Corbin M. Donaldson, CFP®

Wealth Management Advisor

‘Tis the Season…

We are quickly approaching the end of 2020, and like most, frantically preparing for a season filled with friends, family, and festivities. This year might have a different twist, but the preparation likely remains the same. Like most Michiganders, it’s that time of year where we confirm our Amazon accounts are set-up for two-day shipping and our snow blowers are in optimal working condition for that first winter storm. Winter is coming, and just as we prepare for the ensuing next several months of winter, we must also fine-tune our year-end tax planning strategies before we close the books on 2020. Here at Greenleaf Trust, we recommend, depending on your unique circumstance, considering several different year-end strategies, including consideration to Roth IRA conversions, tax-loss harvesting techniques and estate planning strategies.

Roth IRA Conversion

Benjamin Franklin stated that “two things in life are certain – death and taxes.” While a Roth IRA conversion does not escape the first certainty, it does provide you the opportunity to take advantage of historically favorable income tax rates. A Roth conversion strategy is a particularly powerful tool because of its ability to reduce your annual required minimum distribution (RMD) and allows for your assets to grow tax free. You are required to pay ordinary income tax on the conversion amount in the year of conversion; however, lower tax rates now translate into lower conversion costs from traditional IRA assets to a Roth IRA. The CARES Act passed in 2020 also waived RMDs for the year. With the ability to forgo taking an RMD from your traditional IRA in 2020, thereby reducing your taxable income, it may provide additional capacity to cost-effectively convert to a Roth. Additionally, Roth IRAs are not subject to RMDs during your lifetime and provide greater flexibility on how the assets are inherited, given no taxable implications are incurred by heirs since the tax was paid at conversion.

Tax-Loss Harvesting

In addition to the Roth Conversion strategy, Greenleaf Trust pays special attention to capital gains and the ensuing impact on the portfolios of our clients. We are intentionally focused on optimizing after-tax, after-fee returns through the utilization of tax-loss harvesting not only at year-end, but throughout the entire year. This strategy starts from the ground up with the construction of the portfolio, uniquely designed and tailored to match the goals and objectives of our clients. With intentionality, we allocate tax-efficient assets, such as exchange-traded funds (ETFs), within taxable accounts, while designing qualified accounts with tax-inefficient assets, such as fixed income investments yielding ordinary income. Qualified accounts shelter the impact of tax-inefficient assets as they are not subject to capital gains and accumulate on a tax-deferred basis. This strategy is commonly referred to as asset location. This strategy is regularly recommended to our clients due the after-tax impact on the return without comprising the desired level of risk in the portfolio.

Charitable Giving with Cash From Your Tax-Deferred IRA

The introduction of the CARES Act gave taxpayers new opportunities for charitable giving in 2020. One of those advantages was the increase to contribution limits for cash gifts made directly to almost all public charities. In previous years, gifts of cash by an individual to charities were limited to 60% of the donor’s adjusted gross income (AGI) for the year. Exclusively for 2020, the CARES Act eliminated the 60% limitation for cash gifts to charities, allowing for deductible cash gifts up to 100% of an individual’s AGI. Those who are between ages of 59½ and 70½ years old and have an IRA that they intend to bequest to a charitable beneficiary can generate valuable tax and charitable benefits. Somewhat of a younger-person’s Qualified Charitable Distribution (QCD) for this year only, individuals who intend on fulfilling a bequest for a charitable beneficiary should utilize a cash donation indirectly from their IRA.

For example, John, who is 65 years old, distributes $100,000 from his IRA on November 4, 2020, and writes a check to a public charity on December 15, 2020. John’s AGI is $300,000 and because the limit for charitable gifts of cash is 100% for 2020, John deducts the $100,000 from his $300,000 AGI at tax time. Not only does the indirect cash gift from John’s IRA provide a benefit to him in 2020, but also provides a future benefit in the form of reduced required minimum distributions, and therefore, tax liability.

Qualified charitable distributions continue to remain an effective and powerful tool, allowing individuals age 70½ and above to continue to charitability distribute up to $100,000 directly from their IRA. However, for those between the age 59½ and 70½ who are charitably inclined, a cash gifting strategy proves to be the most effective route for 2020.

Education Savings through 529 Plan accounts

For those of you with children or grandchildren, 529 savings plan provide several competitive advantages for funding future educational expenses. Funding a 529 plan provides the ability to remove assets from your estate for future estate tax calculations, while potentially receiving a state income tax deduction (depending on your state of residence). You have the ability to gift up to five years of your annual exclusion amount of $15,000 per beneficiary, for a total of $75,000 as an individual or $150,000 if you are married. Earnings in the account grow free of federal income tax and distribute tax free when used for qualified education expenses. The definition of “qualified education expenses” were expanded to not only include your standard tuition, and room and board, but now can be utilized for laptops, computers, and related equipment. The ability to take a state income tax deduction, coupled by the ability to reduce potential estate tax are important considerations. Most important is the ability to fund the future education expenses of your children and grandchildren.

Election Driven Solutions:

With the 2020 election coming to a close, and still being in the thick of a global pandemic, we find ourselves in a unique position of traversing unchartered waters. Former Vice President Joe Biden is proposing six potential tax increases and changes that primarily impact those individuals and families whose income exceeds $400,000.

Restoration of the pre-Tax and Jobs Act rate of 39.6% for those in the highest marginal tax bracket (currently 37%).

Individuals with income over $400,000 will be subject to social security tax of 12.4%. Currently, there is a wage cap of $137,700 on the 12.4% social security tax split evenly between employers and employees.

Pease limitations, which reduce the value of itemized deductions for high earning taxpayers, will cap itemized deductions to 28% for individuals earning $400,000 or more annually. Pease limitations cap the value of itemized deductions for taxpayers based upon their AGI and are proposed to reduce the deduction by three percent of every dollar exceed $400,000. Pease limitations were suspended until 2026 under the Tax Cuts and Jobs Act (TCJA) reform in 2017.

For individuals and families with income that exceeds $1,000,000, long-term capital gains above that threshold will be taxed at ordinary income tax rate of 39.6%.

Proposed elimination of the commonly referred to step-in basis law. Inherited assets currently receive an income tax basis adjustment to the fair market value of inherited assets as of the date of death.

Proposed reduction of the federal estate and gift tax exemption to $3,500,000 from its current level of $11,580,000 and increased top rate for estate tax to 45%.

The proposed Biden tax changes provide a few big-picture take-ways that are important to highlight. First, for high income earners, gain harvesting in 2020 may become more important to complete prior to year-end, assuming tax rates will increase effectively in 2021. Second, loss recognition could become more valuable in 2021, as higher tax rates on capital gains, and a lowered threshold for the highest marginal tax bracket will impact tax planning strategies. The bunching of charitable gifts, and the use of QCDs, and charitable remainder trusts may make sense to complete in a single year to reduce taxable income.

President Trump’s blueprint for a second term is speculated to remain consistent with current tax law, as the visibility of any proposed changes is somewhat limited. A few of the key items President Trump has proposed focuses on reducing taxes for the middle class, reduction in long-term capital gain rates, and a potential tax credit for domestic travel expenses. At this point, we don’t have a clear definition of what changes or updates will be made for President Trump’s second term in office.

Implementing tax-efficient planning strategies provide a competitive advantage when evaluating the after-tax, after-fee returns of a portfolio, and equally important, the reduction of potential tax liability of your estate. We’re committed to providing uniquely designed approaches specific to the goals of our clients and proactively examining the impact of the changing economy, market and political arena. While several of the strategies introduced in this article are impactful, we understand the planning for year-end 2020 could change depending on the introduction of new policies. However, just as we’ve adjusted our snowblower settings to combat that first Michigan snow storm year after year, rest assured that Greenleaf Trust will be adjusting our year-end planning strategies to fit the uniqueness of each and every client.

COVID-19 Updates

As of January 24

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