Too often, we find clients have not matched their asset ownership and beneficiary designations to their estate plan documents or not updated those documents for changes in circumstances. This can cause problems, like having to file with the probate court at death, having the wrong person in a key role or even paying unnecessary estate taxes.
Here is an example on an ownership error: the couple owns most assets jointly. This means that their revocable trusts are never funded so they will fail to use the available estate tax credits at the first death, and they will probably pay more estate taxes at the second death than they could have. Having assets pass to a spouse may simplify their life but that may cost their children more in estate taxes.
Another example would be owning assets individually rather than in a revocable trust. This means the personal representative must file with the probate court to transfer assets. If all assets were owned by the trust instead, the time and expense of a probate court filing would be avoided, and survivors would have the benefit of the assets in the trust immediately. An alternative would be placing transfer on death or TOD instructions on bank and investment accounts, much as one provides beneficiary designations on IRAs.
Finally, if your relationships with the people named in your will and trust have changed, not updating could mean the wrong people are involved in your estate when you die, leaving a mess for your survivors.
As we mentioned in a prior e-mail, Massachusetts changed the estate tax law last year, so we now have a true exemption of $2 million. This may tilt your approach more toward planning to avoid capital gains rather than estate taxes. Regardless, please be sure that your asset ownership and designations work with your documents.
As we gear up for tax season, here is a collection of thoughts and suggestions:
As noted previously, the TCJA expires after 2025, so we encourage planning for all those changes. For some ideas, see our post on turn tax planning on its head for income taxes and see this post on estate planning.
When you work on your IRS form 1040 for 2023, how do you plan to answer the question on digital assets? That question has changed over the years and now reads:
At any time during 2023, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, gift or otherwise dispose of a digital asset (or a financial interest in a digital asset)?
2023 form 1040
Some tax pros think this question covers items such as a ticket for events like the Super Bowl, as these are non-fungible tokens, or NFTs, being unique and recorded in digital ledgers. Therefore, if you purchased such an NFT, you need to answer “yes.” When in doubt, saying yes may be the best response.
We reported that the SECURE Act 2.0 allows for unused 529 plan contributions to go into a Roth IRAs. Here is a planning suggestion for parents and grandparents: start early with 529 plan contributions so that there is a surplus over college costs that can be converted to a Roth later, within the limits.
There are also some significant cases before the Supreme Court we are watching, including the Moore case on unrealized income.
The IRS continues to deal with a huge backlog of mail to process, including many amended returns. They say that this is due to prioritizing answering calls over processing during the Pandemic.
And the IRS warns again to be wary of phishing attempts by phone, e-mail and text. They have a page on phishing and how to respond.
With the federal gift and estate tax exemption nearing $13 million, a married couple can have close to $26 million in their estates before any federal estate tax would be due. That leaves only a small percentage of people in the US who actually need estate plans focused on avoiding estate taxes. Those who are comfortably below the threshold can instead focus their plans on reducing income taxes.
Estates get a step up in basis at death, so that assets do not pay both estate and income taxes. For example, the house owned by a couple often has a low basis, so taxes will be due on sale. When they die, they get a step up in basis, eliminating that gain and the corresponding income tax that would be due at death.
To illustrate, here’s an example: a married couple own a house worth $2 million for which they paid $500,000, they have $2 million in retirement accounts and $5 million in broker accounts. Their combined estate of $9 million is well below the federal exemption of nearly $13 million per person, so no federal estate taxes will be due. They have $1.5 million of gain if they sell the house, of which $1 million would be taxed after applying the $500,000 exclusion on the sale of a principal residence.
If they have the standard estate plan, they will have revocable trusts that use the state and federal estate tax credits at both the first and second deaths. If proper elections are made, no estate taxes will be due at the first death and no federal estate taxes at the second death. They will also get the step up in basis.
But what if one spouse dies many years later? The half with the step up at the earlier death could now be subject to taxes on gain when the heirs direct the estate or trusts to sell. If the house is then worth $4 million, the half in the trust of the first to die has new gain of $1 million on which income taxes will be due.
If instead of having half the house counted at the first death, what if it is treated as passing to the survivor? Then there is a full step up at the second death, with no gain. And they have not traded capital gains for estate taxes. While assets are counted in the second estate, rather than using the exemption at the first death, the first estate can make proper use of the deceased spouse’s unused exemption or “DSUE.” Since 2012, federal law allows any portion of the gift and estate tax credit not used in the first estate tax filing to be carried to the second spouse’s death or “ported,” if the proper election is made. This “portability election” for the DSUE is made on the estate tax return.
But what happens when the federal credit drops back down in 2026 to the old amount as scheduled, which, after adjusting for inflation, is expected to be around $7 million? The estates for the couple in our example still avoid federal estate taxes, using the DSUE of up to $7 million from the first death and the $7 million credit at the second death.
Planning for state estate taxes may be necessary (for Massachusetts residents, the trusts can be used to shelter $1 million, the maximum credit). And you may want to use trusts to control who gets access to the estates and when. Also, you may need to plan for the generation skipping transfer tax or “GST” tax, which requires use of trusts and proper elections at death.
If your net worth is enough to need estate planning but you do not expect to owe federal estate taxes, then your plan can address avoiding capital gains and use the DSUE to ensure that estate taxes are still avoided.
Note that Massachusetts increased the estate the exemption from $1 million to $2 million as of January 1, 2023. This may affect your planning.
We are told to act before year end because it is our last chance to have an impact on our 2022 taxes. Planning throughout the year could be even better, if you recognize when to act, but most of us are pulled in so many directions that it is hard to organize and act until there is an external pressure, such as the looming end to the calendar year. So, when you are ready to take stock of your situation, you can make the planning effort even more productive by reviewing your investments, estate plan, and finances, not just your taxes – consider it a “financial checkup.”
Overview
This year, there are changes that occurred due to inflation as well as legislation. While we had expected tax increases, none materialized (there may still be tax law changes, but legislation such as the “SECURE Act 2.0,” child credit and tax extenders all remain in flux). We review the changes that did occur before turning to actual year-end tax planning strategies.
Impact of inflation
Is there ever a good side to inflation? Perhaps the IRS adjustments to several tax-related thresholds that change for 2023 count, such as these:
The standard deduction MFJ $27,700 up from $25,900
The gift and estate tax credit $12.92 million from just over $12 million
The annual gift tax exclusion $17,000 up from $16,000
401(k) maximum contribution $22,500 plus $7,500 (for over 50)
IRA max. $6,500 plus $1,000
SEP-IRA max. $66,000
The tax brackets at which rates increase have also gone up, so more is taxed at lower the brackets.
Inflation Reduction Act
The Inflation Reduction Act passed this summer and included changes to tax laws regarding energy saving credits. The Act also contained other provisions, such as the 15% AMT for C corporations and 1% stock buyback tax. It’s unfortunate that the abbreviation for the act is IRA, as we already have that in our tax lexicon.
Beginning in 2023, this new law changes conditions for obtaining the $7,500 credit for new electric vehicles (EVs) and adds a $4,000 credit for used EVs (EVs that are 2 or more years old). The Act also expanded the reporting requirements for the credits on your tax returns. Finally, EV buyers can monetize the credit at purchase to reduce the sale price, rather than wait for their tax filing. Remember there is also a credit for installing a home charger.
To obtain a credit for new EVs, the battery’s minerals must be extracted or processed in the US or a free-trade partner. The battery must also be manufactured or assembled in North America. Final assembly of the EV must be in North America. There are price ceilings on EVs and income limits on claiming taxpayers.
The Act extend and expanded home energy credits but also expanded the reporting requirements.
Tax planning
Start with this goal: to lessen the total tax due in 2022 and 2023 combined. Usually that means delaying income to 2023 and accelerating deductions to 2022. For 2022-2023, the jump in the standard deduction could mean losing itemized deductions in 2023, so pay special attention to what you can shift to 2022. As we pointed out our post for 2021 year-end planning, if you are concerned about future tax rate increases, you can use a Roth Conversions to bring future income into 2022.
Now to the planning: Can you act at all?
Each year, we advise that you be practical, focusing on where you can actually make moves. For many, the high standard deduction (which is even more for over age 65 taxpayers) means you will not itemize (i.e., your total for itemized deductions is less than the standard amount so you take the higher standard deduction). And, if you are not itemizing, you have fewer ways in which to affect change in the taxes due in either year. If you can itemize, you have more tools for planning.
Tools – income
You can reduce taxable income by maximizing your retirement contributions with your employer via 401(k) or 403(b) plans and IRA contributions if you are below the thresholds. If you are self-employed, you can contribute to your own qualified plan such as a SEP-IRA.
You may also be able to contribute to a health savings or flex account. Be sure to see to use any flex account balances before they expire.
Review your investments to see if you can take losses to reduce capital gains and up to $3,000 of ordinary income. ax loss harvesting reduces net taxable capital gains, but be sure not to run afoul of the wash-sale rule.
Tools – deductions
Review your unreimbursed medical expenses, which you can deduct if the total is over 7.5% of your adjusted gross income.
State and local taxes are capped at $10,000, so you may not be able to shift much between years. And it is difficult to accelerate mortgage interest on first and second homes.
Often, the place for the most change is in charitable deductions, where you can bunch two- or three-years’ worth into a single year so you can itemize. You can use a donor advised fund (“DAF”) to bunch, by contributing all in one year, then having the DAF send annual amounts. Also, you can transfer up to $100,000 from a traditional IRA directly to charity if you are over 70½. Note that Congress has not extended the $300 above the line charitable deduction.
Before you finish, check withholdings and estimates paid
Especially if you increase income in 2022, review your total paid to the IRS and state via withholdings and estimates make sure that you meet the safe harbor rules. If not, you could owe interest for under-withholding.
And remember your estate plan review
As noted above, the federal gift and estate tax credit is close to $12 million for 2022 and increases to $12.92 million in 2023. If you have excess wealth, you may want to gift while you can, especially if you want to use certain trusts, like a GRAT or QPRT. For more on estate planning updates, see our estate planning checkup post.
If you do review your estate plan documents, also review beneficiary designations and asset ownership to make sure everything is current and flows correctly.
Summary
As you review your 2022-2023 tax planning, determine what you can shift and project the impact. Then follow through on the details.
Let us know if you have any questions.
Good luck and best wishes for happy and healthy holidays!
Many of the expected tax law changes have not materialized, but legislation remains in flux. This means we plan year-end moves while we continue to monitor new legislation. It is safe to bet that income tax rates will rise over the next several years. This may mean putting year-end tax planning on its head, where you increase taxable income for 2021. The goal is to lessen income ultimately taxed in future years. However, you may not want to delay taking deductions until 2022 (so planning not completely on its head?) For the standard approach, see our 2020 year-end post.
Roth Conversion – One way to increase income now, avoiding future income, is to convert part of an IRA to a Roth IRA, converting from taxable to non-taxable distributions in the future. Decide on the amount to convert by projecting the impact of the conversion on your marginal tax rate. Converting to a Roth also saves you from required minimum distributions, RMDs, in future years (but non-spouse beneficiaries still face the 10-year limit from the SECURE Act on IRA distributions).
Back-Door Roth – Along with converting, the “back-door Roth” is still available, at least for 2021, so you can put more retirement funds aside with no tax on future distributions. That is, for those who cannot contribute to a Roth due to income limits, they can contribute to a non-deductible IRA and then convert that IRA to a Roth IRA. If you have other IRAs, that may affect the amount that is taxed, so review this carefully first to see if it still makes sense.
More income – Other ways to increase income for 2021 include billing more for your S Corp., LLC or partnership in 2021, exercising stock options, and selling ESPP shares.
Capital gains – You probably do not want to accelerate capital gains, as those should still be tax at a lower rate in future years.
On to other considerations: first, SALT deductions
The limit on state and local taxes, or SALT, may increase from $10,000 to $80,000. Also, a number of states have created pass-through entity elections so that the S Corp., LLC or partnership pays the tax and deducts against the income of the shareholder/member/partner. This way, their net federal taxable income is reduced, and they get a credit for the payment on their personal tax returns.
The SALT changes may affect your itemized deduction strategy if you are bunching.
Check the details
Declare Crypto – If you had any crypto currency transactions during the year, selling, buying or receiving, be sure to declare on your federal 1040 filing.
Unemployment tax – Remember, unemployment benefits are fully taxable for 2021, so be sure you withheld taxes or paid estimates.
Charities – If you cannot itemize, you still get up to $300 as an above the line charitable deduction, and up to $600 for a married couple.
Child credits – There are changes in the credits for children and dependent care. Let us know if you have questions on the benefits and strategies for maximizing.
Kiddie tax – The so-called kiddie tax has been restored to pre-TCJA terms, so you may want to review filings for the last two years.
Address change – You will want to file form 8822B to indicate the change of address if your corporation, LLC or partnership moves. On that form, you can also change the responsible party so that the IRS knows whom to contact – this is quite important if you sell your business!
IT PIN – If you are concerned about identity theft, consider obtaining an IT PIN as discussed in our post on IRS scams.
Flex and retirement accounts – Check to see if you have any flex account balances that expire; contribute the maximum to your qualified plans; and setup a new qualified plan if you have a new business.
Before you finish, check withholdings and estimates paid
Especially if you increase income in 2021, review your total paid to the IRS and state via withholdings and estimates make sure that you meet the safe harbor rules. If not, you could owe interest for under-withholding.
IRS disaster relief
Have you received a penalty notice from the IRS? The Pandemic was declared a federal disaster. This means it may provide an exemption to the penalties if you can show that you suffered from the Pandemic.
And remember your estate plan review
While you review your taxes, review your estate plan as well. The federal gift and estate tax credit is close to $12 million for 2021, but that may change in 2022. So, if you have excess wealth, you may want to gift while you can, especially if you want to use certain trusts, like a GRAT or QPRT, that may no longer be permitted in future years. For more on estate planning updates, see our estate planning checkup post.
Update: the annual exclusion for gifts rises from $15,000 per person, per year to $16,000 next year.
If you do review your estate plan documents, also review beneficiary designations and asset ownership to make sure everything is current and flows correctly.
Summary
As you review your 2021-2022 tax planning, consider the impact of future tax rate increases: will bringing future income into 2021 avoid taxes on future income? Then follow through on the details.
Let us know if you have any questions.
Good luck and best wishes for happy and healthy holidays!
