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‘Taxmageddon’ deferral strategies that you might want to punt on

Financial Planning Dentist

‘Taxmageddon’ deferral strategies that you might want to punt on

 

Installment payments from asset sales 

Installment sales are designed to postpone the recognition of taxable gains until installment payments are received. Postponed gains will probably be taxed at the rates for the years they are recognized. So, if rates go up, installment sellers will likely see their strategy unwound with climbing tax rates. 

Maxing out on deductible IRA and retirement plan contributions

Traditionally, savers use 401ks and IRA to defer taxes into the decades to come. So the tax savings we calculate for clients call them to use this vehicle to pay a lower rate in the future, if the rate in the future goes up, the value of this deferral to the saver is diminished. The taxable portion of IRAs and retirement plan distributions received in future years will be taxed at the rates in effect for those years.

Prepaying deductible expenses

Tax savings from current-year deductions from prepaying expenses are calculated using today’s rates. If you don’t prepay and tax rates go up, you come out ahead by claiming deductions in a later higher-rate year. This might also be a first, calling for deductions to be used in the years to come, to offset tax rates at a higher clip. 

Additional Resources for 'Taxmageddon'

Tax Mitigation Playbook

Opportunity Zone
Overview

Taxmageddon

Tax-smart moves that don’t involve tax deferral

Tax-smart moves that don’t involve tax deferral There are several methods that tax planners can use that are not part of the tax deferral strategy category and that might find new and improved legs as this change happens.   Contribute to your Roth IRA Qualified withdrawals from Roth IRAs are federal-income-tax-free, so Roth accounts offer the opportunity for outright tax avoidance. This strategy looks even more impressive as you can pay income tax at today’s lower tax regime, and mitigate any future taxes that will preserve the gains. Additionally, because the account avoids all capital gains tax this vehicle becomes the most promising to see capital gains on, but avoid the tax consequences of selling those assets. Making annual contributions to a Roth IRA is an attractive option for those who expect to pay higher tax rates during retirement.  Convert to a Roth IRA Converting a traditional IRA into a Roth account effectively allows you to prepay the federal income tax bill on your current IRA account. This account also allows you to see the assets grow tax-free. This method is capable of avoiding ramifications from capital gains and provides the necessary insurance from the rising tax rates. This is the only method that straddles both of the coming complications. Determining the amount to convert (all or partial) should be worked into your financial plan.  Contribute to Roth 401(k) The Roth 401(k) is a traditional 401(k) plan with a Roth account feature added. If your employer offers a 401(k) plan with the Roth option, you can contribute after-tax dollars. If your employer doesn’t currently offer the option, run, don’t walk, to campaign for one immediately. There is likely little cost to add such a program and this might be an oversight on the needs employees should convey to the plan sponsor.  The DRA (Designated Roth Account) is a separate account from which you can eventually take federal-income-tax-free qualified withdrawals. So, making DRA contributions is another attractive alternative for those who expect to pay higher tax rates during retirement. Note that, unlike annual Roth IRA contributions, your right to make annual ‘Designated Roth Account (DRA) contributions is not phased out at higher income levels. Key point: If your employer offers the Roth 401(k) option, it’s too late to take advantage of the 2019 tax year, but 2020 is fair game. For 2020, the maximum allowable DRA contribution is $19,500. Contribute to Health Savings Account (HSA) Because withdrawals from HSAs are federal-income-tax-free when used to cover qualified medical expenses, HSAs offer the opportunity for outright tax avoidance, as opposed to tax deferral. You must have qualifying high-deductible health insurance coverage and no other general health coverage to be eligible for HSA contributions. You can claim deductions for HSA contributions even if you don’t itemize. More good news: the HSA contribution privilege is not lost just because you happen to be a high earner. Even billionaires can make deductible contributions if they have qualifying high-deductible health coverage. Additional Resources for ‘Taxmageddon’ Tax Mitigation Playbook Download Opportunity ZoneOverview

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Year-End Tax Planning Under the Biden Administration

A lack of political clarity means not knowing whether Democrats can push their legislative agenda faster. If Democrats gain control of the US Senate, Republicans won’t have the control to force legislation gridlock. Therefore, without this crucial information year end planning just got much more difficult as the decision to who has control of the Senate is likely not coming until January 5th, 2021. Currently, Republicans are likely to keep control of the Senate; however, if Democrats seize the two seats in Georgia, then a 50/50 split would mean VP Kamala Harris gets the deciding vote which means Democrats control the Senate.  The question is to act now before years end and push a lot of income to 2020 or hold off and risk having to pay almost twice as much in taxes if the tax code legislation gets passed. Under the Biden administration, the current proposal has ordinary income tax rates for those making $400,000 a year or more increasing substantially and long term capital gains tax rate equal to ordinary income tax rates when in excess of 1 million. For those earners earning just over $400,000 the tax hit will be a tough pill to swallow. The tax on long term capital gains would be at ordinary income tax rates to the extent gains are in excess of >$1mm of income (including non-capital gain income).   One strategy is doing a Roth Conversion (or a Back Door Roth). In short, taking money out of your IRA and converting it to your Roth so you pay taxes now for the long term play of those assets growing tax free). Unfortunately, since the Republicans passed the Tax Cuts and Jobs Act this decision is now irrevocable. Previously, you used to be able to do a conversion, wait to see if tax law changed, and if it did where it wasn’t beneficial to have done the conversion then you could recharacterize it and pretend you never did it. Now that conversion becomes irrevocable making the decision a more calculated one.  In 2020, the highest capital gains tax rate is 20%. In 2021, the Biden administration has proposed an increase to 39.6%. This increase has a huge impact on whether or not you take gains now and harvest some of your profits as you could potentially decrease your rate by almost half depending on your tax rate. Now these changes will probably not go into effect until 2022, understanding future tax implications will be key as you head into possibly the last year in the next 4 of low tax rates.  Furthermore, as if the situation isn’t already complicated, the Biden administration proposed eliminating the step-up in basis of capital assets at death. For those looking to pass highly appreciated assets to loved ones so they can capitalize on the step up in cost basis which used to be a great strategy, would now force their beneficiaries to pay all taxes on appreciated assets at death which could push them into the highest bracket. A potential increase in taxes in 2021 means accelerating income and deferring deductions when they’re more valuable in 2021. However, if you’re already itemizing deductions then you may benefit from claiming your deductions this year as the new Biden administration proposal would cap itemized deductions benefit at 28%. It may be beneficial to defer for all income earners any deduction that won’t be counted in 2020 into 2021 if there is a chance the rules change. So for example, if you had a $100 of income at the 37% rate then you’d only get a 28% deduction moving forward.  The Qualified Business Income (QBI) under the Biden Proposal could potentially vanish as well. 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Critical questions that investors should discuss

What is the investment objective, and what is the time horizon for achieving it? What is the risk tolerance of the trust or family office? What is the desired return, and what is the asset allocation required to achieve it? What are the investment restrictions, such as asset class limitations, ethical constraints, or legal restrictions? What is the process for selecting and monitoring investment managers? How often will the investment portfolio be reviewed and evaluated? What is the process for making changes to the investment strategy?

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Market InSights
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There Is Too Much Money

You read that right, there is simply too much cash in the capital markets to not see a handful of effects that could impact your investments and plan. The supply of money floating around is massive right now. There is a lot of risk, COVID has us concerned about the economics of the coming year, but it’s getting harder and harder to ignore how much cash has been made available. Even relative to itself, it’s a volume of cash in the money supply that will take at least a decade to settle into long term investments, or be recaptured by the Fed. At the beginning of the year there was roughly $15T in circulation held in cash and cash equivalents. We are in December and the number is closer to $19T of more highly liquid cash in the world. This $4T expansion in only 12 months is remarkable. Here’s some history on money supply. It took until 1997 to reach the first $4T in circulation, the decade from 2009 to 2019 saw that supply double from $8T to almost $16T (the fastest doubling ever), resulting in a major part of the expansion of the stock market for that decade. Now, in twelve months we have seen a flood of almost 27% more money in the supply than there was at the beginning of the COVID-19 pandemic.  One of the best leading indicators for where capital markets are headed, can be found in how much money, especially highly liquid money like cash, is available in the system. This is a reflection of how big the pie is. Usually in investments we are focused on cash flow, and a companies market share – or how effective a company is at capturing cash flow from a given size of market. That’s becoming less relevant as the sheer volume of cash has exploded. The pie is so big right now that there will have to be a a few notable adjustments to make: Inflation – While I have heard that Jerome Powell has not registered an increase in inflation yet, it is hard to believe that as the newly introduced money will not have an expansive effect on the costs of goods and services. Many mark the inflation rate off the CPI, grievances with that benchmark aside, it would be irresponsible to assume that the basket of securities they mark to market does not see an above average increase as more money finds its way into the same number of consumer goods. Additionally, elements like rents will see a disproportionate increase in the coming decade because while supply of say consumer goods will increase quickly to capture this cash, construction of rental properties is a less reactive market and a slower roll out to correct the market. In the meantime expect rental costs and revenues to see above average inflation figures.  Interest Rates – Permanently impaired. As I write this the current observation, the 10 year US Treasury is paying 0.9%, a third of where it was even 2 years ago. It is heard to believe that such a robust introduction of cash doesn’t become a permanent downward pressure on fixed income assets for the foreseeable future. Unless there is a formal and aggressive contraction of the money supply, it will take decades for the amount of cash in circulation to let up that downward pressure on bonds. Interest rates in short term assets will be particularly affected as the demand has become less appetizing in contrast to long term debt, and the supply of cash is chasing too small of demand.  Equities – The real benefactor here. It is hard not to believe that over the course of the coming decade, this cash infusion doesn’t trickle its way up and into the stock market and other asset values. Generally the most “risky” part of the market is the historically the benefactor of excesses in cash. Companies will do what they do best and capture this supply of cash through normal operations, this will expand their revenues and ultimately the bottom line. Additionally, the compressed borrowing costs from low interest rates will lower their operating costs. Compound the poor risk reward ratio in bonds and you will see more of those investments seek out stocks, real estate, and other capital assets. This sector will see a virtuous combination of more revenue, and more demand for shares. Expect permanently elevated P/E reads for the time being.   

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