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As this unprecedented and strange year draws to a close, it is time for businesses and individuals to start planning to reduce next year’s tax obligations wherever possible. So far, we have survived COVID-19 and an adversarial presidential election process. We are approaching 2021 with hope and trepidation – hope for a vaccine and a return to normal life and trepidation for the continuing crisis. But nothing in 2021 is certain but uncertainty… and tax obligations. To help make the process easier, given all of the influences of this past year, here are a few things to keep in mind as you identify opportunities to reduce your tax obligations.
The presidential election impacts
Many believe that if Republicans hold the Senate, President-elect Biden will be unable to enact much of his bold tax agenda. Thus, it will be at least January 5 before we know exactly what tax obligations for 2021 will appear. However, his plan made clear that those making over $400,000 a year will be expected to pay more in taxes. President-elect Biden is also expected to seek increases in corporate and capital gains taxes.
Some basic steps to take now
Regardless of what the new administration can ultimately do, there are several steps that can be taken now to reduce taxes for this year and beyond. For instance, according to Investopedia, it is certainly worth taking any tax losses available this year. With rates and deductibility likely to change in the new year, taking them now makes sense and will provide something to offset against other income this year.
Gifts and estates
Current-low interest rates and lifetime gift and estate tax exemptions continue to offer an estate-planning and tax opportunity. So, you have a window of opportunity to reconsider estate plans while interest rates are still low and the lifetime gift exemption is at an all-time high. However, the current gift and estate tax exemptions will expire soon.
Gift-giving is also a smart strategy. Couples can give up to $30,000 in a tax-free gift right now, which can significantly impact estate issues later on. It is important to remember that President-elect Biden’s tax plans indicate that he hopes to enact major increases in estate taxes that could result, according to the Tax Foundation, in an effective tax rate of 67% on some estates.
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Conversions
You may wish to consider converting traditional retirement accounts to a Roth 401(k) wherever you can, and to do so sooner rather than later. Similarly, according to Forbes, given the potential increases in capital gains taxes, it might be wise to consider taking any large gains before such changes are made, particularly where you have losses against which to offset those gains.
Exercising options
If you have stock options and expect a sizable increase in income in 2021, you could exercise them now and potentially recognize the income in a lower-income year. It can be complicated, but it is worth examining to potentially reduce tax obligations.
Move income into this year
Furthermore, where possible, it may be wise to move income forward to 2020 rather than keep it for 2021 to take advantage of the current lower rates. On the other hand, according to Financial Advisor Magazine, you should perhaps defer charitable contributions into 2021 to take advantage of potential higher tax rates at that time.
Contributions
Be sure to look at traditional and Roth 401(k) and IRA contributions already in place. Although there is limited time to effect changes in 401(k) contributions for this year, you could make some changes, and if you are eligible, you could make a substantial IRA contribution before year-end.
Charitable contributions are not, for many people, what they used to be. However, if itemizing still works for you, it is a good idea to make as many charitable donations as possible this year to get the highest deduction.
Not just taxes
This is not really a tax issue, but it is important at year’s end to check on any flexible spending account balances still available. You can only rollover $500 in FSA balances, and any excess is simply lost to the government. Prescription glasses are one easy way to use up the funds, but others are available. You can even pay for items such as acupuncture and birth control with these funds.
2021 and beyond
You should examine all of your current and future tax obligations for filing for 2020 and planning for 2021 so that you can reduce your obligations where you have the chance. Moreover, depending on the fate of the Senate, you, as a business owner and individual taxpayer, should be sensitive and ready to make rapid and significant changes in your tax and estate plans, given potential drastic changes in both for businesses and high net worth individuals.
Brian Menickella is a co-founder and managing partner of The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, PA.
Securities and Advisory services offered through LPL Financial
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This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation.
Traditional 401(k) account owners have considerations to make before performing a Roth 401(k) conversion. These primarily include income tax consequences on the converted amount in the year of conversion and withdrawal limitations from a Roth 401(k).