2021 Year-End Planning with Potential Tax Legislation In Mind

By on October 1, 2021
Categories: MARKET NEWS

Global equities delivered a mixed performance in the third quarter, with large U.S. stocks inching higher and foreign stocks treading water.  Employment growth continues to improve coming out of the post-pandemic world, but businesses in numerous industries face painful labor shortages and disrupted supply chains, causing inventory delays and price fluctuations.  Real estate held onto its strong performance for the year as interest rates remained very low, keeping financing costs attractive.  Other notable market events during the quarter included:

  • The Federal Reserve (Fed) continued its ultra-low interest rate directive but hinted at a potential start date for rate increases in 2022, as inflation may be more prominent and concerning than originally expected.
  • The yield on the 10-year Treasury bond ended the quarter just over 1.5%, still well below historical measures, keeping mortgage rates and consumer debt at favorable rates.
  • Stock market volatility briefly returned late in the third quarter with news of mega Chinese real-estate company, Evergrande, potentially defaulting on billions in debt, and a looming debt ceiling standoff in the U.S. as a polarized Congress must negotiate an agreement to prevent a partial government shutdown.

Asset class returns for the quarter and year-to-date were as follows:



Asset Class

Third Quarter 2021

Year-to-Date 2021

Barclays U.S. Govt./Credit—Int. Fixed Income 0.0% -0.9%
S&P 500 Large U.S. Stocks 0.6% 15.9%
Russell 2500 Small/Mid U.S. Stocks -2.7% 13.8%
MSCI ACWI ex-USA Foreign Stocks -3.0% 5.9%
S&P Global REIT Real Estate Securities -0.1% 16.9%

It is hard to believe that the end of 2021 is just a few months away.  With continued government spending in response to the global COVID-19 pandemic and trillion-dollar legislative proposals making their way through Congress, many are anticipating some combination of higher income and estate taxes in the future.  While we always look to take advantage of year-end planning opportunities, income tax and estate planning may be particularly important this year.  Strategic personal income tax and estate planning considerations for year-end 2021 are summarized below.

Income Tax Planning

Capital Gain and Loss Harvesting

  • If available, consider harvesting capital losses (short-term or long-term), which may be used to offset gains this year or carried forward indefinitely to offset future gains. Up to $3,000 of the losses may be deducted against ordinary income each year.
  • If 2021 will be a lower income year, consider accelerating the recognition of gains to take advantage of favorable federal capital gains rates (potentially as low as a 0% federal rate).

Charitable Giving

  • If charitably inclined, consider gifting appreciated securities (held for more than one year) from taxable investment accounts for a potential quadruple benefit: 1) the ability to “trim” highly appreciated positions in investment portfolios; 2) potentially receive a current year tax deduction (subject to 30% of adjusted gross income limit); 3) avoid paying tax on the embedded capital gain; and 4) help others.
  • Bunch charitable gifts to offset higher income in 2021 (e.g., liquidity events, Roth conversions, short-term capital gains, bonuses, etc.) or surpass standard deduction (applies to many who give $5,000 or more on an annual basis and may not otherwise receive any marginal tax benefit).
  • If bunching charitable gifts, consider utilizing a Donor Advised Fund to receive a current year deduction while controlling the timing of the actual gift(s) made to charitable organizations. Funds in a Donor Advised Fund may also be invested for future growth.
  • If over 70 ½ years old, Qualified Charitable Distributions (QCDs) up to $100,000 annually can be made from traditional IRA accounts. This gifting strategy can fulfill required minimum distributions (RMDs) and reduce adjusted gross income (AGI), potentially lowering Medicare premiums and/or avoiding 3.8% net investment income surtax.
  • Consider lifetime charitable gifts rather than bequests given current higher estate tax exemptions which are set to be reduced in future years.

Roth Conversions

  • Roth IRA conversions (converting part of a pretax IRA to a tax-free Roth IRA by paying income taxes in the current year) may be beneficial for investors who are currently in a lower tax bracket and expect to be in a higher (or similar) tax bracket in the future. Those who have retired but have not started drawing Social Security benefits or begun taking required minimum distributions (RMDs) from IRAs may be very attractive candidates for Roth conversions.  For these clients, their 50s and 60s could be lower taxable income years than their 70s and beyond.  This may present an opportunity for such clients to “fill up” their current marginal tax bracket with Roth conversion money.  It is particularly advantageous if they see themselves or their beneficiaries being subject to higher taxes in the future.

Retirement Plan Funding

  • Consider contributions to retirement plans, either traditional or Roth depending on current and forecasted income tax brackets.
  • Defined Benefit Plans may be attractive for highly compensated self-employed individuals and may allow for higher dollar contributions and reduction in current year taxable income.
  • “Backdoor” or “Mega Backdoor” Roth conversions may be utilized for additional retirement plan funding options (note: rules for these strategies may be changing soon; more on the proposed limitations below).

Estate Planning and Gifting

The current federal lifetime gift and estate tax exemption amounts are $11.7 million per person ($23.4 million per married couple) in 2021.  Estates exceeding the federal exemption amount are currently subject to a 40% estate tax.  The current exemption amounts were established under the Tax Cuts and Jobs Act of 2017, which are scheduled to sunset and revert to half the current exemption amounts at the end of 2025, if new tax legislation doesn’t change them prior.

Update estate planning documents.

Review estate planning documents, including wills, trusts, and beneficiary designations to ensure they reflect current objectives and family legacy goals.

Annual exclusion gifts.

Consider annual gifts of up to a limit of $15,000 per year per person without utilizing any lifetime gift or estate tax exemptions.

Fund 529 college savings accounts.

529 accounts may be “superfunded” in a single year, allowing up to 5 years of annual exclusion gifts ($75,000) per account beneficiary.  The “superfunded” gift is averaged over five years to avoid utilizing any gift tax exemption.

Pay tuition and healthcare expenses directly.

Individuals can make unlimited gifts for tuition and medical expenses, as long as the payments are made directly to the providers of those services (e.g., pay tuition directly to school), without counting against some lifetime exclusion amounts.

Make gifts utilizing current estate and gift tax exemption.

Assuming sufficient assets are available to fund lifetime spending needs, consider making gifts up to the available gift/estate tax exemption amount to utilize the current exemption amount before it is reduced.

Consider other trust structures to pass along assets to desired beneficiaries.

Various other trust structures, such as Spousal Lifetime Access Trusts and Intentionally Defective Grantor Trusts, could be utilized to facilitate passing along assets to beneficiaries while offering some flexibility and maintaining tax efficiency.

The strategies referenced above are not comprehensive and should be considered in the context of each client’s financial plan, goals, and long-term objectives.  Clients should consult with their legal and tax advisors before implementing any strategies described herein.  Additionally, tax changes may be on the near-term horizon, such as the Build Back Better Act, which is outlined below.

The “Build Back Better Act (BBBA)” Tax Proposal

In mid-September, the House Ways and Means Committee unveiled new tax proposals in the Build Back Better Act.  Proposals by the Ways and Means Committee have a reasonable chance of surviving the Budget Committee process and making their way into Congress for amendments and ultimate voting.  If the proposed tax law makes it through the reconciliation process (which may require only a simple majority of the Democrat-controlled Senate to approve), then the proposed changes would become law.

Below are four key proposals that could affect income and estate planning in the near term if the current bill is enacted.

1. Top ordinary income tax bracket increased to 39.6%. 

The bill would not only increase the top ordinary income tax bracket, but also lower the income thresholds in this new, highest ordinary income tax bracket.  Single filers with taxable income over $400,000 and married filers with taxable income over $450,000 would fall into the highest income tax bracket.  Additionally, the current 35% ordinary income tax bracket would become narrower, causing more taxpayers to potentially drift into higher marginal income tax brackets.

  • Planning Implications: If income in future years is projected to be higher than the proposed thresholds, accelerating income into this year may result in tax savings.

2. Reduction in estate and gift tax exemption. 

The current lifetime unified gift and estate tax exemption of $11.7M per person ($23.4M per married couple) would be essentially cut in half to approximately $6M per person ($12M per couple), adjusted for inflation.  Under current law, this reduction is scheduled to take place on January 1, 2026, so the BBBA proposal would simply accelerate the planned reduction.  Notably, in the current proposal the 40% estate tax would remain intact, and the stepped-up cost basis rules, which “step up” the cost basis of assets to market value at the decedent’s death, wouldn’t be changed.

  • Planning Implications: If you have more than a $6M estate as a single person or $12M as a couple, you may wish to review your estate and gifting plan.  You may consider making gifts to use some of your current $11.7M per person estate, gift, or generation-skipping transfer tax exemption before it is cut in half (which, if the proposed changes go through as-is, would occur very soon).

3. Roth conversion limitations for high income earners and elimination of after-tax conversions. 

For high earners (single filers with taxable income over $400,000 and married filers with taxable income over $450,000), Roth conversions would be prohibited, but not until the year 2032.  For IRAs and employer-sponsored plans, any conversions of after-tax dollars would be disallowed beginning next year, in 2022.  As a result, this could potentially close the “Backdoor Roth IRA” strategy, and later prohibit Roth conversions altogether for higher-income taxpayers.

  • Planning Implications: If you have an IRA or 401k plan with after-tax contributions – consider a partial or full conversion now so the after-tax portion can grow in a Roth IRA.  With at least 10 years to plan for Roth conversions, there may be an opportunity for high-income earners to manage tax brackets and convert IRA dollars to Roth dollars methodically over time.

4. Long-term capital gains tax increase for high earners.

The highest long-term capital gains rate would increase to 25% for single filers with over $400,000 in taxable income and married filers with over $450,000 in taxable income.  This would mean that the same threshold for the highest marginal tax bracket would align with the threshold for the highest capital gains tax.  The new 25% capital gains tax would be the highest since 1997, when it was then lowered from a maximum of 28% down to a maximum of 20%.  The proposal contains transition rules that would generally apply the increased rate to capital gains recognized retroactively, any time after September 14, 2021.

  • Planning Implications: The retroactive nature could throw a wrench into planning.  If the retroactive language is dropped from the bill, there may be advantages to accelerating some capital gains into 2021 at a potentially lower rate.

The above are still proposals at the time of this writing—and may change before signed into law.  We will continue to monitor the progress and negotiations of the Build Back Better Act and how it could impact your investment portfolio, financial plan, and estate planning.

RMDs and Tax Reporting

Lastly, as we enter the final months of the year, we would like to remind our clients of a few timely administrative items related to taxes.  If we have not already, we may be consulting with those of you who are obligated to take required minimum distributions (RMD) from IRAs and other retirement accounts by December 31.  Please inform us of any IRAs you own that are not managed by our firm so we can take them into account when calculating your RMD.  If you plan to make charitable donations of appreciated stocks or other securities in 2021, please notify us as soon as possible — ideally no later than the first week in December.  Finally, if we are not currently reporting tax information directly to your tax preparer and you would like us to do so, please provide us with his or her name and contact information (including email address) by the end of the year.

We appreciate the trust you have placed in us to guide you through these ever-changing times.  We encourage you to call or e-mail anytime you would like to discuss your portfolio or your financial plan.




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