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Is Your Money Protected Against a Rising Tax Environment?

Why High-Income Earners Need to Harvest Capital Gains Before December 31

There is no question that tax rates will undoubtedly be higher when you retire than they are today. How much they will rise can only be speculated as many variables will determine tax rates in the future. 

Proposed changes to tax policy, however, point to a rising tax environment.

Knowing that tax rates are on the rise is enough information, however, to take action now to safeguard your nest egg in retirement. The last thing anyone wants is to watch their retirement savings drastically depleted at the point of taking distributions because Uncle Sam gets a larger share than anticipated.

When it comes to taking appropriate action with your personal wealth, it’s always a good idea to consult with your financial advisor first. That being said, here is why I am encouraging my high-income earning clients to harvest capital gains before December 31, 2021 - and you may want to as well. 

Biden’s Proposed Tax Changes Mean Higher Tax Rates 

President Biden’s new American Families Plan tax proposal seeks to raise taxes for the wealthiest in an effort to raise $1.5 trillion over the course of a decade.

The goal of the American Families Plan is to fund expanded education, child care, paid leave, and other reforms by collecting more tax revenue from Americans who make more than $400,000 a year.

To accomplish this, top income and capital gains tax rates will rise, taxation of wealthy estates will change, and so-called tax loopholes will close with a renewed focus on audits to prevent tax evasion.

Some of the most significant changes that will contribute to a rising tax environment include the following:

  • Biden’s tax plan would raise the top income tax rate to 39.6%.
  • For taxpayers with an annual income of more than $1 million, Biden’s plan would raise the top tax rate on long-term capital gains to 39.6% — the same rate as their wages. (Including a 3.8% Medicare surtax, they would pay a 43.4% top rate.)
  • Biden’s tax plan would increase capital gains at death. Biden’s proposal eliminates the so-called step up in basis at death for any gains of more than $1 million. That means the appreciation of any unsold assets (unrealized gains) would be subject to capital gains tax upon the owner’s death. 
  • Households earning more than $400,000 of income a year would face more scrutiny from the IRS through audits with Biden’s proposed tax plan. 

Why You Should Harvest Capital Gains Now Instead of Waiting Until 2022

As of this article, Biden’s tax proposal is just that - a proposal. But if it passes in Congress as expected, his proposed tax plan would take effect in 2022. 

Harvesting capital gains lets investors reduce how much they owe in taxes and realize higher gains. 

If we anticipate that a higher capital gain tax rate is likely in 2022, it may make sense to harvest your gains now in 2021 so that you are paying the lower rate instead of Biden’s proposed higher rate. 

Keep in mind that the IRS taxes short-term capital gains like ordinary income. So, high-income single investors making over $523,600 in tax year 2021 will pay a rate of 37%. Under Biden’s proposed tax plan, these same single investors will pay 39.6%.

Long-term capital gains would be impacted even more by Biden’s tax plan. Under Biden’s proposal, the tax rate for long-term capital gains would nearly double. Investors currently pay a 20% tax rate for long-term gains made over $445,850. 

Therefore, in most instances for either short-term capital gains or long-term capital gains, investors are looking at a higher tax rate in the future under Biden’s plan, which makes harvesting capital gains in the current year more attractive.

Financial Steps to Take Before December 31, 2021

Regardless of whether or not Biden’s Americans Families tax plan passes, there are a few money moves that are always a good idea before the end of the year to help you maintain as much of your money as possible. There are many other moves financial advisors may talk about, but I find that these three are always applicable no matter the economic or political environment.

  1. Sell stocks that have lost money, aka tax-loss harvesting. That way, you can offset any capital gains and ultimately owe less taxes at the current rates.
  2.  Make your charitable contributions. This will ensure your generosity is counted toward the current tax year. And you can donate stocks or other appreciated assets.
  3.  Max out your retirement account. Pay yourself first before paying the government. Generally speaking, the funding limits on retirement accounts are annual allowances, so make sure you know those limits and dates so you can get the most out of your wealth long-term.
  4.  Consider Roth conversions. Know where your income falls on tax brackets and fill up lower tax brackets by converting Traditional IRA dollars to Roth IRA dollars. The deadline for doing these in a current tax year is December 31, so get them done while you can.

At the end of the day, taxes are rising. The cost of living is rising. Life will be more expensive later than it is right now. Knowing this, making proactive decisions with your money today can significantly impact your wealth in retirement.

What I’ve suggested here - harvesting your capital gains now rather than later - is just one micro-step in a series of micro-steps that help you build and sustain wealth for the long term. This is what comprehensive financial planning can accomplish. Know that no matter what policies get handed down from our political leadership, you can maintain control of your finances when you know the proper steps to take.