With 2021 just around the corner, you may be thinking about New Year’s resolutions and setting goals for the year ahead. The IRS recently released the 2021 planning limits which we will incorporate into your plan. Additionally, with a new administration taking office, we wanted to highlight some of the proposed changes in tax laws and how this might impact you if they go into effect. Most financial professionals are predicting the major tax changes would not go into effect until 2022, but after this year, we’ve all learned that change could happen at any moment and it’s best to be prepared.
New 2021 Retirement Plan Contribution and Gifting Limits
Let’s start with some good news: you will not need to waste any mental energy memorizing new limits for 2021, as the IRS has confirmed that employee contribution limits to 401(k)s, 403(b)s and IRAs remain unchanged for 2021. The annual exclusion gifting limit and the Federal estate tax exemption amount also remain the same. H.S.A. contribution limits increased slightly, along with the standard deduction. As we plan for 2021, here are the maximum contributions limits to keep in mind:
How Tax Rates are Expected to Change in the Coming Years
As President Elect Biden prepares to take office in January 2021, one of the outstanding questions on the minds of many Americans is not so much whether the new administration will plan to increase taxes, but when the tax increases could be implemented and approved by Congress.
The 2018 Tax Cut & Jobs Act (TCJA) made substantial changes to tax law when it was implemented. In order to comply with budgetary constraints at the time, the TCJA contains a “sunset,” or an expiration date, for many of its provisions. This means several rules that reduced taxes are scheduled to end at the end of 2025, including changes to the income tax rates, standard deductions, itemized deductions, and estate taxes.
The new administration could potentially enact changes to tax laws effective as early as 2021, however, the majority consensus believes the likelihood of retro-active rate changes to January 2021 is low. We will continue to monitor through 2021 and update tax planning depending on how things are trending in 2022 and beyond. A few of the anticipated changes and planning opportunities we are closely monitoring are outlined below.
Increased Income Tax Rates
The anticipated increases to income tax rates are most likely to impact individuals or families with over $400,000 of income. The proposed highest Federal rates would jump back to 39.6%, the same level as before the 2018 TCJA.
Planning: If you anticipate income in future years being over $400k, it might make sense to consider making Roth conversions or IRA distributions to accelerate income while in a lower tax bracket. If you are a business owner, you may consider speaking with your accountant about accelerating billing and income recognition to the lower tax year and/or postponing certain expenses to higher tax-rate years.
Capital Gain Tax Rates
The long-term capital gains for many investors are currently taxed at preferential rates of 15% or 20% with a 3.8% Medicare surtax. One proposed change to tax rates impacts future long-term capital gain rates for taxpayers with incomes over $1,000,000. At this level, long-term capital gains would lose preferential treatment and be treated as ordinary income.
Planning: If you are anticipating withdrawing funds or recognizing gains in the next few years, you may consider accelerating capital gains when possible. We are not recommending wholesale liquidations of appreciated assets, but if you know capital gains on current assets will need to be recognized in 2021 or 2022, it may be worthwhile accelerating some of these gains to 2020 and 2021 under the lower, known long-term tax rates. If the legislation for higher capital gains rates passes, we anticipate installment sales of businesses or property may become more popular to help keep annual income under $1M.
While the TCJA reduced certain amounts of itemized deductions that could be claimed (such as a limit of $10k on state income and property taxes), under Biden’s plan there could be a further cap on the value of itemized deductions which could be limited to the 28% tax bracket.
Planning: If you are planning on making charitable contributions in the future and anticipate having income over the 28% tax bracket, we would suggest bundling and accelerating your charitable gifts in order to receive the most benefit under the current tax laws.
Perhaps one of more controversial items being proposed by the administration is the elimination of the step-up in cost basis upon death. This means that when a family member dies, the cost basis of assets is not adjusted, which could result in less after-tax money being left for the spouse or heirs.
The other notable proposed legislation is rolling back the TCJA exemption from $11M per person to pre-2018 levels of $5.85M per person ($5 Million indexed for inflation). In all likelihood, the elimination of the step-up in basis is likely to be accompanied by an exemption amount (resorting back to 2010 levels)*.
Planning: If the step-up in basis goes away, gifting of securities to charity or family becomes even more important to the plan. We would also want to consider whether to hold appreciated securities in perpetuity or whether it makes sense to sell during an investors’ lifetime. Of course, if your net worth is over the proposed future estate exemptions, we’ll want to work closely with your estate planning team to determine whether there are additional estate planning strategies that should be considered.
Figuring Out Your New Year Planning Opportunities
Your Paracle Team is closely monitoring future tax and estate planning changes. Please reach out if you have any questions, thoughts, or concerns on how your plan may be impacted, and we can work with your CPA and estate planning attorney to revisit your strategy.
Thank you for your continued support of Paracle and the trust you place in our team. We look forward to 2021 with great optimism for the health and financial security of you and your family.
Paracle Personal Financial Management is an independent financial planning firm founded in 2004 with an honest desire to help people optimize their finances by providing unbiased financial planning and investment advice that puts their clients first. Paracle specializes in delivering expert, comprehensive wealth management services to busy families. Their expertise integrates financial planning with investment management to ensure their clients experience confidence in every aspect of their plan so they can focus on what matters most. To learn more about Paracle, connect with them on LinkedIn.