Executive Summary: Year End Planning: 10 Steps to Consider
High net worth individuals are strongly encouraged to coordinate with their accountant and estate planning attorney to review whether potential planning opportunities should be pursued prior to December 31, 2020. Below, we outline planning considerations most closely tied to potential tax reform under the new Biden Administration.
- Using the Lifetime Gift Tax Exemption
High net worth individuals should evaluate current assets and assess how much might be needed for their remaining lifetime, with consideration to gift ‘excess assets’ to loved ones, which would reduce the size of an otherwise taxable estate. Individuals who are likely to one day have a taxable estate should also consider direct payments (to the educational/medical provider) for tuition and medical expenses, which do not constitute gifts, as well as annual exclusion gifts ($15,000 for 2020 and 2021). Remember that 529 accounts allow for five years of annual exclusion gifts to be pulled forward to the current year for a one-time contribution of $75,000 per recipient.
- Accelerating Long-Term Capital Gains
President-elect Joe Biden has proposed increasing the tax on long-term capital gains (as well as qualified dividends) to the top ordinary income rate for individuals with taxable income over $1 million. With a proposal to raise the top ordinary income tax rate from 37 percent to 39.6 percent, this proposed change to the taxation of long-term capital gains, if passed, could be substantial.
- Accelerating Charitable Donations
Charitably inclined individuals should evaluate whether to accelerate charitable gifts prior to year-end as the Biden administration has proposed limiting the benefit of itemized deductions to 28 percent for individuals with more than $400,000 of taxable income. This consideration may also be particularly beneficial for taxpayers who experienced higher-than-normal income in 2020, as increased charitable giving shields a portion of income from otherwise being taxed at a higher rate.
Of special note, while the Tax Cuts and Jobs Act increased the deduction for cash contributions to public charities to 60 percent of adjusted gross income (previously 50 percent AGI limit), the Coronavirus Aid, Relief, and Economic Security (CARES) Act increased the deduction for contributions to public charities (other than donor-advised funds) to 100 percent of AGI for the 2020 tax year. As a result of this CARES Act-provision, high income taxpayers may have a unique 2020 charitable planning opportunity.
- Consider a Roth Conversion
With income tax rates at historically favorable levels, individuals who believe their future tax rate might be higher than their current tax rate might consider converting a portion, or all, of existing Traditional IRA assets to a Roth IRA. In exchange, the Roth IRA grows tax-free with qualified distributions also treated as tax-free. This strategy can be beneficial for individuals with a taxable estate, as the tax cost for the conversion effectively reduces the size of the estate, while the named beneficiaries one day receive a very tax-favorable asset.
Individuals with notable assets, but with lower-than-normal income in 2020, might also consider this strategy, as it allows the taxpayer to essentially pay a reduced rate on the conversion while taxable income is low.
- Review Estate Plans & Retirement Account Beneficiaries
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted on January 1, 2020, effectively eliminated what was known as “the stretch IRA,” for which a beneficiary could stretch required minimum distributions (RMDs) for an inherited IRA over their lifetime. Estate plans which previously incorporated this “stretch” strategy are now outdated and in need of updating.
Periodically reviewing and updating estate plans is a recommended best practice in light of potentially changing estate planning rules and limits. Individuals who have recently experienced a significant life event (marriage, divorce, birth/adoption) may also need to make updates to existing estate plans.
- Harvest Losses
Review unrealized gains and losses in taxable investment accounts and harvest losses where available. Realized losses can offset other realized gains; to the extent that realized losses exceed realized gains, net realized losses can offset up to $3,000 of ordinary income with any remainder resulting in a loss carryforward to be used in future years.
- Analyze Mutual Fund Year-End Capital Gain Distributions
Mutual funds are required to pass along capital gains to fund shareholders. It is important to review unrealized gains and losses across mutual fund holdings in taxable accounts and to compare those figures against capital gain distribution estimates to determine if selling a mutual fund position before the year-end distribution would produce a tax savings.
- Satisfy Required Minimum Distributions (RMDs) using the IRA Charitable Rollover
The SECURE Act raised the beginning age for required minimum distributions (RMDs) to 72, from age 70½, previously. However, the Coronavirus Aid, Relief, and Economic Security (CARES) Act waived Required Minimum Distributions (RMDs) for the 2020 tax year.
The SECURE Act did not adjust the age 70½ requirement for taxpayer eligibility to make a Qualified Charitable Distribution (QCD) up to $100,000 each year from an IRA to qualified 501(c)(3) charitable organizations (donor advised funds, private foundations and supporting organizations are excluded). A qualified charitable distribution neither counts as an itemized deduction nor as taxable income, though it does count towards satisfying the RMD for that year. This strategy may be beneficial for charitably inclined individuals who receive a greater tax benefit from the increased standard deduction rather than itemized deductions.
Note: While taxpayers can still make a QCD in 2020, with 2020 RMDs being waived under the CARES Act, it may instead be beneficial to delay any QCDs until 2021.
- Evaluate When to Collect Social Security Retirement Benefits
Individuals nearing eligibility for Social Security retirement benefits should give proper consideration for when to start benefits.
- Consider a Change in State Residency?
Changing your primary state of residency is not as simple as spending more than half the year in a new state. With many states more aggressively contesting such residency changes, individuals should take extra precaution to ensure that “facts and circumstances” support the case for changing resident states.