With 2021 underway, many investors and financial advisors are focused on potential tax reform in the year or years to come. The new administration, a slight Democratic edge in Congress, the continued impacts of COVID-19 and other factors could drive changes in the tax code for the 2021 or 2022 tax year. Yet at this point, any predictions about the potential for tax increases in 2021 are largely speculative. The unknowns still significantly outnumber the knowns when it comes to possible tax reform.
Despite these unknowns, 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 investmentstrategies 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. In other cases, less prominent proposals, such as a change to the 2020 estate tax exemption, may warrant a greater planning focus for some individuals.
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 receiving a fair amount of attention is President Biden’s proposal to increase the capital gains tax rate for high-earning taxpayers.
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.
Another proposed tax law change would increase the top tax bracket, which currently stands at 37 percent. One way to avoid paying the potential 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 talking with an advisor about 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, being strategic about which retirement accounts to withdraw from, when to implement charitable giving strategies, and more. Other strategies 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, the Wescott Tax Alpha Group recently published its 2021 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 earned the number one spot in 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.
