2021 Tax considerations
As we all know, 2021 has ushered in a new administration in Washington, including Democratic control in both the House and the Senate. Within the first 90 days, we have seen several changes, with a massive focus on government spending. When thinking about spending to the tune of trillions of dollars, something about a drunken sailor comes to mind. The thing about a drunken sailor is he still has to wake up the next day, usually with a bucket of water to the face, deal with the hangover, and figure out how to make up the spent money. The U.S. is still spending like a drunken sailor, but that can't last forever. This certainly explains why many of my clients are waiting for the next shoe to drop and want to prepare for what may be coming.
What Can We Expect?
In the near term, I believe we can expect lawmakers to focus on issues related to economic recovery, continued vaccine distribution, stimulus aid, and another round of massive spending with the Americans Jobs Plan. But at some point, we must realize someone is going to pay. Look in the mirror to figure out who.
One option on the table is a new auto mileage tax, which would raise money for highway infrastructure. Another is higher fuel taxes, which could increase what Americans pay at the pump. However, both proposals would be difficult to get through Congress, so they seem unlikely to come to fruition.
Some economists favor funding long-term infrastructure spending with ultra-long bonds. Treasury Secretary Yellen may consider issuing 50-year bonds for the first time since 1911 to take advantage of low-interest rates.
I believe, the most likely source of revenue will probably come from good old-fashioned federal income taxes on businesses and individuals. Even before taking office and government spending at historical levels, Biden campaigned on tax hikes, focusing mainly on those making over $400,000 a year. For many, that seems like a free tax increase pass. However, it seems hard to believe he'll generate enough revenue while only focusing on high-net-worth individuals. While I don't have a crystal ball, it seems likely that we may see higher top income tax rates, higher capital gains rates, higher corporate tax rates, and lower estate exemptions meaning, you guessed it, higher estate taxes.
No matter how it rolls out, a new tax plan is likely coming. We'll know more when Congress starts to focus on the tax rates, but it's clear these possibilities make 2021 even more important for tax planning.
Tax moves you can consider in 2021
Roth Conversions allow you to change a traditional IRA to a Roth IRA and game when you or your beneficiaries pay taxes. The ideal situation is to pay federal taxes at the lowest rate possible. In anticipating increases to tax rates in the coming years, 2021 tax rates look attractive. Any amount converted from a traditional IRA to a Roth IRA is added to your income and is taxed as ordinary income in the year you convert it. You are effectively locking your taxes at today's rates. Roth conversions may be a good strategy for you, especially if your income is still down due to the pandemic shutdowns. There are specific rules to be aware of with Conversions, so it is essential that you plan and implement this strategy carefully. We recommend working with your financial and tax advisor to see if this strategy makes sense for you.
Accelerating Income – Pushing Deductions
Consider your income sources. While you typically do not have control over when your employer pays you, you may have control over the timing of other income. Given the recent stock market gains, it could make a lot of sense to take profits and realize capital gains while rates are potentially lower. If you anticipate an upcoming expense next year that you will cover from your taxable retirement account, consider taking all or a portion of the distribution this year.
Not all income affects your tax liability; it's taxable income, so deductions come into play. For those that still itemize, bunching deductions for 2022 could be even more valuable. Consider holding off paying miscellaneous expenses like professional dues, postponing charitable gifts, and avoiding prepaying property taxes and interest due in the following year. Bunching your deductions and pushing them to a year where you believe taxation will be higher will help reduce your ultimate tax liability and save you money.
Given the assumption that the 2021 tax rates will be lower than in 2022 it could make sense to consider strategies that accelerate your income for this year and postpone deductions to the following year.
Deductible retirement plan contributions
During campaign season, President Biden proposed changes to 401(k) retirement savings plans. Rather than using a tax deduction for your 401(k) contribution, you would utilize a tax credit. Biden's plan would likely result in high earners getting fewer tax breaks on their 401(k) savings and low and middle earners getting a more significant benefit. If you're a high earner, maxing out deductible retirement contributions enhances your retirement success. 2021 may be the last year to get the full tax deduction.
For the 2021 tax year, you can defer up to $19,500 to your employer-sponsored retirement plan. An additional catch-up deferral of $6,500 is allowed if you are over the age of fifty.
As recently as 2001, the federal estate tax exemption amount was just $675,000.00. Meaning estates over $675,000 were subject to federal estate taxes. It's not likely that new rules would go back to such low levels, but I believe it could be a mistake to think that estate planning is only for people with multi-million-dollar estates.
Estate and gift tax exemptions are up to $11.7 million per person this year. Carefully review your lifetime cash needs and consider using up some of your lifetime transfer exclusion amounts in 2021. You should talk with your financial planner and coordinate with your attorney to consider estate planning techniques that help optimize your estate and protect it from future taxation.
The Bottom Line
Tax laws are in a constant state of flux. Remember, what is proposed, especially during campaign season, and what is passable are often vastly different. We don't know when taxes will change or what the new rules will look like, but we can consider proactive steps during the remainder of this year. These are just some initial ideas that could have benefits for your situation. Panicked decisions rarely result in favorable outcomes. As we learn more about what could be coming down the pipe, we will continue to look for other options to potentially lower the impacts of any tax increase.
It is crucial to get sound advice before you pull the trigger. Part of our job is to help you stay on top of the rules and maximize your opportunities. Not just now, but every year. Our passion is to help you achieve your financial goals. If you would like to discuss which strategies make sense for your situation or need help implementing them, please reach out to us at firstname.lastname@example.org or call 904-374-9098.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. Advisory Services Network, LLC does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation.