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The Tax Man Cometh - Part 1

The Tax Man Cometh - Part 1

| December 02, 2020

In Part 1 of our Edu-Blog series for December on year-end tax strategies we will take a look at the possibility of changes to the tax law and how to prepare for them. We all know that each president has their own policys around just about everything but at this time of year, with an epic election under our belts, tax policy changes are front of mind. The techniques below are things that should be reviewed with your accountant as we are not tax advisors. The information provided is for education purposes only, your tax situation is unique so we encourage you to work with Grover Financial Services and your accountant to maximize your strategy.

We expect that the first order of business will be shoring up the economy however, President-Elect Biden has talked about reversing the 2017 Tax Cuts and Jobs Act and reverting to 2016 rates and exemptions. He has also talked about select taxes increases and broadening the standard deduction. 

So, what can we do now to prepare for possible tax increases? 

Well, the first thing we feel everyone should do is speak to their accountant about how increased income will affect them. This is an important first step, because by understanding how long it will take you to make back the cost of this years taxes against the cost of higher taxes next year, you are able to be confident in exactly what steps you should take. 

Let’s take a look at some of the things that might cause your income to increase in 2021. 

  1. Deferred compensation
  2. Exercising stock options
  3. Receiving capital gains earlier than expected
  4. Converting a traditional IRA to a Roth IRA

Let’s look at one of the possible scenarios should tax laws change. Perhaps you own many shares of a stock with a low basis and want to diversify your portfolio which would result in a capital gain. So instead you think it’s better to hold off so you can take advantage of the cost basis step-up at your death. Well, not so fast because this policy is on President-Elect Biden’s chopping block.

The biggest change could come in the form of higher transfer taxes. 

Next year, in 2021, the estate and gift tax exemption will increase to $11.7 million per individual, up from $11.58 million in 2020. If you are in a position to gift this amount of money it’s probably a good idea to do it before the rule changes. However, it’s important to note that regardless of what Biden does with the exemption, as of right now it will be cut in half in 2026 anyway. At Grover Financial Services, most of our clients that are able to make large gifts are doing so for tax reduction purposes and his can be pretty complex, so best to start early.

What if you want to keep access to family funds while taking advantage of a larger exemption. Well, one tactic is to take advantage of the “spousal limited access trust” or the SLAT. For example, if you are a married couple with $20,000,000, you could create a SLAT for one spouse with half of the money. The benefit of doing this is that while the trustee spouse is alive they can take distributions from the account which the family can use.

You may not be in a financial position to do this type of thing, but that’s ok, there are plenty of things you can do that can remove appreciation from your estate so what’s left is not subject to the 40% estate tax after your death. One of these techniques is a grantor retained annuity trust. This is basically a loan you make to an irrevocable trust for your children and it works best in a low-rate environment like ours. 

In fact, many of the tax techniques out there work best in a low rate environment. With the grantor retained annuity trust you are able to keep access to the capital in the loan if you need it while lowering any tax liability should your taxable gifts eat up the estate tax exemption we spoke about earlier.

There are two important things here. First, we are not telling you exactly what to do with your taxable assets, we certainly aren’t accountants, but these things should be discussed with both your financial advisor and your accountant. Your accountant can bring clarity to your exact situation and work in tandem with your advisor to create the right tax scenario for you. Second, preparation is key, you need to know what is possible and be ready to put your plan into action if needed. 

Join us next week for Part 2 of our month long discussion on year-end tax strategies where we will talk more about income tax planning with blocking and tackling techniques. Have a wonderful week!

P.S. If you enjoyed what you've read here and found it beneficial, we encourage you to share it with your friends and family. I firmly believe that and educated investor is more confident, which leads to healthy finances and fewer sleepless nights.

Source: 2020 Year-End Tax Planning