With the election of Joseph R. Biden Jr. as the 46th U.S. President, higher federal taxes are almost certain to be enacted in 2021.
The tax hikes are going to be negotiated in Congress in 2021 and will be subject to old-fashioned Washington horse-trading. Exactly which taxes will rise and by how much is not known yet, but federal emergency aid to individuals and businesses after the Covid outbreak has exploded the federal deficit and a second aid package is expected in early 2021. With the balance-sheet of the United States weakened unexpectedly by trillions of pandemic relief, planning for taxes is prudent, let’s highlight four types of situations in which you might able to reduce your tax bill significantly, as long as you act by December 31st, 2020.
One situation is if you take required minimum distributions from a retirement account or are about to start taking RMDs; a provision under the federal emergency relief in the CARES Act allows you to defer your RMD in 2020. With the epidemic keeping retirees at home in 2020, your expenses may be really low this year. Deferring all or part of your distribution will leave more invested in a tax-advantaged account. This strategy involves investment risk but tax-free compounding may make the math work depending your personal circumstances.
Another situation requiring action by the end of 2020 applies to individuals 59½ or over with retirement assets in an IRA. You need to consider converting assets in a traditional IRA or qualified retirement account to a Roth IRA, to make that money tax-free for the rest of your life, which can benefit your surviving spouse and children, too. With the stock market nosediving more than 7% in a single day several times in 2020, between now and the end of the year you want to consider converting assets in traditional IRAs or retirement accounts the next time stocks plunge. That would reduce the taxes that would be owed on the withdrawal from the traditional IRA. Which would then you set you up to convert that money to the Roth account. The tax- free compounding may make a big difference in your after-tax outcome and benefit your heirs.
An unusual variety of opportunities are available if you are charitably inclined. Under the CARES Act, those age 59½ and older you can deduct up to $100,000 withdrawn from an IRA if you give it to charity, lowering your taxable income dollar for dollar. If you’re a pre-retired doctor or dentist, bunching your deductions for charitable donations can be especially beneficial to you as well as the cause you want to support, if you take care of the details by the end of this year. Another charitable-giving tip: In 2021, the Biden tax plan would hike the top tax rate to 39.6% and the favorable capital gains rates of 2020 could be history. If you are sitting on a large capital gain or have a singlestock or other asset in which your wealth is concentrated, then a charitable donation of that property may be wise before the end of 2020. To head off the higher taxes expected on capital gains property, you may want to donate the property before the end of the year. Another charitable situation is the case of someone who is about to retire and who has most of their retirement portfolio invested in a single company: You may want to consider setting up a charitable trust, which would sidestep the capital gain tax while assuring a stream of income for yourself and your spouse and leave a remainder amount to a cause you’re passionate about.
President-elect Biden’s tax plan calls for cutting the estate tax exemption from the current $11.58 million to $3.5 million. This would expand the estate tax to millions of families as of 2021. By the end of 2020, parents and grandparents expected to have taxable estate under Biden’s plan should consider selling property – like real estate, securities, or interests in private companies – on an installment-loan basis to children or grandchildren. With interest rates low, the minimum rate on intrafamily loans is extremely low and structuring transactions to give parents or grandparents annual income from the sale proceeds can be a smart family plan. Moreover, structuring the sale would maximize the lifetime exemption from gift and estate taxes, which can save families from paying estate taxes.
With a slimmer majority of Democrats in the House of Representatives and control of the Senate undecided until after runoff elections in Georgia on January 5, 2021, we’ll keep you posted on developments as they unfold.
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