5 Things to Discuss With Your Tax Advisor Before Year-End

  • Tax strategies
  • 10/26/2021
Cheerful Businesswoman Meets with Client

Key insights

  • Proposed tax legislation may affect your year-end financial plans, so review your strategies now.
  • Meet with your advisors to discuss opportunities regarding capital gains and losses as well as your approach to estate and gift taxes.
  • Review the installment method and potential benefits of opting out.
  • Determine the most tax-efficient classification for your business model.

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As we approach the end of the year, now is a good time to review last-minute actions to potentially reduce your tax bill for 2021 — and maybe even beyond. Whether you are currently contemplating when and how to transfer wealth, or whether you already have a comprehensive plan in place, the latest congressional proposals may affect your strategy going forward.

Although the final tax policies of the Biden administration are still being debated, the majority of the proposals could substantially change many Americans’ tax and financial plans. Below are five ideas to consider before year-end.

1. Make a definite plan

Set up a year-end planning meeting with your tax, legal, and financial advisors. Discuss your current situation as well as what the next few years might look like. Planning can be difficult in any given year (and this year is no exception), so assess your situation now. Lay out a specific plan with an eye toward the future to help identify potential tax savings opportunities before year-end.

2. Consider capital gains and deferral opportunities

Previous tax reform added incentives for reinvesting gains through a qualified opportunity zone fund (QOF) in certain economically distressed areas, referred to as opportunity zones. Gains can be deferred in a QOF until the earlier of the day the QOF is sold or exchanged, or December 31, 2026.

If you hold the QOF at least five years, you may be able to permanently exclude up to 10% of the deferred gain. Holding the investment at least 10 years could help you achieve permanent exclusion of post-investment appreciation in the QOF.

3. Revisit estate and gift tax planning

The budget resolution passed by the U.S. House of Representatives Ways and Means Committee includes several tax changes for estates, gifts, and trusts. Although the budget reconciliation package is still a work in progress, the amendment gives us an indication of what provisions have broad Democratic support in the House.

Under the proposal, the estate and gift tax exemption would drop to roughly $6 million in 2022. Married couples could transfer double that amount during lifetime or at death before paying a transfer tax.

Under current rules, an estate and gift tax generally applies once cumulative wealth transfers exceed $11.7 million ($23.4 million for couples) for 2021. This exemption amount was scheduled to drop after 2025, so the proposal would accelerate the exemption reduction by four years.

In addition, the primary tax benefits of intentionally defective grantor trusts (IDGT) would effectively be repealed. Under current law, assets transferred to an IDGT are treated as a gift at the time of the transfer to the trust and valued at that time for gift tax purposes. Any future appreciation of property held by the IDGT escapes the estate tax. Under the proposal, assets transferred to an IDGT are not treated as a gift. Instead, the assets remain part of the transferor’s estate and are valued for transfer tax purposes at death. This change would prevent the “freezing” of your estate with an IDGT because any future appreciation would be taxed as though you still owned the asset personally.

If you continue to transfer funds to an irrevocable life insurance trust (ILIT) each year to pay the life insurance premiums, the death benefit of the policy could be fully or partially included in your estate — and could potentially be subject to estate tax if the total value of your property (net of liabilities) exceeds your remaining exemption at death. Furthermore, existing ILITs are not “grandfathered” for future transactions. The change to ILITs would become effective the date the bill is signed into law.

Consider making gifts by the end of this year to take advantage of the higher gift exemption. If you are undecided about making major gifts before the exemption drops, talk with your advisor as soon as possible. It may take longer than you think to finalize paperwork and transfer assets, particularly because advisers are busy helping others make transfers before year-end.

4. Consider electing out of installment method for transactions closed in 2021

The House’s draft bill increases the top capital gains tax rate to 25% (28.8% taking into account the proposed expansion to the net investment income tax).

If all or part of the consideration in a sale transaction is received after the close of the tax year in which the sale occurred, the seller generally reports gain as proceeds are received under the installment method. However, the seller can elect to report the entire gain in the year of the sale.

Depending on the facts, electing out of the installment method may allow the gain to be taxed at the old rates. The election out is made by reporting the gain on a timely filed return for the year of the sale, providing an opportunity to make this decision with hindsight.

5. Evaluate tax classification of operating businesses

When you organized your business, you selected how you wanted the business to be treated for tax purposes (e.g., C corporation, S corporation, partnership, etc.). Proposed tax changes could affect the relative benefits of that choice. For example, the House Ways and Means Committee proposal for the Build Back Better Act would eliminate the 100% exclusion from certain capital gains from the sale of small business stock of a C corporation for many taxpayers. Consider what effect, if any, the proposals would have on the tax structure for your business.

How we can help

Before you implement any of these ideas, consider your personal tax situation. Our tax professionals can answer your questions regarding new tax proposals and devise a personalized year-end tax plan to help you take advantage of potential opportunities.

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