After much speculation in recent years, the start of 2022 has seen minimal changes to tax law. Still, many investors and financial advisors are understandably focused on potential tax reform in years to come. As the pandemic continues to impact daily life, many are coming to terms with the reality that COVID-19 and its effects will always exist. Other factors, including rising inflation and the Fed’s imminent interest rate increases, could also result in future changes to the tax code.
While the unknowns still significantly outnumber the knowns when it comes to possible tax reform, it is always best to be prepared. Financial advisors at Wescott are constantly monitoring potential and proposed changes and incorporating them into efficient tax planning strategies for clients.
For investors, understanding how your retirement tax planning and tax-smart investment strategies are positioned for potential reforms offers peace of mind and a more secure path forward. Start with a proactive conversation with your advisor about your tax planning strategies by asking these five questions.
It’s essential to look at any potential tax reform in the context of your overall financial situation and long-term goals. Updates to tax law can have far-reaching impacts on an individual’s portfolio. Preparing for those changes requires a good deal of planning and flexibility to adapt any strategy to the specifics of the reform.
No change should be taken in haste – every action should be evaluated as part of a comprehensive approach that considers all aspects of your portfolio and your mindset. For instance, if you anticipate your income will increase significantly in the coming years, that may impact how you plan for potential tax rate increases. Meanwhile, for some individuals, changes to estate and gift tax laws could warrant a greater planning focus. Proposed changes to those laws last year were dropped but could resurface in upcoming legislation.
In building a sound tax strategy, it pays to combine personal planning considerations with the potential for political change.
With a broad planning context in mind, there are a few tactical tools to talk through with an advisor. One potential tax reform element that received a fair amount of attention in 2021 was President Biden’s proposal to increase the capital gains tax rate for high-earning taxpayers. While the infrastructure and tax reform bill has stalled in congress, President Biden and lawmakers are still discussing increasing the capital gains tax rate to 25% in 2022.
If capital gains were to be taxed at the ordinary income tax rate or other higher rate in the future, it may be beneficial for some investors to consider accelerating their gains and pay the preferred 20 percent rate for long-term capital gains and qualified dividends.
The top tax bracket currently remains at 37 percent this year, the same as in 2021, despite a proposed increase from the current administration. A similar proposal is expected to come up for debate later this year. One way to avoid paying a potentially higher rate in the future would be to accelerate declared income to benefit from the current rate.
Several tactics and retirement tax planning strategies, such as accelerating retirement distributions, can increase the amount of declared income in a given year. It’s worth discussing with an advisor the benefits and downsides of increasing income this year in context of your larger financial goals.
Like accelerating capital gains and taxable income, delaying deductions until a year when you expect rates to be higher can reduce your overall tax burden. By delaying deductions, you may be able to maximize their impact in a year when you are taxed at a higher rate.
It’s important to note that with all strategies involving accelerating or delaying tax liability, the planning considerations can be quite complex. These tactics can have far-reaching consequences on long-term planning. Having regular conversations with your advisor can ensure your plan reflects your current goals and anticipates potential reforms
There are a number of investing and financial planning strategies financial advisors can utilize to minimize an individual’s tax burden. Some of these include capital loss harvesting, strategic withdrawals from retirement accounts, when to implement charitable giving strategies, and more. Other tactics to consider are, if the capital gains tax rate were to disappear, long-term savings strategies such as net unrealized appreciation and section 83(b) elections may not have the same advantages in the future. Deciding if – and when – to harness those tools depends on the specific policy changes and the specific investor goals
To help investors understand which tax planning tools are at their disposal, Wescott’s Tax Alpha Group recently published its 2022 Tax Strategy Guide. The guide offers a deeper dive into the complex tax issues and strategies clients face on their financial planning journey.
The Wescott advisory team is committed to helping individuals and families navigate potential tax reform changes and execute a strategic plan that allows them to accomplish their long-term financial objectives and broader life goals.
Our role as fiduciary investment advisors delivers deeper expertise and value for clients. It’s why we are one of Barron’s top advisors in Pennsylvania and have an industry-wide reputation as one of the top Philadelphia financial advisors.
Download our free tax strategy guide for tips.