Year-End Tax Planning Comes with a Twist in 2021

If there’s one thing that’s important to know about year-end planning, it’s to be proactive right now. With legislative changes hovering dangerously close, and with no one really knowing what the final budget bill will look like, planning early is essential. Even if nothing changes, which is unlikely, you will still have a solid plan in place and will also be prepared for what may transpire over the next few months.

This is year-end planning with a twist: Do what you would normally do, but if you believe tax laws will change, then be ready to do something different.

For example, some of the traditional, tried-and-true, routine year-end planning strategies include deferring income to next year and maximizing deductions for this year. This would decrease the overall current tax bill for calendar year 2021.  The twist here is that if income tax rates go up, whether because of tax law changes or you expect to have higher income next year, you will want to do the opposite — recognize income this year and defer deductions to next year.  This may result in you accelerating income through strategies such as taking more in required minimum distributions from retirement accounts, doing a Roth IRA conversion, or harvesting capital gains to realize more income this year. 

In terms of deferring deductions, you may want to wait until 2022 to make sizable charitable donations, because a charitable deduction at a higher tax rate next year could be “worth” more from a tax perspective than one in this year at a lower tax rate.  Other deductible expenses, such as medical and certain interest expenses, may be better if taken in 2022.

All of this would be bucking conventional wisdom.  The challenge here is that it is unclear whether rates will go up, and if so, at what level and how much.  As of the time of this writing, the previously proposed increases in ordinary income tax rates and capital gains taxes are no longer in the latest legislative proposal. Instead, there is now a proposed surcharge for individuals with income over $10 million and trusts with income over $200,000.  That said, it is prudent to keep in mind that all previously proposed increases may still be possible as negotiations continue. 

Let’s take a look at some other strategies you may want to consider.

High-net-worth and ultra-high-net-worth individuals need to give now

If your assets are significant enough to constitute a taxable estate, year-end planning has even more significance. For 2021, the amount exempt from federal gift and estate tax is $11.7 million per person, which means that you may give this amount during your lifetime, free of gift tax, with any unused amount applied against federal estate taxes at your death. Under current law this exemption amount is scheduled to sunset on Dec. 31, 2025. However, there is a very strong possibility that legislation may be enacted earlier that may abruptly, and potentially dramatically, reduce the exemption. Previous proposals have suggested the date may be as early as Jan. 1, 2022.

If you are considering making a substantial lifetime gift, now is the time. Although we don’t know for certain what the new tax laws may look like, chances are they are not going to get any better for high-net-worth taxpayers. Don’t lose the chance to take advantage of some very beneficial wealth-transfer opportunities this high exemption allows.

Take advantage of trusts

Gone are the days of your grandfather’s trust, which operated as an immovable black box. Today’s modern trusts are built with much more flexibility and can be structured to continue to meet the needs of your family with transparency, and over multiple generations.

Utilizing your exemption to make larger gifts today to a trust will give your gift more time to grow outside of your estate. In addition to the traditional benefits of a trust — such as professional management, tax mitigation and creditor protection — you can also structure your trust as a grantor trust. Grantor trusts effectively allow the trust assets to grow income-tax-free, as all income tax obligations are paid by the grantor. The grantor trust structure also benefits the grantor in that all payments for taxes further reduce the taxable estate yet are not subject to gift tax.

Although there have been numerous legislative proposals this past year that, if passed, would have severely limited the effectiveness of this strategy, the latest round of budget proposals from the House of Representatives and President’s Biden’s tax framework do not contain such restrictive terms.  Therefore, it is an important time to speak with your advisers about the possibility of establishing a grantor trust.

Planning for business owners

When it comes to what is likely your most valuable asset — your business — tax planning and gifting become a bit more complex. And, if you are contemplating selling your business, it’s critical to consult with your advisers to time the sale when it’s in your best interest to do so. For example, with higher income tax rates possible, selling business interests may help reduce tax by selling ownership in installments, versus selling as a whole.

A final word

Don’t let the twists and turns of an uncertain tax horizon threaten your carefully constructed wealth plan. Speak with your advisers about whether or not you should implement some advanced planning strategies to be sure you are utilizing this year’s opportunities while staying prepared for what the future may bring.

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This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional adviser should be sought.