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Jon T. Meyer, CFP®| Chief Operating Officer and Investment Manager | BGM Wealth Partners
While we do not have complete clarity on tax policy under a new president, we can assume that the pressure to raise taxes would have been much greater had the November election been a sweep. Although we need to wait until January to see how the Georgia Senate race turns out, it looks like we will have a Republican Senate and Democratic House.
A divided government means tax policy as proposed by President-elect Biden will have less chance of being enacted. We’re not saying tax law won’t change, but the changes probably will be slightly less dramatic.
This means that we face fewer decisions today than if we felt that tax rates would jump upward next year. If the election had resulted in a less divided government, it might have made sense to take more capital gains this year (anticipating higher tax rates) or even gift assets to children (assuming gift and estate limits would drop).
Yet there are decisions to make, so grab your 2019 tax return (if you work with us, we’ve already been reviewing it for you!) because you only have until December 31 to make your 2020 moves.
Even if tax brackets don’t change next year, the Tax Cuts and Jobs Act of 2017 expires in 2025. Thus, over the next five years, there is an opportunity to accelerate income into lower tax brackets.
For example, in 2020, the 12% tax bracket for married individuals filing joint returns ends after the first $80,250 of income ($40,125 for unmarried individuals). The 22% bracket then picks up from $80,251 ($40,126 for unmarried individuals) through $171,050 ($85,525 for unmarried individuals).
Thus, if taxable income is below one of these thresholds and you anticipate moving into a higher tax bracket down the road, it might make sense to accelerate income and fill up a bracket. (This can work in higher brackets as well if you anticipate being pushed into even higher brackets in future years.)
For many, executing a Roth conversion is the simplest way to accelerate income.
Planning opportunity: Meet with your accountant and/or financial advisor to discuss whether filling up lower tax brackets makes sense for your situation.
Charitable giving has evolved as well. Under current tax law, if you don’t have itemized deductions totaling over $24,800 married filing jointly (add $1,300 per person as each individual turns 65), then you get the standard deduction of $24,800 ($12,400 if you are filing single; add $1,300 if you are over 65).
Since other deductions have been reduced (like the cap on state and local income taxes) or eliminated (like miscellaneous itemized deductions), it is now harder to hit these numbers. Thus, timing charitable giving to influence your tax return is more important.
For example, a married couple with $15,000 of real estate and state income taxes is now capped at deducting only $10,000 of that. Assume they have no medical expenses to deduct and their deductible interest on their mortgage is $8,000. In this scenario, if they gave $3,000 to charity, the donation would have no effect on their tax return because they fall below the $24,000 standard deduction ($10,000 + $8,000 + $3,000 = $21,000).
The better answer for this couple would be to bunch their charitable giving into one year, giving multiple years’ worth of donations at once, and then skipping for a few years until they want to do this again.
One way to use this strategy is to through a donor-advised fund (DAF). With a DAF, you can give larger chunks away today and get the tax deduction, but you hand the money out on the back end as fast or slow as you want.
In our example above, it could make sense to give away three to five years of donations ($9,000-$15,000) to the DAF since that would elevate their deductions above the standard deduction. Of course, this strategy makes sense only if you have charitable intent.
A second way to give to charity is by using your IRA to make a qualified charitable distribution (QCD). The SECURE Act, passed in the last few weeks of 2019, changed how you must start taking required minimum distributions (RMDs) from your IRAs. Instead of starting at 70 ½, you can now wait to start them at age 72. But what the law did not change is your ability to give money directly from your IRA to a charity starting at age 70 ½.
You can give away up to $100,000 in the year you turn 70 ½, and again at age 71, without the IRS considering it a taxable distribution. Then, when you turn 72 and have to start your RMDs, you can give up to $100,000 to charity and count it toward your RMD for that year—again, because you gave it to charity, you do not have taxable income on your tax return for this amount.
Note that the gift must be given directly to charitable organizations and cannot be given to DAFs or private foundations. Also keep in mind that you don’t get a charitable deduction since you were never taxed on this income in the first place. The benefit is never being taxed on the income, which will help your overall tax return. This strategy is not reliant on whether you hit the standard deduction.
Planning opportunity: Meet with your accountant and financial advisor to look at how charitable giving can impact your return. Consider whether combining the charitable strategy with the tax-bracket strategy (i.e., Roth conversion) helps you accomplish several objectives at once.
A second planning opportunity is in assessing whether you might give to charity via the DAF method versus the QCD method. Since RMDs increase your taxable income, they can push you into a higher bracket for Medicare premiums. It could make sense to use the QCD method to reduce income and, in turn, qualify for lower Medicare premiums.
Look at your portfolio to determine if you had any losses that you can use to offset gains (like if you took any in March with rebalancing). In addition, review your mutual fund distributions to see if they will be considered short term (taxed more heavily) or long term (taxed less heavily). Then consider if it makes more sense to sell the mutual fund and pay taxes on your gains than paying taxes on the distributions (if you work with us, we are doing this now).
While you are reviewing your mutual funds, look them up on www.morningstar.com. Funds with higher turnover should go in tax-deferred accounts such as IRAs since these funds tend to make more taxable distributions each year. And if you are investing in fixed income (e.g., bonds or CDs), consider whether it makes more sense to use municipal bonds for more tax-free income.
Planning Opportunity: Investigate the structure of your portfolio to see how it is affecting your tax return each year.
We have written a lot about why we like HSAs as savings vehicles for health spending later in life. But one thing that gets missed often is how to maximize the savings.
In 2020, you can contribute $3,550 for an individual, or $7,100 for a family. If you are over age 55, you can contribute an extra $1,000 per year, per person. Note that you can contribute the full $1,000 in the calendar year you turn 55 (this is not prorated by number of months you were 55 that year).
The issue here is the words “per person.” While you might have a family HSA account in the name of the spouse whose work is sponsoring the plan, the other spouse (working in or out of the home) cannot contribute the extra $1,000 catch-up contribution if they are over age 55. They must set up a separate account under their name to do that.
Planning opportunity: Call your HSA provider to make sure the appropriate accounts are open to contribute the maximum allowable if you/your spouse are over age 55. Also note that you do not have to open an account for your spouse with your HSA provider. You can open that account anywhere that allows HSAs.
In the age of COVID-19, it is always good to make sure you have an up-to-date estate plan (including a health care directive) since things can change on a dime. And while we might not expect a new administration to change tax policy as much, you have a unique opportunity to consider for gifting assets in case gifting and estate limits are reduced.
As of now, each individual can give away $11.58 million under the estate tax exemption. President-elect Biden has proposed dropping this limit to $5 million.
Another gifting point to consider is the current environment of low interest rates. This environment opens opportunities such as lending money to children for a new home or business at interest rates that are lower than what the bank might give them.
Planning opportunity: Schedule a joint call with your attorney and financial planner to discuss what options you might have, assuming you are interested in gifting assets to your children or grandchildren in 2020.
While we anticipate tax policy won’t change as much as some predicted, it still can change. Elections have consequences, so unique circumstances can always weigh into the equation of whether you should do more or fewer of the above planning strategies in 2020.
Call your accountant, attorney, and financial planner before December 1 to discuss your options. Remember that you might need time to implement some of these strategies, so get a jump on this.
If you have questions or would like to learn more, contact Jon Meyer at [email protected].
The opinion of the author is subject to change without notice and must be considered in conjunction with relevant regulation, as well as subsequent changes in the marketplace. Any information from outside resources has been deemed to be reliable but has not necessarily been verified. Each individual has unique circumstances to which this information may or may not be relevant. Under no circumstances will this information constitute an offer to buy or sell and it does not indicate strategy suitability for any particular investor.
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