How to minimize taxes

Consider ways to reduce income, capital gains, and estate taxes regardless of election outcomes.

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Every 4 years, we take a look at how the presidential and congressional elections may impact your personal finances: taxes, investments, health care, retirement, and more. Our analysis is intended to be non-partisan and focused on helping you plan today for potential scenarios and outcomes.

Key takeaways

  • No matter what happens with tax rates in the future, there are some moves you can consider now designed to benefit your finances.
  • If you are skipping required minimum distributions this year, as allowed by the CARES Act, a Roth conversion may save on future taxes.
  • Bunching several years of charitable donations in 2020 to make a bigger itemized deduction may impact your tax bill more this year than in the future.
  • No matter what happens with the election or future tax law changes, review and update your estate plan.
  • If you have large, concentrated stock positions, consider if it makes sense to reevaluate your diversification strategy.

Given mounting deficits and a robust election debate over taxes, many Americans are concerned about the prospect of increases to their federal tax rates on income, capital gains, and estates and wondering if they need to act now to take advantage of current laws.

"Everyone wants to know if they should be doing something, because there is just so much uncertainty about what might happen and when," says David Peterson, head of wealth planning at Fidelity. "But making kneejerk moves is never wise, especially since many of these proposals may never get enacted. You need to think about them in terms of your long-range plan. Being prepared mostly means being educated about your options."

What might happen? No one knows for sure. This election is still very much in play. And whether the Senate goes Democrat is as important as who wins the White House. At Fidelity we do not take a position on candidates or elections. What we aim to do is to lay out the candidates’ positions and a range of possible outcomes, depending on what party controls the White House and Congress, and to suggest some financial planning strategies to consider this year, no matter who wins.

Vice President Joe Biden has proposed raising federal taxes on corporations, individuals, and capital gains. A Biden administration with full Democratic control of Congress might put plans to raise federal taxes into action quickly after the inauguration, possibly making any new laws retroactive to January 1, 2021. Biden's options range from simply allowing the provisions of the Tax Cuts & Jobs Act  to expire at the end of the 2025 to making major changes to tax laws that could impact financial planning for upper income earners, investors, and anyone who is leaving assets to heirs. Most affected would be those earning more than $400,000, especially those earning more than $1 million, and those with estates over $3.5 million based on projections. But tax proposals under consideration could impact anyone from a high-income earning young executive with few assets, to a retired couple living mostly off their retirement savings, to anyone leaving their home to their kids.

State taxes play into this too, given mounting pressure on state budgets in the wake of the COVID-19 pandemic. Already, California and New Jersey are moving to raise state taxes, and others may follow.

It's also possible that the pendulum could swing in the opposite direction toward some further tax cuts if President Donald Trump wins re-election and Republicans maintain control of the Senate.

That said, without control of both Houses of Congress, big changes are less likely regardless of who wins the White House, and campaign proposals are rarely adopted in their exact form and often lack the specifics to perform pinpoint planning.

The best kind of long-range financial planning helps you today, possibly helps you out much more in the future, and leaves in you a better position than if you hadn't planned at all. To that end, here are some ways to look at the possibilities and considerations that may help you—no matter the election outcome.

Income taxes

Possible changes: If the top federal income tax rate increases in 2021, it could move from 37% currently back to what it was before 2018, 39.6%, as Biden has proposed. Also, the thresholds for the top brackets could get adjusted down to $400,000 under Biden's proposal. While certain deductions may come back into play, they could be limited at high income levels, reducing the benefit of items like very large charitable deductions. Bottom line: The impact could be significant for those currently in the top tax bracket.

Actions to consider: High-income earners 72 and older who get a break this year from required minimum distributions (RMDs) through the CARES Act might consider converting some of their traditional IRA or other tax-deferred retirement savings accounts to a Roth IRA.1 If the RMD vacation or other circumstances puts them in a lower income tax bracket than their usual one, conversion can be a rare opportunity to reduce their taxes over time. They'd need to pay income taxes on the amount converted this year, but later on, qualified withdrawals from Roth IRAs are tax-free after 59½ and 5 years of the account being open, providing more flexibility in managing their overall tax bill for years to come. Plus, Roth accounts have no RMDs during the original owner's lifetime. This is one of those moves that can make sense even if there are no changes ahead, but it would be especially beneficial if your tax rates go up in the future.

If you are thinking about exercising stock options and believe tax rates will rise, it may make sense to take some action this year to lock in low tax rates. Alternatively, if you happen to have access to a nonqualified deferred compensation (NQDC) plan at work, you may want to think about taking advantage of this year's open enrollment season to move some of next year's taxable income into a tax-deferred NQDC to either offset planned stock option exercises or just generally to reduce next year's tax bill. Of course, you'll want to make sure you have enough to live on without that money and consider other aspects of NQDC plans, so make sure to talk it through with a financial advisor.

Another move to consider this year involves charitable giving. One way of making the most of the tax deduction for charitable contributions is to "bunch" several years of planned contributions into a single year to take fuller advantage of itemizing. "You might assume if tax rates go up next year, you would benefit more from a large charitable donation, but that does not hold if at the same time deductions are capped and there are phaseouts. Actually, you would do much worse," says Matthew Kenigsberg, vice president of investment and tax solutions at Fidelity.

The caveats: Your retirement income strategy and your charitable giving are highly personal decisions that depend on a lot of different factors. You do not want to make financial moves just because you think a tax change is coming but do so because it helps you toward your overall goals. Whatever you do, make sure to work with a tax professional.

Capital gains taxes

Possible changes: Capital gains rates could go up in the future—Biden has proposed raising the top tax rate on long-term capital gains and qualified dividends from the current top rate of 20% to higher ordinary income tax rates for those earning more than $1 million a year. The top ordinary income rate is 37% currently and 39.6% (exclusive of the Medicare surcharge) under Biden's plan.

Possible actions: If you are considering realizing some gains held in taxable accounts and believe rates will rise, you may want to think about doing it this year to capture today's capital gains rates. That's particularly true if you are considering or in the process of diversifying out of a concentrated stock position, and think your income will be over $1 million in the future, perhaps due to the sale of stock, a business, or other earnings.

Higher taxes down the road might also make certain investments and rebalancing strategies relatively more attractive. "We like municipal bonds for our highly taxed clients now, but they may be even more beneficial if tax rates rise," says Jim Cracraft, senior vice president, head of portfolio engineering for Fidelity. "We believe tax-smart investment management4 is a year-round endeavor, but there can be a seasonal view. For example, we typically are less inclined to realize gains in December and prefer to rebalance in January. As we approach year-end, if it looks like tax rates will rise next year, we might be more aggressive in bringing portfolios back in line with the client's target asset mix in December."

For both taxable investments and stock options, you want to think about your overall timetable, understand your tax rates, where your taxable income falls in the tax bracket, and how the increased income fits into your overall tax picture now and if rates rise.

For the sale of a business that can't be completed this year, you may want to consider the value of an installment sale versus an outright sale to spread out the gain and defer the potential tax impact of rising rates.

You may also want to look at your charitable options, because donating appreciated stock now could provide a taxable benefit even if laws change next year. When you gift appreciated stock to a qualified charity or donor-advised fund, you pay no capital gains taxes and can write off the contribution if you itemize, with some limits. In 2019, half of all assets contributed to Fidelity Charitable®, an IRS-qualified 501(c)(3) public charity that sponsors a donor-advised fund program, were appreciated securities, such as stocks. Also, under the CARES Act, in 2020 you can deduct cash contributions of up to 100% of adjusted gross income (AGI) that are made to a charity (but not to a donor-advised fund).

The caveats: You may be tempted to realize gains on highly appreciated stock you want to hold for the long term, and then buy it back later at a higher cost basis. This strategy could work for some. But for others, paying taxes early on some gains could end up reducing after-tax returns over the long term.

“Don’t let the tax tail wag the investment dog,” says David Peterson. “You should be buying and selling based on your view of the long-term value of the assets, not based on the tax consequences.”

Estate taxes

Possible changes: The changes proposed in the estate area could be significant, especially for higher net worth families. At the top of the list is the current federal estate tax exemption amount of $11.58 million for an individual (double for a married couple), which under current law is set to sunset in 2026 and revert back to prior amounts, adjusted for inflation. Biden's proposal could further reduce this amount. This would change the planning calculations for many families.

Further, Biden has proposed repealing the step-up in basis at death for gifts, which means that these assets would be subject to capital gains taxes based on their original purchase price not the price at death. It's possible that Democrats would require that bill to be paid at death versus when your heirs sell the property, but it is unclear whether a tax credit against any estate tax due would be allowed. That would affect anyone who plans to pass on appreciated assets, from a family home to a stock portfolio.

Actions to consider: Review your needs and goals. Estate planning for years has leaned toward setting up a plan for your assets to pass to heirs after your death, but if the taxation changes, the focus could shift to spreading out gifting of an estate over a longer span of time while you are still alive, either outright or with the help of a variety of trusts. You can give up to $15,000 a year ($30,000 for married couples) to anyone without affecting your lifetime gifting limit of $11.58 million for individuals ($23.16 million for married couples), which can add up. You can also pay for a loved one's tuition or health care costs directly, without impacting your lifetime giving limit. And there are different trust options to consider. Many, however, will be irrevocable, meaning they are difficult to change once established. You may want to set up the trust structure you desire now and then take the step to fund the trust later.

Another strategy to weigh if the step-up in basis is ultimately eliminated: buying life insurance to cover estate taxes that may be owed at death.

The urgency here is that estate planning takes time—you must think through what you want, which is difficult for many people. You then need to engage financial and legal professionals, who get very busy at times of uncertainty. No matter what happens with the election or potential tax law changes, reviewing your estate planning needs is one of those tasks that's best to do sooner rather than later.

The caveats: Once you give money away or fund an irrevocable trust, you can't control it, so be sure that it's what you desire. You want to test your plan to make sure you have the assets and income you need for your own retirement. You also may want to test the water with your heirs to make sure they can handle the responsibility of managing the potential tax payments for the assets they will inherit.

With all financial planning, it's important to make sure to think and plan for the long term. It can help to consult with a financial planner and a tax professional for support in assessing your own future needs and setting the right course, no matter what happens to taxes.

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