Corbin M. Donaldson, CFP®

Wealth Management Advisor

Planning for an Uncertain Future in a World of Tax Reform

“Anything is possible,” were the iconic words spoken by former Boston Celtic, Kevin Garnett, upon clinching Game 6 of the 2008 NBA Finals against the Los Angeles Lakers. At Greenleaf Trust, we would love to be able to peer into a crystal ball and tell you exactly how things will turn out, but we simply cannot. Market downturns and new legislation are bound to happen — we cannot control circumstances, but we can control our preparedness. Within this article, we will evaluate at a high-level several of the much-anticipated tax proposals from the House’s Way and Means Committee. We will explore several planning strategies that could be effective approaches for certain clients, dependent on what legislative proposals are passed. While Garnett was referencing his historic run to the title, it similarly appears that “anything is possible” as we explore what tax proposals could become law.

One of the first proposals, and one that should come as no surprise, revolves around an increase to the capital gain tax rates. The Biden Administration’s original proposal suggested doubling the long-term capital gain rate, and qualified dividends, from 20% to 39.6%. However, the Committee’s most recent recommendations reflect a more modest increase from 20% to 25% for individual filers earning more than $445,850, and married couples filing joint earning more than $501,600 (2021 brackets). Added to an existing 3.8% surtax on net investment income and the total tax bite would be 28.8% if the proposal becomes law. Worse yet, the proposed increase would apply to gains realized after September 13.

Potential Planning Strategies

Gain Harvesting – If debate in Congress pushes the effective date forward to 2022, you should consider selling your appreciated assets earmarked for sale sooner rather than later. If you were contemplating a liquidity event regardless, selling appreciated assets prior to year-end would lower your ultimate capital gains tax bill should the effective date be pushed out.

Installment Sale – Alternatively, utilizing an installment sale would defer the recognition of capital gains; but if not retroactive to the date the bill was enacted, then the seller can opt-out of the installment sale contract and take the capital gains in 2021 to avoid future tax adjustments.

Second, the American Families Plan, along with the proposed Budget and Green Book, would look to restore the top tax rate of 39.6% for individuals earning more than $400,000 or $450,000 for married couples filing joint. The top ordinary income bracket was reduced to 37% in 2018 with the enactment of the Tax Cuts and Jobs Act. There is also speculation surrounding a limitation on income tax deductions with gifting to charities or contributing to tax-deferred retirement accounts, with both being restrictive based upon their respective tax bracket. If implemented, the changes are anticipated to be effective for the 2022 tax year.

Potential Planning Strategies:

Tax-Advantaged Accounts – Maximize contributions to your tax-deferred retirement accounts, including your 401(k) and IRAs. Evaluate whether it make sense to fund a Roth 401(k) or Roth IRA (if eligible), or consider completing a Roth IRA conversion or funding a Back-Door Roth. Completing a conversion at a lower rate today will allow for tax-free growth and income for future distributions, or passing of assets tax-free to beneficiaries in your estate plan.

Asset Location – Implement and utilize an asset location strategy. Asset location strategies have been shown to increase the after-tax returns of consolidated portfolios without increasing the overall risk profile. This strategy holds tax-inefficient assets (e.g. taxable fixed income) within accounts that receive preferential treatment (traditional 401(k)’s and IRAs), while tax-efficient assets (e.g. equity) are held within taxable accounts. The overall asset allocation is maintained; however, each account has different targeted allocations to generate tax alpha in a portfolio.

Tax Alpha – Incorporate a tax optimization strategy that focuses on a providing customized, tax-efficient, and low-cost direct indexing with a quantitative tax loss harvesting approach. This strategy is utilized to maximize the after-tax return of your portfolio, while closely replicating benchmark-like performance. The tax benefit is generated through selling an investment trading at a loss, reducing your taxable gain, and reinvesting the proceeds into a similar investment to maintain your asset allocation and diversification in your portfolio. The difference between your portfolio’s pre-tax return and after-tax return is known as tax alpha.

Lastly, the Tax Cut and Jobs Act expanded the estate and gift tax exemptions in 2017, with a scheduled “sunset” at the end of 2025. The latest version of the House’s Way and Means Committee proposal would reduce and revert thresholds back to 2010 levels, from $11,700,000 currently, to $5,000,000 and indexed for inflation (closer to $6,000,000). If introduced and passed, we anticipate the exemptions to be effective as of January 1, 2022.

Potential Planning strategies:

Annual Exclusion Gifting – Individuals may gift up to $15,000 per recipient in 2021, without having any impact on their lifetime exemption amount.

Roth Conversion – Consider completing a Roth conversion to reduce the amount of assets in your taxable estate. For clients with a disproportionate amount of wealth in pre-tax retirement accounts, Roth conversions shift the tax burden from a future date into the current tax year. This improves the tax efficiency of the beneficiary’s future inheritance through providing tax-free distributions, while reducing in-estate assets by being utilized to pay for the conversion tax.

Estate Plan Check-up – Review and evaluate your estate planning strategy with your Trust Relationship Officer, Wealth Management Advisor, CPA, and Attorney to determine what wealth transfer techniques should be implemented. While there are several different approaches that can be taken, your team at Greenleaf Trust can knowledgably provide recommendations that align with your personal and financial goals.

The tax proposals by Congress are slowly progressing, but seemingly changing daily, so it is yet to be determined whether we will see a law passed later this year (or not at all). Regardless, its these types of impactful events, along with several others, that should cause you to pause and evaluate your holistic financial picture. While we don’t recommend focusing on taxes as a driver of investment strategy, we can explore and implement several tax-efficient strategies to help manage, defer, or possibly even reduce the potential tax impact of the proposed legislation. In conjunction, coupling these investment decisions with customizable estate planning techniques will further help to solidify your long-term planning decisions, while maintaining the goals and legacy you have established for your family, friends, and charities. Rest assured that Greenleaf Trust is committed to being proactive with each and every client, whether its tax law change now or in the future, we will be here for you and your family for generations to come.