Even a fortune teller couldn’t have foreseen what a crazy 2020 was.
And it wasn’t just the pandemic. There were also wild and close presidential elections, and now the question is which party will control the United States Senate. The answer will determine what tax changes President-elect Joseph R. Biden Jr. can make.
Two runoff elections in Georgia in early January will determine whether the Republicans will hold a majority in the Senate or if the Democrats will hold 50 seats, with Vice President Kamala Harris breaking all votes.
However, the result won’t be known until early next year, making it harder to plan now what the next year might look like. So how can you make financial decisions that have significant tax implications before the end of the year?
“Regardless of whether it is income tax or inheritance tax issues, there is a common denominator for what to do and that is: what is the opportunity cost of taking action or not?” said Tony Roth, chief investment officer at Wilmington Trust.
“There are some things you can do that have a high opportunity cost,” said Roth. “Then there are other things that don’t have as potential as high opportunity costs. That is why everything has to be framed. “
In making your choice, you must consider the possibility of increasing tax rates on income, capital gains, and capital transfers as gifts or through estates in the event of death.
Here’s a look at four areas where weighing the cost of decisions could have an impact in the years to come.
Realigning a portfolio is a typical end-of-year endeavor. But this year it has a little more weight.
One of Mr Biden’s tax proposals is to raise capital gains rates – now at 23.8 percent for the highest earners – to bring them in line with income tax rates, which under a Biden administration could be 43.4 percent.
So the question is, are you going to sell now and pay the familiar tax? Or do you hold the shares until next year, hope for an increase in value after the inauguration and possibly pay a higher tax?
“It scares clients,” said Ed Renn, partner on the Withers law firm’s private clients and tax team. “It’s a doubling of the capital gains tax. Then throw in state and local taxes and the customer is over 50 percent. “
One thing to consider is when you are most likely to sell the stock. If it’s something you were up to anyway, do it now when you know what the tax will be, said Herr Roth.
“If you think there is a good chance you will sell the asset one way or another over the next four years, the opportunity cost of selling it by year-end may be relatively low,” he said.
The counter-argument is that once the exchange opens, it could be ready for another run, fueled by investors sitting on cash until they see how much Mr Biden can do. Michelle Connell, founder and president of wealth management firm Portia Capital Management, noted that a measure of available investment known as M2 is up about 25 percent year over year.
“Money has to go somewhere,” she said. “I think the markets will rise to a much higher level because there is so much liquidity on the sidelines.”
If you tend to believe this argument, the appreciation of your stock could outweigh a potential tax hike. But it is a bet that has to be right twice, on taxes and on the appreciation of stocks.
Selling a business
The decision to sell a family business at the best of times is both emotional and financial. However, there could be several factors that make this year a better time to close a deal.
The potential increase in capital gains tax is certainly a factor. With the work that has gone into building a business, it’s hard to pay 20 percent more capital gains tax. It’s also less likely that a closely held company will appreciate the way securities might perform after the inauguration.
One tax strategy that families can use to keep their businesses without involving outside investors or borrowing is to depreciate the value of the business and invest those reduced portions in trusts for heirs. With the Internal Revenue Service, business owners can typically cut reviews by around 30 percent, as outside buyers typically don’t want to pay full price if they don’t have more control than family members would keep.
But Mr Biden put the idea into practice to reduce the allowable discount, which alone would mean a lot more taxes. Add to this the potential for higher capital gains taxes and the incentive to close a sale this year is high.
“If you want to sell and maintain your business now, will the buyer pay you 20 percent more next year?” Herr Roth asked. “That’s what you need to offset the transfer tax.”
This year also offers an additional planning tool for family business owners. You can request an “as-of” assessment to evaluate the company at a specific point in time, presumably at the beginning of the pandemic, when the company value was lower.
“With the exception of internet or medical companies, most of my clients were able to receive a review as of June 1 that saw the numbers drop dramatically,” said Sarah Wentz, partner at Fox Rothschild law firm. “With the numbers back now, you can use an assessment within the last few months.”
As long as the rating is not older than six months, it is allowed by the IRS
Transfer of assets to heirs
A broader problem with the transfer of assets to heirs is the level of exemption under democratic administration. It is currently $ 11.58 million per person. This exemption is set to be reduced as early as 2025, but a new Biden government could lower the exemption faster.
“There is just so much wealth that moves,” said Ms. Wentz. “I’ve moved half a billion dollars worth of fortune in the past six weeks and I’m just a lawyer in the Midwest.”
She said she had 20 families who asked to send the full amount before the election – over $ 23 million for couples – and all but one went through it afterwards.
In this case, it depends on whether you are giving away the money anyway and how much wealth you have. If the answer to the first question is yes and you can afford to give a fortune of $ 23 million to your heirs, then this is still you.
“The theme for this year is stick to your overall plan,” said Carrie Galloway, investment advisor at JP Morgan Private Bank in New York. “It hasn’t changed because of the choice. We still advise our customers to do this sooner rather than later. We have historically high exemptions. “
Even people with lower wealth could be affected by changes in tax laws. Mr. Biden is considering changing the valuation of assets when someone dies. Currently, assets are valued at the time the person dies. However, the proposal would value the assets based on their original price. The person who inherited the assets would then also inherit all of the capital gains, Mr. Renn said.
Securing your bets
In 2012, wealthy people rushed to complete gifts by the end of the year, fearing the per-person exemption would drop from $ 3.5 million to $ 1 million or less. Instead, the opposite happened: the exemption amounted to USD 5 million and was linked to inflation. There was a giver’s remorse.
This time around, a once obscure trust relationship known as SLAT (Spousal Lifetime Access Trust) has grown in importance. It allows someone to give an irrevocable gift and takes the money from the person’s estate, but the person who gave the gift can still access it if necessary. The other spouse can then set up a similar foundation.
These trusts are a little tricky to create if you want them to stand up to IRS scrutiny. “The flexibility really is in being able to adapt to changing circumstances,” said Pam Lucina, trustee and head of the trust and advisory practice for Northern Trust Wealth Management. “It shouldn’t be seen as a way to reverse the entire plan. If you do, you will be inviting an IRS audit, adding to your complications. “
In a year of so much uncertainty, flexibility is attractive.