Year-end tax planning: 5 actions to take in times of uncertainty
Proposed legislation may enact significant changes to tax law. Here’s what you can do even while Congress debates.
Congress complicated most wealthy U.S. taxpayers’ year-end planning when it began considering a bill that proposes to meaningfully alter the tax landscape. The proposed measure could be passed before December 31 and go into effect January 1, and may have some key, retroactive features.
The potential new law—called the Build Back Better Act (BBBA)—includes increases to the top tax rates on ordinary income, capital gains and corporate income. Additional provisions would reduce the efficacy of some gift and estate tax planning strategies.
All of the BBBA’s proposals, if adopted, would significantly affect most top earners’ tax planning in the years ahead.
No one expects the bill, introduced on September 13, to pass unchanged—if it passes at all. Even many of its advocates acknowledge many provisions will be removed; others, modified. Moreover, other measures, not yet included, may be added later. That’s what happened in 2017, the last time significant tax-related legislation was enacted.
So how should you approach your traditional year-end planning, given all this uncertainty?
1. For starters: What’s your “base case”? You can find out now.
Your first step is to get a “pro forma” tax return from your tax advisor so that you can understand your current tax situation. From there, you can see what would happen if you were to realize more income or incur any additional deductions this year.
Good information to have every year, the pro forma is even more important this year.
How important? A few numbers can give you a sense. If the BBBA were enacted as is:
- The top long-term capital gains (LTCG) tax rate would go from 20% to 25%—effective September 14, 2021
- The top ordinary rate (37% for a married couple earning more than $628,300 in 2021) would increase to 39.6% for a married couple with income in excess of $450,000 in 2022
- A 3% surtax would be imposed on income of taxpayers in excess of “modified” adjusted gross income (AGI) of $5 million beginning in 2022
With your tax snapshot in hand, you can better assess whether it makes sense to implement any of these tax planning strategies before year-end.
2. Can you reduce your 2021 tax liability?
Tax-loss harvesting is a classic strategy that may reduce your tax liability.1
To do it, you sell an investment at a loss. Then you use this loss to offset either already-realized gains, or embedded gains that you realize now or in the future.2
If you still like the asset, you can buy it back—so long as you are careful not to violate the “wash sale rule.” This rule prevents you from taking a loss if you buy a security “substantially identical” within 30 days before or after the trade.3
If you do not want to be out of the position for an entire month, you might “double up” on your position, then wait 30 days before selling the original loss position. November 30 is the last day to do so and still be able to recognize the loss in this tax year.4
The BBBA proposes to expand the definition of assets subject to the wash sale rule to include foreign exchange, commodities such as gold and digital assets such as cryptocurrency starting January 1, 2022.
What might that mean for you? If you hold gold or cryptocurrencies at a loss and like those positions, you may want to—before this year ends—sell and quickly repurchase them, so you can take the loss now and keep the positions without being subject to the wash sale rule.
For any positions you hold at a gain: The BBBA would increase the top LTCG rate from 20% to 25% effective September 14, 2021, so there’s little you can do about that now. However, if your income is projected to be greater than $5 million a year, you might want to take gains this year to avoid the 3% surtax BBBA proposes to impose on income starting in 2022 if you had planned to sell the asset in the near term.
It is always advisable to try to time your charitable donations to ensure their associated deductions are effective in the intended tax year. Depending on what you plan to gift, it could take time to complete the transfer. Consult your financial institutions to understand estimated timelines to ensure your donations will be considered to have been made by December 31.
If you’re unsure which charity you want to support but would like the deduction for this year, you might consider giving to a donor-advised fund (DAF). Tax deductions for gifts to DAFs are immediate, but the payout from the DAF to another charity does not have to be.
You may, however, decide to defer making donations until 2022. That’s because the value of the deductions created by those donations would generally be more valuable if your effective tax rate in 2022 would be higher than it was in 2021.
3. Are you making the most of your compensation and benefits?
If you can contribute to a retirement account, we recommend doing so—up to the full amount permissible. The maximum amounts you can contribute to retirement accounts in 2021 before year-end are:
- IRAs—$6,000 a year. If you are 50 or older, it’s $7,000
- 401(k)s/403(b)s—$19,500 a year. If you’re 50 or older, it’s $26,000
If you think your future income tax rates may be higher, consider converting your traditional IRAs to Roth IRAs before year-end.
Overlaid against all of these considerations is this: If you have a large balance in retirement accounts—as in more than $10 million—the BBBA would require that you distribute (and therefore pay tax on the distribution at ordinary rates) 50% of that excess. Additional distributions would be required from Roth IRAs, even resulting in possible exhaustion in certain instances if the total balance of retirement assets is north of $20 million.5
Be sure to take your RMDs this year to avoid steep penalties. If you’re charitably inclined, remember that you can make a qualified charitable distribution (QCD) from your IRA directly to a public charity (not a DAF), and the amount given will go toward satisfying your RMDs.6
If your employer allows you to defer your compensation, you must elect to defer your 2022 salary and bonuses by December 31, 2021, if not earlier as specified by the employer.
With a deferral, there is no income tax liability on either the compensation or its growth until you receive it. Then, the payment will be taxed at the ordinary rates in effect when you receive the funds.
Once again, these types of decisions need to be taken in consideration of what you expect current and future income tax rates to which you would be subject will be, including the impact of BBBA.
If you are an executive, you may want to exercise some of your options in 2021.
The important question is: Which ones?
Good candidates include those options that are deep-in-the-money, on high-dividend-paying stocks or that have a short time to expiry.
If under the BBBA the intrinsic value would be subjected to a higher tax rate than it would be if exercised in 2021, options that have more time until expiration or are not as deep-in-the-money could also be contenders for exercise.
4. Are you giving tax-wisely to your family?
Do you have a taxable estate, the capacity and desire to gift, and lifetime gift and estate tax exclusion remaining?
Then you may want to use it now while the exclusion amount is at an all-time high. An individual can now transfer, tax-free, $11.7 million (married couples can transfer twice that).
This exclusion amount is set to decrease to $5 million (inflation-adjusted) after 2025.
The BBBA proposes to accelerate that effective date to after 2021.
The BBBA also seeks to essentially nullify the tax benefits of irrevocable grantor trusts starting on the date of the enactment of the BBBA. So you should consider using your lifetime exclusion by making a gift to an irrevocable grantor trust not before year-end exactly, but before date of enactment (a moving date—and one, to be sure, that may not come).
Your J.P. Morgan team can help quantify your gifting capacity so that you can confidently proceed with transferring assets without fear of jeopardizing your own financial security in the future.
Every year, most U.S. taxpayers also have the opportunity to give, without any gift taxes due, an “annual gift tax exclusion” amount to as many individuals and for whatever use. This year, it’s $15,000; for married couples, it’s $30,000.
Parents and grandparents often use their annual gift tax exclusions to fund 529 accounts, where the funds can grow free of federal taxes. As long as the money is used for the account beneficiary’s qualified education expenses, no federal tax will be due on distributions.
5. Are you getting the help you need?
These are just a few examples of the many opportunities you may have right now to strengthen your financial health before year-end. Speak with your tax advisor about which actions may be right for you.
Also consult with your J.P. Morgan team, which can work closely with your tax advisors and help you evaluate how any potential action might align with your financial goals.
The sooner you have these discussions, the more benefit you may be able to reap from your year-end planning.
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