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Year-End Tax Planning With the Senate in the Balance

In the final days of 2020, here are some tips on planning for 2021 when control of the Senate is yet to be determined. By Daniel F. Rahill, CPA, JD, LL.M., CGMA | Digital Exclusive - 2020

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Year-end tax planning in an election year is often guided by the policies of the prevailing political party. This year, a Georgia Senate runoff race that will not take place until Jan. 5, 2021 may determine the likelihood of stimulus money, tax policy, and other actions. This race will decide control of the Senate—if the Republicans win one or both seats, they will maintain control. If the Democrats take both, they will have control of the House, Senate, and White House for the first time since 2010.

If the Democrats win, President-Elect Joe Biden’s progressive tax policies have a very good chance of making it into law. If the Republicans prevail, partisan gridlock will likely continue for another two years, hindering chances of broad stimulus programs or big tax changes.

Regardless of the outcome, here are a few tax planning issues investors should bear in mind as year-end approaches.

Planning for a Democratic-Controlled Congress

Higher Income Tax Rates

During the 2020 election campaign, Democrats proposed to raise taxes on earners with more than $400,000 of annual income, cut them for others, and raise benefits for the lowest earners. Those affected would want to deploy basic tax bracket management strategies for times of rising tax rates, such as accelerating income into 2020 by converting traditional IRAs to Roth IRAs, exercising stock options, and taking bonuses early if possible.

Limits on Itemized Deductions

Under Biden’s proposal, a itemized tax deductions would save a taxpayer with more than $400,000 of income no more than 28 cents on the dollar, even if that person’s top tax bracket is higher. In addition, itemized deductions for those with income over $400,000 would be reduced by 3 percent of adjusted gross income over a certain threshold—up to 80 percent of itemized deductions.

Affected taxpayers should consider accelerated deductions into 2020, especially large charitable donations, to take advantage of increased limits currently in place as part of the CARES Act. However, if Biden removes the $10,000 cap on state and local tax deductions, itemizers should plan to defer payments of these taxes until after the law change.

Higher Capital Gains and Investment Income Taxes

Per Biden’s proposal, individuals earning over $1 million would be subject to ordinary income tax rates on their long-term capital gains and qualified dividends. Investors with incomes over $1 million should seriously consider selling appreciated assets in 2020 as the 20 percent preferential rate for long-term capital gains and qualified dividends would very likely be eliminated. Conversely, any capital loss harvesting should be delayed until 2021 as capital gains rates would be expected to go up.

Estate and Gift Tax Changes

The current estate tax exemption threshold is $11.58 million per individual with a top tax rate of 40 percent. Biden’s plan reduces the lifetime exemption threshold by either $5 million (indexed for inflation) or as low as the 2009 level of $3.5 million per individual as proposed by the Obama administration. The tax on estates above this threshold would also increase to 45 percent.

Another significant change proposed by Biden is the elimination of the “basis step-up” at death. Currently, a future capital gains tax upon disposition of an inherited asset is based on its value at the time of inheritance, rather than the time of purchase—referred to as the “basis step-up.” Such a change would create significant practical problems with establishing the tax basis of long-held assets such as appreciated securities or a family business. Combined with the possibility that the estate tax exemption could be cut in half, taxpayers with estates worth in excess of several million dollars and with significantly appreciated assets should seriously consider a wealth transfer plan prior to year-end.

Planning for a Republican-Controlled Senate

If Republicans maintain Senate control, major tax legislation is doubtful. Among the more likely developments are an infrastructure bill and further relief packages. There are several year-end planning strategies to implement in this scenario.

Income Tax Planning

Traditional year-end tax planning would include postponing income into the following year combined with accelerating deductions into the current year. With the current itemized standard deduction amounts, a bunching strategy for itemized deductions may be effective. This strategy consists of taking the standard deduction every other year and bunching itemized deductions such as charitable contributions into the itemized year. This year may be a good year to bunch itemized deductions with higher limits on charitable contributions and a lower 7.5 percent threshold for medical expenses only available for 2020.

Health and Education Savings

Year-end planning for those with a high-deductible health plan should always include consideration for contributions to a health savings account (HSA). Taxpayers with self-only coverage can deduct up to $3,550 ($7,100 with family coverage) for 2020, and an additional $1,000 contribution is permitted if the eligible taxpayer is at least age 55. After age 65, withdrawals can be used for non-medical expenses as well. Consider an HSA as a form of long-term care insurance, which grows tax free for use during retirement. A 529 plan or Coverdell education savings account should also be considered to help ease the burden of future qualified higher education expenses. Any investment growth is federally income tax-free to the extent distributions do not exceed qualified expenses, and many states offer income tax benefits for qualifying contributions. Keep in mind, taxpayers also can use 529 plan distributions to pay up to $10,000 of elementary or secondary school expenses per student per year.

2020 has been a uniquely challenging year in many ways and facing year-end tax planning with important political questions still unanswered is just another challenge we will overcome.

Illinois CPA Society member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Services. He is also a former chair of the Illinois CPA Society Board of Directors.

This information may answer some questions, but is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained. Securities, insurance products, financial planning, and investment management services are offered through Wintrust Investments, LLC (Member FINRA/SIPC), founded in 1931. Trust and asset management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. © 2020 Wintrust Wealth Management Investment products such as stocks, bonds, and mutual funds are: NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE | NOT A DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY

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