It is never too early to start planning tax reduction strategies. While a number of changes to the tax code are being debated in Congress, taking time to review your financial plan now can help you save on taxes in 2021. Here are a few areas to explore with your wealth advisor.
1. Take Advantage of Long-Term Capital Gain Rates
Selling an asset — such as a stock, bond or shares in a mutual fund — when held for longer than one year means a preferential tax rate of only 0%, 15%, or 20% will be applied to the capital gain, depending on the investor’s income level. These tax rates have the potential to help the investor, as they are encouraged to buy and hold securities for a longer period of time.
Conversely, if an asset is held for less than a year before selling, the capital gain is taxed at ordinary income rates, which are much higher in most cases.
To grow wealth over the long term, it is to your benefit to understand the difference between long-term and short-term capital gains rates. For 2021, you will apply one of three tax rates for long-term capital gains – 0%, 15%, or 20% – which is based on your total taxable income. For example, a married couple filing jointly would pay 20% on their long-term capital gains if their taxable income is above $501,600; and for single filers if income is above $445,850. Keep in mind that capital gains are included in a 3.8% net investment income tax when your modified adjusted gross income is more than $250,000 (married) or $200,000 (single). This means that your total tax rate will be higher if your income exceeds these thresholds.
2. Maximize Your Retirement Contributions
Making contributions to employer-sponsored retirement plans or personal IRAs can help reduce tax obligations. For calendar year 2021, the limit for contributing to a 401(k) is up to $19,500 for those under age 50, and $26,000 for those 50 and older. Self-employed individuals can contribute up to $58,000 per year to a solo 401(k).
The 2021 traditional IRA contribution limits are $6,000 for individuals under age 50 and $7,000 for those 50 and older.
3. Consider Charitable Contributions
To encourage the continued support of charitable organizations, the adjustments to itemized donations enacted in the 2020 Coronavirus Aid, Relief and Economic Security Act (CARES) still apply in 2021.
You can deduct cash contributions up to 100% of your adjusted gross income (AGI) under the CARES Act, up from the standard 60%. These limits do not apply to contributions to donor-advised funds. You can deduct up to 60% AGI in cash and up to 30% AGI in appreciated assets when contributing to donor-advised funds. If your donations exceed your AGI deduction limits, you may carry forward excess deductions for up to 5 subsequent tax years.
Another opportunity to gift to charity is through an IRA qualified charitable distribution (QCD). Individuals age 70½ and older may donate up to $100,000 from their IRA and gift directly to charity without recognizing the distribution as taxable income.
4. Review Estate Planning Gifts
The gift and estate tax exemptions increased in 2021 to $11.7 million for individuals and $23.4 million for a married couple. Estates valued more than this amount are generally taxed at the top estate tax rate of 40%.
Keep in mind that an additional amount each year can be gifted without incurring gift or estate taxes. This annual exclusion remains at $15,000 per person in 2021. For example, a married couple with four children could give their children a total of $120,000 each year ($15,000 from each parent to each child) without owing any tax and without it counting toward the lifetime exemption.
It is also worthwhile to note that when trusts are used for estate planning, many are taxed as legal entities. For trust and estate income above $13,050, the tax is $3,146 plus 37% of the amount over $13,050.
There are other possible tax changes on the horizon. For instance, President Biden’s administration has proposed:
• Increasing tax rates for those whose income exceeds $400,000.
• Discontinuation of preferential rates for qualified dividends and long-term capital gains for those with more than $1 million in income.
• Capping itemized deduction benefits at 28%.
• Removal of some tax treatments in real estate.
• Decrease the current tax exemptions for gift, estate, and generation-skipping transfer tax.
It is recommended to wait until tax law is certain before building a final plan. Designing an income tax strategy is complex and should involve your professional team. Contact your wealth advisor to explore how tax planning in 2021 can benefit you.