A significant topic of conversation is the 2017 tax legislation, known as the Tax Cuts and Jobs Act (TCJA), which is scheduled to expire at the end of 2025. This legislation introduced major modifications to the tax framework, including:
- The expansion of tax brackets and a reduction in the highest tax rate;
- An increase in the standard deduction;
- Restrictions on mortgage interest and state and local tax (SALT) deductions;
- An increase in the federal gift and estate tax exemption.
Vice President Harris has suggested allowing many of the TCJA tax reductions to lapse, while former President Trump has indicated a desire to extend the 2017 income tax cuts, partially funded by raising tariffs on imports. Ultimately, the outcome will largely depend on the composition of Congress.
If you anticipate a potential rise in your tax rate in the coming years, consider the following strategies to capitalize on the currently lower tax rates.
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🔹The Option of a Roth Conversion
In light of the potential for increased taxes, a Roth conversion enables you to transfer funds from a traditional 401(k) or IRA into a Roth IRA. While you will incur taxes on the amount converted, this strategy offers growth potential, allows for tax-free qualified withdrawals, and exempts you from mandatory minimum distributions during the account owner’s lifetime.
You might want to explore a “back door” Roth conversion, which involves making nondeductible contributions to a traditional IRA and subsequently converting those funds into a Roth IRA. This method differs from a standard Roth conversion, where tax-deductible contributions from a traditional IRA are transferred to a Roth IRA.
Regarding tax loss carryforwards, if your portfolio has substantial gains, it may be wise to realize those gains this year, especially if there is a possibility of increased capital gains taxes in the following year.
🔹Tax Loss Harvesting can be an Effective Strategy
It involves selling underperforming investments and replacing them with similar ones, allowing you to offset realized gains with those losses, which may lower your tax liability.
If your capital losses exceed your gains, you can apply up to $3,000 annually to offset ordinary income on your federal tax return, with any excess losses carried forward to subsequent years.
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🔹Consider Making Gifts to Decrease Your Taxable Estate
Without an extension, the current estate tax exemption of $13.61 million for individuals and $27.22 million for couples could potentially be halved.
Now could be an opportune moment to enhance your gifting strategy. For 2024, the annual gift tax exclusion has risen from $17,000 in 2023 to $18,000. This allows you to give up to $18,000 to an unlimited number of individuals each year without triggering any gift tax.
Additionally, making gifts can effectively lower the value of your estate while preserving your lifetime exemption from gift and estate taxes.
📌 It is important to consider the following aspects regarding gifts:
- If you exceed the annual exclusion limit for a single recipient, it will reduce the amount of your lifetime exemption and the available amount at your death to mitigate estate tax liability.
- Filing IRS Form 709 is advisable when implementing an annual gifting strategy. However, if your gifts surpass the annual limit, it is crucial to monitor the excess amount, as it will diminish your lifetime exemption.
- Gifts encompass anything of value, and their worth is typically assessed using the fair market value on the date of the gift. Certain items, such as artwork, may necessitate a formal appraisal. Generally, any taxes owed are the responsibility of the donor.
🔹Using a Qualified Longevity Annuity Contracts (QLACs)
You may also need to develop new strategies for managing Required Minimum Distributions (RMDs), which are taxed at ordinary income rates. If you anticipate falling into a higher tax bracket, a QLAC could be a viable option. This type of deferred annuity is typically funded with retirement assets from a traditional IRA or 401(k).
A QLAC permits you to postpone income payments until you reach the age of 85. While the payments from a QLAC are subject to ordinary income tax, the amount you invest is excluded from RMD calculations, allowing you to defer tax payments until you start receiving distributions. The maximum allowable investment in a QLAC is $200,000.
Given the unpredictability of future tax policies and the potential for changes as the new Congress convenes, it is crucial to remain proactive and prepare for various tax scenarios.
➡️ It is important to recognize that each individual’s financial situation is unique. At Wave Tax, we prioritize understanding our clients’ specific needs and provide tailored tax planning solutions.
📩 Contact us at info@wavetax.us