The 2020 election could have a significant effect on your finances over the next few years. There are actions you can take in the last quarter of this year to minimize your taxes now and over the next few years.
I rarely write about politics and often caution against making major changes in your finances in anticipation of, or in reaction to, an election. Most of the time, the forecasts about how an election will affect your finances are wrong or exaggerated. We could have a different situation in 2020. A lot could change by Election Day, but right now there’s a good possibility of a sweep of the presidency and both houses of Congress by the Democrats.
In addition, the differences in the policies of the parties are farther apart than they’ve been in a long time and are especially stark in taxes and other financial issues.This year, it’s not a good idea to wait for the election results before making plans. If the election ends the way polls currently indicate, income and estate taxes could increase quickly. There likely won’t be enough time to begin planning and execute a plan by the end of the year.
Democratic nominee Joe Biden issued specific tax policies he plans to implement if elected with a Democratic Congress. The estate tax would be changed significantly. The top estate and gift tax rate would be increased to 60% or perhaps higher. The lifetime exemption would be reduced. A number of estate and gift tax reduction strategies that are widely used today would be eliminated.
Capital gains taxes would increase, especially for the wealthy. The income tax brackets would change.
There likely would be changes in itemized expense deductions.Remember, in addition to these possible changes, most elements of the 2017 tax law are scheduled to expire after 2025.Most people have been waiting until closer to 2025 to decide how and when to lock in the 2017 income and estate tax benefits. But if the election out-come is similar to today’s polls, you’ll want to implement strategies by the end of 2020.
In the future, estates are likely to be taxable when they are valued at $5 million or more (indexed for inflation each year), though the exemption might decline to $3 million if a Democratic sweep leads to significant majorities in Congress.But you can take advantage of the current high exempt amount through at least the end of 2020. Some of you should plan to make gifts by the end of 2020 to remove property from your estate. You can give property directly to children or other loved ones, or you can put it in trusts.
Meet with your estate planner and have any trust documents drafted soon. Estate planners are likely to be in high demand if the election results are in line with the polls. It is better to pay to have the trust ready and not use it if the election is a surprise than to be unable to execute a plan after Election Day because estate planners are overwhelmed.In addition to a reduction in the exempt amount, a number of estate planning strategies are at risk. Some of these strategies allow you to remove the value of property from your estate while retaining some control or income. Others remove property from the estate at an estate and gift tax discount.
The strategies on the chopping block include family limited partnerships, estate freezes, grantor retained annuity trusts, Crummey trusts and more. If you, or your estate planner, have considered one or more of these strategies for you in the past but you haven’t felt an urgency to execute them, reconsider the decision. The strategies might not be available in another year or two.Capital gains taxes are likely to in-crease, especially for those with higher incomes.
Before the end of the year, you might want to sell assets in your taxable accounts that have paper losses. You always can reinvest in the assets after more than 30 days if you like the long-term prospects. By realizing these losses now and locking them in, you have a valuable asset that can shelter future capital gains that would be taxed at higher rates than today.
Capital losses you can’t deduct this year can be carried forward to future years and deducted against gains taken then.Because future capital gains taxes are likely to be higher, avoid making gifts of property that already have appreciated a lot.
The donees, also known as gift recipients, would take the same tax basis as the donor and eventually have to pay capital gains taxes when they sell the property. It is often better to keep the property in your estate. After you pass away, the tax basis is increased to its current fair market value (though some in Congress want to eliminate that rule). Your heirs can sell it and incur no capital gains taxes.Tax diversification and bracket management will be more important.
Different types of accounts receive different tax treatment. Some, such as Roth IRAs, are tax-free.Long-term capital gains and qualified dividends earned in taxable accounts are taxed at lower rates. Also, losses can offset gains in taxable accounts. Distributions from traditional IRAs and 401(k)s are taxed as ordinary income, even when the distributions are of long-term gains or qualified dividends. It is important to be sure you have money in each of these types of ac-counts. That lets you manage your tax bracket in retirement.
Each year, you will receive some income you don’t control, such as Social Security, maybe a pension, and inter-est and dividends earned in taxable accounts. A traditional IRA might have required minimum distributions.You control the sources of other income you need each year to pay living expenses. With a little work, you take money from the accounts in ways that ensure you stay in a low tax bracket.
You might decide to take some long-term capital gains from the taxable account instead of an additional distribution from the traditional IRA, for example. When you’re near the top of the tax bracket but still need additional income, you can take a tax-free distribution from a Roth IRA.As I said earlier in the year, 2020 is a good year to convert at least part of a traditional IRA into a Roth IRA. (See our July 2020 issue). The potential tax code changes after 2020 make a conversion in 2020 even more shrewd.
Pay taxes at today’s tax rates instead of higher rates in the future and ensure future earnings of the account are tax-free.
My recommendation is that very soon you start putting together a plan of the actions you want to execute by the end of the year. Hold the plan until after Election Day. If the election turns out as the polls indicate today, begin executing the plan.