We live in an age that confounds planning. No matter how organized you are, travel, family gatherings, and yes, even tax planning can be easily derailed. President Joe Biden’s budget bill—however it looks in its final iteration—will certainly contain a host of changes for next year, and possibly one big one for this year. And that uncertainty is making year-end tax planning exceptionally challenging.
But there are a number of moves that taxpayers should consider now to cut their 2021 tax bills, several of which are scheduled to expire at the end of this year. Barron’s canvassed financial advisors and tax experts to determine the best moves for these very uncertain times.
Minimize capital gains. Opportunities to harvest losses in your stock portfolio to offset capital gains may be slim, given the broad stock market rally in recent years, but don’t overlook losses in other asset classes.
Cryptocurrencies, which have been extremely volatile this year, may offer tax-loss harvesting opportunities, says Tara Thompson Popernik, director of research for the wealth strategies group at Bernstein Private Wealth Management. You can mix-and-match losses and gains between asset classes, she says. Bitcoin or Ethereum losses, for instance, can be used to offset stock gains.
Be sure to match time frames. Realized losses from long-term investments—meaning those held for more than a year—can be used to cancel out realized long-term gains. Short-term losses can offset short-term gains. Up to $3,000 in excess losses can be deducted against ordinary income, and any remaining excess losses can be used as offsets in future years.
For stocks and bonds, the so-called wash-sale rule prohibits buying the same or similar asset back for at least 30 days after a sale. But the rule does not apply to cryptocurrencies—at least for now. Changes to the wash-sale rule to include cryptocurrencies starting in 2022 are among the numerous proposals in the budget bill still being considered.
Head to the opportunity zone. Beyond using losses to offset gains, consider deferring capital gains by investing in opportunity zone investments before a special incentive expires at year end.
Under the Tax Cuts and Jobs Act, beginning in 2018 investors have been able to defer, reduce, or wipe out capital-gains taxes by investing realized capital gains in any of about 8,700 opportunity zones in the U.S. These are typically low-income areas in need of economic stimulus.
The program allows for the cost basis on reinvested capital gains to be stepped up by 10% when the investment is held for five years. After 10 years, all capital gains in the investment become exempt from taxes.
“The opportunity to get the 10% step-up after five years expires this year,” says Michael Prinzo, managing principal of tax at CliftonLarsonAllen. Starting next year, investors can still reinvest realized gains in opportunity zones to defer taxes, and if held for 10 years, their tax obligation is wiped out.
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Another way to manage large gains is to donate some of your highly appreciated assets to fulfill your charitable goals. By donating stock directly to a charity, you will get a deduction for the market value of the shares, without owing any tax on the unrealized gains. The charity can sell the stock without triggering any tax.
Weigh benefits of year-end versus early-2022 tax moves. When tax rates are expected to remain level or decline the following year, taxpayers can benefit by deferring income or tax-triggering events, such as rebalancing a portfolio with big embedded gains, until the new year.
Advisors are recommending this approach for most taxpayers, given that an increase in income and capital-gains tax rates seems unlikely next year. Biden’s plan to raise top rates on gains and income hasn’t gotten enough support to survive the budget bill negotiations so far.
However, wealthier taxpayers and owners of trusts should weigh the benefits of doing the opposite: accelerating income—both earned and from investments—into 2021. Their overall tax burden may be higher next year if lawmakers push through a proposed surcharge, Popernik says.
Support has coalesced around a levy of 5% on adjusted gross individual incomes of more than $10 million and 8% on income of more than $25 million. Adjusted gross income includes wages, capital gains, dividends, and other income, so the surcharges would raise effective income and capital-gains rates.
Trusts would get hit at a much lower level: The 5% surcharge would kick in when trust income exceeds $200,000; the 8% rate would kick in when income is more than $500,000.
Popernik says she is waiting as long as possible to see if the surcharge passes this year before deciding when it’s best to rebalance client portfolios, a process that typically produces significant gains.
Use the estate-tax exemption. In this case, don’t wait to see how the political push-and-pull resolves, says Justin Miller, national head of wealth planning at Evercore Wealth Management.
If you have been preparing to gift up to this year’s $11.7 million-per-person exemption on expectations that it will be dialed back next year, follow through, he says. “If it was a good plan to begin with, don’t rip it up. The exemption is set to expire after 2025 anyway,” as scheduled by the Tax Cuts and Jobs Act.
In addition, consider taking advantage of annual tax-free gifts, Popernik says. Taxpayers can give $15,000 per person with no gift-tax consequence. For married couples who want to help an adult child and spouse, they can give a combined $30,000 to each spouse. “You can give $60,000 in December and another $60,000 in January without gift taxes—you’re not only gifting the money, you’re also gifting future growth on the money,” Popernik says.
Maximize charitable gifts. Two temporary perks for cash gifts to charities expire this year. The first allows 100% of cash gifts to be deductible. Normally, deductions are capped at 60% of adjusted gross income.
This benefit is available to folks who itemize deductions, which has become more difficult since 2018, when the standard deduction was doubled (this year it is $12,550 for singles and $25,100 for couples), and a $10,000 limit was set on state and local tax, or SALT, deductions.
Condensing several years’ worth of charitable donations into a single year can help taxpayers achieve a deduction that exceeds the standard deduction, enabling them to itemize, Popernik says. But she cautions that with the $10,000 SALT cap potentially rising—another change debated by lawmakers—taxpayers must carefully evaluate their year-end gifting strategies.
The second expiring benefit, passed under the Coronavirus Aid, Relief, and Economic Security Act, is the opportunity to deduct cash gifts to charities of up to $300 for singles and $600 for couples against taxable income, even if you claim the standard deduction.
Revisit IRA strategies. Consider a Roth IRA conversion before year end. It could be cheaper than waiting, says Gretchen Hollstein, a senior advisor at Litman Gregory Wealth Management.
Assets converted from a regular IRA to a Roth are taxed at income tax rates. If you’re in the crosshairs of the proposed surcharge for high-income taxpayers beginning in 2022, “you may pay less taxes on a conversion this year,” says Hollstein.
Roth conversions are also a topic this year for clients interested in estate planning, says Hollstein. The 2019 Secure Act eliminated the opportunity for heirs to spread IRA withdrawals over their lifetimes, setting a 10-year draw-down schedule. “This makes inheriting a Roth IRA much more attractive,” she says. “Although heirs have to take the money out in 10 years, it won’t be taxable.”
Withdrawals from regular IRAs are taxed at income tax rates. From a Roth IRA, they are tax free.
As for investments, if you have upward of $5 million or so in IRA accounts, carefully weigh whether to add new investments—or if you do, favor liquid investments such as stocks and bonds, Miller says.
That’s because many lawmakers support limiting aggregated assets in an IRA to less than $10 million by requiring distributions starting in 2029. Miller says that at an annual growth rate of 7%, “someone with $5 million in an IRA today could easily fall into that trap in 10 years.”