The watchword for wealth management in 2021 is uncertainty. With potential tax changes on the horizon, questions over which asset classes will fare well, remain flat or falter abound and permeate nearly all aspects of wealth management and investments.
As always, helping clients navigate this environment requires clear and direct communication and an organized approach. There are a wide range of considerations, goals and preferences to discuss. But in terms of taxation, the following four focus areas will likely be relevant for the widest swath of clients.
1. Realization of short- and long-term gains and losses
Deciding when to sell an asset to recognize taxable gains and losses can be tricky in any environment. First, an investor must have a view on current vs. future income to determine whether to take a gain or loss in the current year or defer it to the next. They must also pay close attention to the nature of the asset: is it only the excess gains or losses in a given individual category of assets — short term or long term — that can be used to offset gains or losses in that same category of assets?
But this calculus becomes even trickier amid uncertainty over a potential increase in the capital gains tax rate. The Biden administration seeks to increase this rate
Timing is everything. In our view, it is highly unlikely that any action will be taken until at least the fall of 2021. Moreover, it is doubtful that any change to the capital gains tax rate will be retroactive. In any case, investors and their advisors need to have a discussion as to the risks and opportunities presented by
2. Charitable donations
Philanthropy is a goal for many investors in any market. But in an environment of shifting tax rules and rates, charitable strategies require careful consideration.
With the sharp uptick in markets over the past years, many investors may find themselves holding low basis, highly appreciated securities. Donation can be far more tax efficient than selling and then donating the proceeds — but recognize that the rules differ depending on whether the securities are publicly or privately traded.
When an appreciated public security is donated, the rules are relatively straightforward: donating the asset avoids any capital gains tax. This means the value of the donation is actually 20% greater than it would have been otherwise; 28% greater if and when the capital gains tax increases.
Clients may also donate highly appreciated private securities. However, the rules here are more complex and can be administratively burdensome. So before donating any private securities, an advisor needs to make their clients aware of additional steps and apprise them of the rules to avoid risks and pitfalls.
Finally, clients should look closely at
3. Domicile change
Digitization across the global economy has made it easier for people to live and work where they choose, a trend that has accelerated exponentially during the global pandemic.
Many clients are working remotely and have moved from high-tax jurisdictions to locations with low or no state taxes. Such a shift has the potential to greatly impact investment results and strategies.
For clients who have relocated, advisors can begin by helping determine whether they are able to announce and document this shift. By clearly establishing the new primary residence, an investor has a better chance of refuting claims on income made by the state or city officials from the former residence.
From there, the discussion should turn to the mix of assets in the portfolio. For example, tax-free municipal bonds that might have once made sense while living in a high-tax state may no longer be preferable to other taxable securities.
4. 529 college plans
529 college plans, available in every state, allow an individual investor to donate up to $15,000 per year for each beneficiary. This is essentially a gift, so the $15,000 figure is governed by the gift tax limit and as such can increase to $30,000 per year if coming from a married couple. The money is invested and will be free of both income and capital gains taxes when accessed at a future date to pay for tuition, books, room and board and other stipulated expenses.
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Those with truly high-net-worth assets or those experiencing a particularly lucrative year may be in a position to take advantage of another key provision within 529 plans and consider super funding a 529 plan. Specifically, investors are allowed to make contributions using five-year gift averaging. This not only reduces taxable income for the donor in the current year, it offers the recipient five additional years for the fund to grow.
Note that there is an aggregate limit to how much can be invested in such a plan and that this amount varies by state. However, one possible option is to open 529 plans in multiple states.
The above list is by no means exhaustive. There are numerous additional circumstances and investor interests that need to be part of the conversation. But in an environment in which tax rates and policies remain uncertain, we think these are some of the most broadly applicable considerations that should be a key part of informed client discussions.
