 million threshold, accelerating sales into 2020 could be beneficial. However, with control of Congress still in the air and tax laws uncertain, it’s a difficult decision to make.

By deferring sales to 2021, your tax bill could be postponed until April 2022.  But if Biden’s proposals become law effective to the date of sale, that tax bill could be doubled.   

Of course, you never want to make investment decisions for tax reasons alone. The underlying economics for any major asset transaction should always be the guiding force. Your main guide should always be the underlying investment decision, especially for regular events like rebalancing your portfolio.    

4. Should I accelerate income into the current tax year?

Under normal circumstances, conventional wisdom is to defer income into later years to postpone payment of the tax. However, the possibility of higher taxes in 2021 has led certain taxpayers to consider going against conventional wisdom by accelerating ordinary income events they can control (like bonuses or exercising of stock options) into this year before there’s a potential for higher taxes.  

Based on Biden’s campaign pledge not to increase taxes on those making less than $400,000, accelerating income is something to consider if your 2021 income exceeds that threshold. Of course, if Congress remains split, the likelihood of new tax laws being passed will be low. Even so, it may be worth taking the chance for this year since the interest income you would earn by keeping that money in the bank until tax is due next year may be negligible in today’s environment. 

5. Should I defer deductions?

The question depends on what deductions you have available. If paying an expense or making a charitable contribution isn’t going to yield a benefit in 2020, waiting until 2021 may make sense to give you a chance for those deductions to save you tax. 

While not part of the official Biden campaign release, Democrats have urged the repeal of the $10,000 cap on itemized deductions for state and local income and property taxes (SALT). If you’re sitting on a property tax bill that can be paid next year and wondering if you might hold off your payment, that could be a good idea. If you’re over the $10,000 limit for 2020, it’s better to have some shot at a deduction in 2021 than none in 2020. 

With charitable contributions, you always want to make sure they are aligned with the years when they will have the biggest impact. You may want to defer deductions to 2021 if you will have higher taxes next year or believe the rules will change.

With larger charitable gifts, it’s best to run the numbers to look at the factors on both the income and deduction sides for both years. In 2020, the CARES Act allows a deduction of up to 100% of your adjusted gross income for cash contributions to a public charity or private operating foundation (rather than the normal limit of 60%). This may lead you to make more donations in 2020 if you’re in the right circumstances.

Taking the Next Step

If you believe you will be impacted by new tax rules, take the time to consider potential precautionary steps before the end of the year.

There are a variety of factors to consider with any decision. The legislative process takes time and is always subject to uncertainty until new laws are signed. We can help you bring clarity to your personal situation and ensure you make the decisions that make sense.

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Craig Richards, CPA/PFS, CFP

Bryan Kirk