With only a few weeks left in 2021, financial advisors are considering year-end tax moves for their clients while federal legislators mull tax changes.
While there are some classic moves to make, such as having clients top up investments in tax-sheltered accounts, this year is slightly different because budget negotiations in Congress may result in changes to the tax code.
But tax specialists say not to be overly concerned about those discussions. “Everything is up in the air right now … and it’s hard to predict what’s going on out there,” says Tim Steffen, director of tax planning at Baird.
He cautions advisors against making decisions for client portfolios based on current talks in Congress. “You don’t want to do anything right now that you can’t undo later,” he says. “You don’t want to commit to a particular strategy because we just don’t know what’s going to happen.”
Take these steps to put your clients in a good position, no matter what the future holds.
Gather Documents to Take a Holistic Approach
Financial advisors should have clients gather all their documents and information and use a big-picture approach to determine where clients stand in terms of income, withholdings, potential capital gains and retirement plan contributions, Steffen says.
The pandemic affected people differently in terms of income. Some clients may have been unemployed for a year and are just returning to the workforce, so this year may be a low-income year, while next year, their income will be higher. Some clients may have decided to retire this year, and their income will be lower next year. Understand where the client is with respect to income this year in relation to next year, Steffen says.
Advisors should use this time of year to take a multiyear, holistic approach to taxes, rather than thinking only of the usual moves to make, says Kevin Swanson, CEO of Potentia Wealth.
Swanson works in conjunction with a client’s tax preparer to look at the client’s short-term and long-term plans.
“A tax preparer will look at how we reduce your taxes today. As a financial planner, what we’re looking at is potentially eight to 10 years or more into the future,” he says. “And that conversation together allows us to have discussions about what the time horizon is, when we’ll be using money, what type of gains we’ll have in the future, and whether we should be harvesting losses this year or not.”
His approach to tax-loss harvesting depends on when his clients expect to see significant gains, such as after the sale of a business. In that case, clients will want to save losses to help offset those bigger gains.
Review Retirement Accounts
If clients have the means, they can top up their tax-sheltered retirement accounts, such as 401(k)s or traditional individual retirement accounts.
One of the tax strategies that might be on the chopping block for next year is the backdoor Roth IRA conversion. This strategy allows wealthy people whose income is too high to directly contribute to a Roth IRA to get around those income limits. “If you’re someone who has traditionally done a backdoor Roth conversion, you’ll want to get that done before the end of the year,” Steffen says.
Look at Estate Tax Exclusions
Advisors of high-net-worth clients may want to start planning for changes to the estate tax exclusion, says Dean Borland, private wealth advisor at FineMark National Bank & Trust. Currently, about $11.7 million per individual is excluded from estate taxes. That high level is sunsetting at the end of 2025, and it is expected to be cut by half or more, depending on whether the administration of President Joe Biden targets this tax break.
Whether a family wants to create a trust to shield money depends on its time horizon and financial situation, Borland says.
If clients are going to live more than 10 years, Swanson says, “we’re not going to rush into an irrevocable trust that’s going to lock them into something today when they may have a better opportunity in the future.” He adds, “If we think we’re getting close to that 10-year period, then we can start to look at what type of estate tax planning we can do to help reduce that tax impact for their beneficiaries in the future.”
Make Tax-Smart Charitable Contributions
Steffen says taxpayers can make a $300 cash charitable contribution ($600 for married individuals filing a joint return) this year and receive a tax deduction, as an extension of the charitable giving benefits first introduced last year under the coronavirus stimulus plan.
For larger gifts to be tax-deductible, however, taxpayers must itemize rather than take the standard deduction, which for married couples filing jointly is $25,100. People can only use income tax deductions to offset $10,000 of the standard deduction. The remainder must come from other deductions. For most people, those are for mortgage interest and charitable gifts.
That’s where multiyear planning comes into play, Steffen says. Some people may try to “bunch” the charitable contributions they normally would give over several years into one year to get over the standard deduction threshold. Donor-advised funds are a way to implement that bunching strategy, so clients can put those gifts into a fund and then dole out the money to charities over time.
Charitable remainder trusts are another option. However, Swanson says charitable remainder trusts are best for people who are already philanthropic, have incurred significant gains and would like to take part of those as a tax benefit this year, rather than use an all-purpose tax shelter.
Take Advantage of the Gift Tax Exclusion
Borland suggests that advisors take advantage of the annual gift tax exclusion for high-net-worth clients. The exclusion allows clients to give up to $15,000 to another individual without having to pay taxes on the gift. “If a couple has one child, they actually can give $30,000 to that child, $15,000 from each parent,” he says. The $15,000 gift isn’t restricted by family status; it can go to anyone, he adds.
Don’t Forget RMDs, Filing Status Updates
Steffen says advisors should remind clients who are 72 or older to take their required minimum distributions, which were suspended last year.
Also, advisors need to ask clients if their filing status has changed. People who were married, divorced or had a spouse pass away will likely be in a different tax bracket. “The tax rates in brackets are so different for a single person than they are for a married couple,” he says.
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