#taxplanning

Mid-Year is a Good Time for a Financial Checkup

As life emerges from the pandemic to a “new normal,” a mid-year financial checkup may be more important than ever this year.  Here are some ways to make sure that your financial situation is continuing on the right path.

Reassess your financial goals

At the beginning of the year, you may have set financial goals geared toward improving your financial situation. Perhaps you wanted to save more, spend less, or reduce your debt. How much progress have you made? If your income, expenses, and life circumstances have changed, you may need to rethink your priorities. Review your financial statements and account balances to determine whether you need to make any changes to keep your financial plan on track.

If you are a BFSG client, please remember to contact your financial advisor if there are any changes in your personal or financial situation for the purpose of reviewing our previous recommendations.

Take a look at your taxes

Completing a mid-year estimate of your tax liability may reveal new tax planning opportunities. You can use last year’s tax return as a basis, then factor in any anticipated adjustments to your income and deductions for this year. Check your withholding, especially if you owed taxes or received a large refund. Doing that now, rather than waiting until the end of the year, may help you avoid owing a big tax bill next year or overpaying taxes and giving Uncle Sam an interest-free loan. You can check your withholding by using the IRS Tax Withholding Estimator or by talking with your tax advisor. If necessary, adjust the amount of federal or state income tax withheld from your paycheck by filing a new Form W-4 with your employer.

Tax planning typically is backwards looking at just the past year. We recommend you take a proactive forward-looking approach by coordinating with your tax professionals to find ways to reduce your taxes now and in future years.

Check your retirement savings

If you’re still working, look for ways to increase retirement plan contributions. For example, if you receive a pay increase this year, you could contribute a higher percentage of your salary to your employer-sponsored retirement plan, such as a 401(k), 403(b), or 457(b) plan. For 2021, the contribution limit is $19,500, or $26,000 if you’re age 50 or older. If you are close to retirement or already retired, take another look at your retirement income needs and whether your current investment and distribution strategy will provide the income you will need. Check out BFSG’s recent webinar on Retirement Accounts (Traditional vs. Roth) and learn ways to maximize your retirement savings.

Evaluate your insurance coverage

What are the deductibles and coverage limits of your homeowners/renters insurance policies? How much disability or life insurance coverage do you have? Your insurance needs can change over time.  As a result, you’ll want to make sure your coverage has kept pace with your income and family/personal circumstances. The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased.

Ask questions

Finally, you should also ask yourself the following questions as part of your mid-year financial checkup:

  • Do you have enough money in your emergency fund to cover unexpected expenses?
  • Do you have money left in your flexible spending account?
  • Are your beneficiary designations up-to-date?
  • Have you checked your credit score recently?
  • Do you need to create or update your will?

As always, our team of CERTIFIED FINANCIAL PLANNERS™ stands ready to assist: financialplanning@bfsg.com.

Prepared by Broadridge Advisor Solutions. Copyright 2021. Edited by BFSG, LLC.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

2021 Child Tax Credit Portal Now Open

As we previously explained in a prior blog post, The American Rescue Plan Act of 2021 makes substantial, temporary improvements to the child tax credit for 2021, which may increase the amount you might receive .The IRS will now be paying taxpayers the Child Tax Credit on a monthly basis rather than including it all on the annual tax return. They are scheduled to start being issued on July 15, 2021. The monthly amount will be $250 for children ages 6 to 17 and $300 for children under 6 in families receiving the full credit. You may also be able to claim a partial credit for certain other dependents who are not qualifying children.

You will automatically be enrolled for these payments, but to manage your payments, ensure the bank account is correct OR to opt-out, please access this portal www.irs.gov/credits-deductions/advance-child-tax-credit-payments-in-2021.

There is a downside! Anybody who receives the advance payment for which they are not eligible may have to repay these advances when they file their 2021 return. The most conservative approach is to unenroll. Please note though, that if you unenroll, then you can’t re-enroll.

Additional information about the Child Tax Credit portal is available at: https://content.govdelivery.com/accounts/USIRS/bulletins/2e50c8e

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

Better Alternatives to Making Cash Gifts

By: Paul Horn, CFP®, CPWA®

You do not have to turn on the news to know that many in the world are hurting. There is a greater need for charitable giving today than any time I can remember and there are so many different causes that need support. The most common way to make a charitable gift is with cash and this works fine for smaller gifts (think one-time small charitable donations) but for larger charitable gifts there may be better alternatives to consider.

Gifting Appreciated Assets

There are several tax benefits of gifting stock instead of cash. We are amidst the longest bull market on record, and many have large gains in their taxable accounts. If you gift appreciated stock you don’t have to pay taxes on the gains of the stock and you still get credit for the total gift if you itemize your deductions. Let us take a look at an example below:

You can see in this example gifting appreciated stock instead of cash can save the person over $8,000 in taxes. Even for smaller gifts, this strategy can still be very effective!

Gifting From Your IRA

Did you know you can make gifts out of your IRA? This strategy is called a Qualified Charitable Deduction (QCD) and often is better than gifting cash. The IRS allows QCDs up to $100,000 per year and the amount you gift decreases your Required Minimum Distribution (RMD) by the same amount. For example, if you have an RMD of $20,000 for the year and use a QCD of $12,000, all you are required to take for the RMD is $8,000. You do not pay taxes on the QCD amount (in this example $12,000).    

If you are 72, own an IRA, and donate to charities, QCDs may make sense for you. If you would like to learn more about charitable gifting please check out our webinar. As always please consult with us or your CPA before implementing these or other strategies.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

Understanding Biden’s Proposed Tax Plan

President Biden recently announced his $1.8 trillion plan (American Families Plan) for new benefit spending and increased taxes. Please keep in mind that this is the first iteration. We expect to see new items added and changes made as the proposal advances through Congress. Below is a summary to understand the proposed changes.

Capital Gains Tax

Right now, depending on your taxable income, the federal long-term capital gains tax rates are either 0%, 15% or 20% for most assets held for more than a year. High earners with significant investment income over certain thresholds pay an additional 3.8% surtax (net investment income tax) on top of the top capital gains tax rate (20% capital gains + 3.8% surtax = 23.8%).  The Biden proposal would increase the top federal long-term capital gains tax rate to 39.6% and those high earners would still be subject to the 3.8% surtax creating an actual tax rate of 43.4%. This tax rate would apply to individuals and married couples (filing jointly) that make over $1 million a year (this includes dividends and capital gains) and is estimated to impact about 500,000 Americans (Source: Bloomberg).

 CurrentProposed
Top Federal Long-Term Capital Gains Tax Rate20.00%39.60%
Net Investment Income Tax3.80%3.80%
Total Highest Combined Rate23.80%43.40%

Note: The above reflects what has been proposed; the general expectation is that the capital gains tax rate will most likely be increased to around 28% (a rate that is roughly between the current rate and Biden’s proposal).

What is Included in the $1 Million Income?

For now, the proposal appears to focus on those making more than $1 million annually. That means, most individuals would not be impacted by these changes. It is important to note, however, that the $1 million represents total annual income, which may include capital gains and qualified dividends (this could become an issue for anyone with a large liquidity event like selling real estate or a business).

Factoring State Taxes

This increase would make the capital gains tax rate the highest it has been since 1954. When looking at this change combined with state taxes, individuals would become hugely impacted:

As you can see Californians in the top tax bracket would be hit with a combined tax rate of 56.7% since California taxes capital gains at ordinary income tax rates.

What Assets are Impacted?

The new proposal would impact stocks and bonds. Individuals that sell a home or business with large capital gains would need to do additional planning as they would be impacted by these changes as well. There would not be capital gains taxes for family-owned businesses or farms if the heirs continue to run the business. Primary residences would still maintain the current exemption of $250,000 ($500,000 for a married couple) as well.

Killing the Step Up In Basis

Another proposed change announced is the elimination of the current step-up in basis at death for gains of $1 million ($2 million for a married couple). Under current laws when someone passes the heirs receive a new cost basis on the inherited property, which is the value of the assets at the time of death (or, if elected, six months after the date of death). This new cost basis would eliminate capital gains that would have normally been taxed. The possibility of eliminating the step-up in basis is being discussed so that a strategy is not employed of just holding stocks until death to avoid paying capital gains taxes. Below is an example of what would happen if they remove the step-up in basis.

Example Under Current Law: Kim’s father passes away and she inherits a taxable stock account worth $1.5 million with the original cost of the investments being $300,000. Under current rules, Kim will inherit the account and her cost basis becomes $1.5 million instead of her dad’s $300,000. If she chose to sell the $1.5 million of stocks, she would not incur capital gains taxes.

Example Under Proposed Law:  Kim’s father passes away and she inherits a taxable stock account worth $1.5 million with the original cost of the investments being $300,000, meaning long-term capital gains of $1.2 million. Since the gain is over $1 million that means $200,000 ($1.2 million – $1 million exemption) is subject to capital gains tax that needs to be paid regardless if Kim keeps the stock or not. Assuming a proposed higher capital gains tax rate of 43.4% this would trigger a tax bill of $86,800 ($200,000 * 43.4%)

Note: The above reflects what has been proposed; the elimination of the step-up in basis is expected to be more difficult to pass without some revisions (possibly a phaseout).

Potential Planning Opportunities

Many different planning strategies would be impacted by these changes. In recent years we have seen a large disparity between the highest income tax rates and capital gain tax rates creating some unique planning strategies like Net Unrealized Appreciation (NUA).1 If the capital gains rate is similar to income tax rates, then it is no longer a viable planning strategy. 

Additional planning should be done if there is a large liquidity event like selling real estate or a business to defer or eliminate some capital gains taxes. Such as possibly using a Qualified Opportunity Zone Fund and other planning strategies.2 Charitable gifting strategies (stock donations and donor-advised funds) are not expected to be impacted and may continue to be an attractive way to reduce capital gains taxes. We expect to see an increase in the use of charitable trusts as well in response to these proposed changes.

The real winner here is going to be the insurance industry. Life insurance death benefits are still tax-free and will become the best way to pay for these taxes or to pass money to heirs in the most efficient manner.

Potential Portfolio Management Considerations

Typically, you want to hold less tax-efficient assets (i.e., bonds) in tax-deferred accounts (i.e., retirement accounts, health savings accounts) to shelter the ordinary income generated. Under the proposal, for those earning more than $1 million in taxable income, we may want to consider flipping the script by (i) holding stocks that generate capital gains and qualified dividends in tax-deferred accounts, and (ii) holding bonds in taxable accounts, especially tax-free municipal bonds.

BFSG already builds portfolios in a tax-efficient manner, but others may want to consider holding more exchange-traded funds (ETFs) in taxable accounts which are usually more tax-efficient investment vehicles relative to mutual funds.3 Furthermore, Real Estate Investment Trusts (REITs) would be favored to invest in and hold in taxable accounts due to a qualified business income deduction.4 Finally, depending on the outcome of the step-up in basis proposal, many investors may want to invest for the long-term (buy and hold forever).

Finally, we will continue to tax-loss harvest portfolios (selling securities at a loss to offset securities sold at a gain) to minimize capital gains exposure.

What Do We Expect to Happen?

Whatever we do predict today is most likely to be wrong because we do not expect the proposals to go through without several revisions and changes. We expect to see more potential additions from Republicans and Democrats (i.e., possibly a reinstatement of the deduction for state and local taxes).

The proposal most likely will not be enacted until July or September, which is when we expect the Senate to debate and pass the reconciliation bill. The higher tax rates could become effective when the bill is enacted into law, given a retroactive effective date (May at the earliest), or delayed until January 1, 2022. The last time Congress legislated an increase in the tax rate (President Reagan and a Democratic House settled on an increase from 20% to 28%), the policy became law in October 1986, but the increase did not take effect until January 1987.

While tax increases are on the horizon, they are likely to be watered down by the time the final bill passes and take longer to be passed. We will continue to monitor the situation and keep you updated.

  1. Net Unrealized Appreciation (NUA) transactions occur when you convert employer stock in your 401k or retirement plan with your employer into a taxable account. When securities are sold, any NUA is taxed at the long-term capital gains rate. Any additional gain is taxed based on the holding period of the shares after they are distributed.
  2. Investors can deploy realized capital gains from the sale of an appreciated asset into a Qualified Opportunity Zone Fund which may allow deferral, permanent reduction and elimination of capital gains taxes provided certain investment deadlines and holding timeframes are met.
  3. Exchange-Traded Funds (ETFs) tend to have lower turnover (many ETFs are passive strategies), trade on a secondary market, and have a structural tax benefit of in-kind redemptions, therefore limiting capital gains.
  4. The majority of Real Estate Investment Trust (REIT) dividends are taxed as ordinary income up to the maximum rate of 37% (returning to 39.6% in 2026), plus a separate 3.8% surtax on investment income. Taxpayers may also generally deduct 20% of the combined qualified business income amount which includes qualified REIT dividends through Dec. 31, 2025. Considering the 20% deduction, the highest effective tax rate on qualified REIT dividends is typically 29.6%.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

Five Potential Tax Changes Under Biden

With a new president often comes new agendas and philosophical changes. This is especially true with the Democrats controlling the House and picking up important seats in the Senate. President Biden is expected to pitch his “Build Back Better” infrastructure plan on Thursday and how to fund the estimated $3 trillion price tag.

Democrats will be forced to choose between budget reconciliation, which requires only a simple majority in each chamber for passage or securing at least 10 GOP votes in the 50-50 Senate.

Below are four potential changes to taxes that we are watching closely:

1. Increase in Income Tax for the Affluent

For those in the highest tax bracket (currently 37%) there is chatter in DC to raise it back up to the previous level of 39.5% or higher. The tradeoff they are considering is removing the State and Local Tax (SALT) deduction limit of $10,000 or more likely raising the SALT limit. This would be a great benefit for homeowners in high-tax states like California.

2. Increase in Corporate Tax

The corporate tax rate was lowered from 35% to 21% under the Tax Cuts & Jobs Act (TCJA) law in 2017. Many of the individual tax provisions of the TCJA sunset and revert to pre-existing law after 2025, however, the corporate tax rates provision was made permanent. Biden has previously voiced support for raising the corporate tax rate to 28%.

3. Changes to Estate Taxes

There is some concern that the new Congress may want to make significant changes to estate taxes.

Some of the proposed changes could include:

  • Reducing the lifetime exemption back to $5 million (adjusted for inflation). Currently, the limit is $11.7 million per person but sunsets in 2025 (see the discussion above about the TCJA). Lowering this exemption would also impact gifting and those subject to generations skipping taxes (GST).
  • Removing the ability of heirs to get a step up on a cost basis. For example, under current rules assume a $1 million after-tax investment has a cost basis of $300,000. Currently, the heir gets a new cost basis of $1 million and would not pay capital gains on the inheritance. There is talk of this being changed so the cost basis for the heir stays at $300,000 so they would have to pay capital gains taxes on the $700,000 in gains where under current law they do not have to.

4. Raise Social Security Tax Limits

Under current law, individuals pay 6.2% taxes for Social Security on the first $142,800 in earnings for 2021. Earnings over this amount are not subject to Social Security taxes.  There is speculation that this number could be raised to help meet the social security shortfall. There is also speculation about adding a new tier for payroll tax contributions for incomes over $400,000. There could be additional changes to the Medicare taxes as well. Read here about other possible changes to Social Security and Medicare.

5. Other Potential Changes        

There has been some discussion on making changes to popular planning strategies as well. There has been speculation but nothing concrete as of yet. Aside from federal changes, we may see more changes at the state level as many states are struggling with budgets in light of the pandemic and they will be searching for additional sources of revenue (read more taxes). This could lead to higher property or income taxes, or other potential changes like developing estate taxes or taxing Social Security. For example, California recently passed Prop 19 possibly triggering higher property taxes for inherited property.

Again, this is a tough item to predict but certainly something we are watching closely.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.