Planning · November 18, 2021

How to Modify Your Year-End Plan with Higher Taxes in Mind

Nerre Shuriah

JD, LLM, CEPA | Senior Director of Wealth Planning


Does approaching the end of the year ever make you introspective? Like you want to take a deep dive into several aspects of your life to see how you're performing against your personal goals, including your financial ones?

When it comes to your financial plan, there's a lot to consider as we approach the end of 2021. We've continued to learn the lesson that it's impossible to predict the future. This is especially true as we find ourselves in a performing bull market mixed with apprehension about high inflation, and other influences making the market volatile.

In this article, we'll discuss how to adjust your financial plan for higher income taxes in the event tax legislation being debated on the Hill passes.

Planning for Higher Taxes on Individuals

We anticipate some version of the Biden Administration's tax plans will likely pass. However, tax increases are set to occur through inaction. Many of the corporate tax changes in the Tax Cuts and Jobs Act of 2017, or TCJA, were permanent, but the provisions affecting individuals are scheduled to expire on December 31, 2025.

Proposed Tax Legislation for Individual Taxes

The bills coursing through Congress are extensive. We've included some of the broader proposed tax increases below.

  • Capital gains and qualified dividends: Long-term capital gains and qualified dividends of taxpayers with adjusted gross income of more than $1 million ($500,000 for married filing separately) would be taxed as ordinary income. This could result in a top rate of 43.4% when the 3.8% net investment income tax is included.
  • Ordinary income: Proposed legislation would increase the top marginal individual income tax rate from 37% to 39.6%.
  • Like-kind exchanges: Congress may limit the deferral of gain from like-kind property exchanges of real estate. Gains in excess of $500,000 for each taxpayer, or $1 million for married filing joint taxpayers, would be taxed in the year of the like-kind property exchange.
  • Inherited assets: Realizing a capital gain upon death or gift of appreciated assets may change with proposed legislation. Death would be treated as a recognition event, and there would be no more step-up on the basis of assets transferred at death. In addition, gains on unrealized appreciation of property would be realized every 90 years, targeting assets held in dynasty trusts.
  • Corporate tax rates: TCJA instituted a flat tax of 21% for all C corporations, but new legislation would likely increase that rate. Bills have varied the exact percentage from 25% to 28%.

Strategies to Consider for Higher Individual Taxes

Even though the infrastructure and spending legislation is not yet final, let's consider strategies for a rising income tax environment. Consider implementing these strategies before year-end to help minimize your tax liability and shore up your long-term financial wellness. But before taking any action, please meet with your First Citizens Consultant as well as your tax and legal advisors for a customized strategy.

1 Adjust asset allocation for taxes

Taxes can erode a portfolio's investment return. A portfolio's asset allocation is its mix of cash, bonds, stocks and other investment classes. You should consider taxes as a factor in asset allocation when working with your strategist. Overall, net investment return is still the factor that matters most. Leaning too heavily on tax consequences could result in missing earning opportunities.

2 Contribute to tax-efficient accounts

Certain vehicles like IRAs, 401(k)s, similar qualified plans and life insurance have tax-deferred or tax-free aspects to their tax treatment. In an environment where income taxes are increasing, it makes sense to invest new monies in such tax-efficient accounts to help reduce current and future taxes. Traditional IRA or 401(k) accounts may be tax deductible when you contribute. However, your total annual contribution to any qualified account—whether traditional or Roth—is subject to a dollar limit. Your deductible portion is also subject to limits based upon your active participation in an employer-provided retirement plan.

Keep in mind there are some proposals within the tax bills circulating Washington that could impact large balance tax-efficient accounts specifically (over $10 million). Some of those proposals include conversion limitations above a certain tax bracket, prohibiting contributions to IRAs over a certain combined value and changes to required minimum distribution, or RMD. You can learn more about the proposed legislation in our full Year-end Planning Guide for 2021.

3 Tax loss harvesting

Tax loss harvesting is a common strategy recommended in most year-end guides and will be even more prevalent with rising income tax rates. Tax loss harvesting isn't permanent tax avoidance but rather a tax-deferral. The proceeds will be reinvested and eventually taxed at a profit. Also, keep in mind that it can occur throughout the year as opportunities arise, not just in December.

Investors can harvest losses on capital assets to offset reportable gains on other capital assets. You get $3,000 of ordinary income offset for personal capital losses. Harvesting requires selling securities at a loss or less than cost basis. Combined with increasing taxes, market volatility raises the possibility that the activity of harvesting capital losses can or should be done when the opportunity arises, such as during market swings. As with any investing strategy, there are rules to keep in mind. Namely, the wash sale rules, which prevent you from repurchasing a similar security within 30 days of selling at a loss.

We cover a bit more on tax loss harvesting in our full Year-end Planning Guide.

4 Tax-efficient charitable gifting

Assets that don't receive a step-up in basis at death are the most tax-efficient choice to give to charity. Right now, those are qualified plan assets. However, that could change for upper middle class or mass-affluent estates. Legislation proposals would limit the step-up in basis for estates exceeding $1 million ($2 million for joint filers) and the current capital gains exclusion of $250,000 for single filers and $500,000 for joint filers for primary residences.

One such way to give to charity in a tax-efficient manner is through a qualified charitable distribution, or QDC. QDCs allow individuals who are at least age 70 1/2 and have traditional or inherited IRAs to distribute up to $100,000 per year directly from their IRA to a 501(c)(3) nonprofit, with no federal income tax consequences. Doing so can help a taxpayer avoid being pushed into a higher income tax bracket and prevent phaseouts of other tax deductions due to RMDs. QCD could also reduce the value of your IRA, thereby potentially reducing the size of your RMDs.

Conclusion

In times of uncertainty, your greatest asset is having a solid financial plan that helps flatten the ups and downs. While we wait for final legislation from Congress, we can help you adjust your portfolio using strategies that work well in a rising tax environment.

If you don't have a financial plan, our consultants and planners are here to help you get started. If you already have a thorough financial plan, it's likely a good time to review it with your team of advisors and financial consultants to consider the options provided in this article.

As we near the end of 2021, make sure you’ve taken necessary steps to avoid potential tax erosion in your finances. To help in this process, we've developed a full Year-end Planning Guide, plus a Year-end Planning Schedule Checklist to help you stay informed and organized.

Insights

A few financial insights for your life

No results found

This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.

Links to third-party websites may have a privacy policy different from First Citizens Bank and may provide less security than this website. First Citizens Bank and its affiliates are not responsible for the products, services and content on any third-party website.

Your investments in securities, annuities and insurance are not insured by the FDIC or any other federal government agency and may lose value. They are not a deposit or other obligation of, or guaranteed by any bank or bank affiliate and are subject to investment risks, including possible loss of the principal amount invested. Past performance does not guarantee future results.

First Citizens Wealth Management is a registered trademark of First Citizens BancShares, Inc. First Citizens Wealth Management products and services are offered by First-Citizens Bank & Trust Company, Member FDIC; First Citizens Investor Services, Inc., Member FINRA and SIPC, an SEC-registered broker-dealer and investment advisor; and First Citizens Asset Management, Inc., an SEC-registered investment advisor.

Brokerage and investment advisory services are offered through First Citizens Investor Services, Inc., Member FINRA and SIPC. First Citizens Asset Management, Inc. provides investment advisory services.

Bank deposit products are offered by First Citizens Bank, Member FDIC.

See more about First Citizens Investor Services, Inc. and our investment professionals at FINRA BrokerCheck.