Tax strategies for higher-income taxpayers
This overview summarizes some of the key areas that you and your tax advisor should assess. Your Financial Advisor can assist in evaluating investment decisions that could help mitigate your tax liability.
Investment and Insurance Products: NOT FDIC Insured NO Bank Guarantee MAY Lose Value Understanding how key tax laws may afect you
u Medicare surtaxes on compensation and/or net investment income Two key tax provisions that afect higher-income taxpayers: • A 0.9% Medicare surtax on compensation (including net self-employment income) above $200,000 (individual flers) or $250,000 (married/joint flers) • A 3.8% Medicare surtax on the lesser of net investment income or the excess of your modifed adjusted gross income (MAGI) over those same thresholds For more details on these Medicare surtaxes, ask your Financial Advisor for a copy of our report, “Medicare Taxes for Higher-Income Taxpayers.”
u Higher income, capital gains, and qualifed dividend tax rates For those with taxable income greater than $518,400 (single flers) or $622,050 (married/joint flers): • Ordinary taxable income above those thresholds will be taxed at a 37% rate. For those with taxable income greater than $441,450 (single flers) or $496,600 (married/joint flers): • Long-term capital gains above the thresholds will be subject to a 20% tax rate. If you are in this tax bracket, you must also add in the 3.8% Medicare surtax on capital gains (discussed above), resulting in a possible combined federal rate of 23.8%. • Qualifed dividends above the thresholds will be taxed at a 20% rate along with the 3.8% Medicare surtax, resulting in a possible 23.8% federal marginal rate.
u Alternative minimum tax (AMT) The exemption amounts used to calculate a taxpayer’s 2020 AMT income are $113,400 for married/joint flers and $72,900 for single flers. The AMT calculation is separate from the regular tax calculation and requires you to add back certain tax deductions and income exclusions to your regular taxable income to arrive at your alternative minimum taxable income. For more details on the AMT, ask your Financial Advisor for a copy of our report, “AMT and the Individual Investor.”
2 2Tax strategies for higher-income taxpayers Strategies to consider in the current tax environment
The broad scope of tax legislation that has become law over the past several years has prompted many higher-income taxpayers to take a closer look at their tax situation. Since some tax changes are permanent and some are temporary, it will be important to remain focused on your long-term objectives, and meet with your Financial Advisor to develop and manage an asset allocation strategy that will help you work toward your goals. Keep in close touch with both your tax and Financial Advisor to stay abreast of the latest tax Be mindful of how much money you provisions. As you consider adjustments based on tax considerations, be mindful of how will keep versus much money you will keep versus what you will pay in taxes. what you will pay in taxes. For example, even at the highest possible combined long-term capital gain and Medicare surtax rate of 23.8%, you retain all of your cost basis value from a transaction plus 76.2% of your gain (minus any applicable state income taxes). If you and your Financial Advisor determine that repositioning some of your portfolio will better help you achieve your goals, tax considerations should not hold you back.
It may be challenging to keep your income below the thresholds. Some common tax planning considerations include timing of income and deductions as well as understanding the character of the income you receive. You may have such questions as: u Should you defer compensation? u Should you choose investments that ofer tax deferral? u Can you change the tax character of income you receive? u How may the timing of gain recognition afect your tax bill? u What is the most tax-efcient way to make charitable gifts? u Are you subject to alternative minimum tax (AMT)?
In the remainder of this report, we’ll address these questions, providing you and your team of advisors—tax, legal, and fnancial—both the advantages and limitations of various strategies.
Tax strategies for higher-income taxpayers 3 Should you defer compensation?
Whether you should defer income depends on your individual situation, what goals you’re attempting to accomplish, your need for current income, and your employer’s (or business’s) fexibility. As always, taxes should be only one of many factors you weigh as you make your fnancial and investment decisions. However, deferring receipt of taxable income can help reduce your current exposure to the: • Highest (37%) tax bracket, which starts with taxable income of $518,400 (single) or $622,050 (married fling jointly) • 20% long-term capital gain and qualifed dividend rate for those with taxable income exceeding $441,450 (single) or $496,600 (married fling jointly) • 3.8% Medicare surtax on the lesser of net investment income or the excess of MAGI over $200,000 (single) or $250,000 (married fling jointly) Keep in mind that the current ordinary income rates are temporary and are set to expire after 2025. You should consider whether the income you defer today may actually be taxed at a higher rate in the future. Some strategies that may allow you to defer compensation include:
Technique Benefts Considerations Maximize contributions to • Boosts your retirement savings and • Reduces your net take-home pay tax-deferred retirement savings improves the chances of retirement • If contributed to non-Roth accounts, [IR , (k), SEP, etc.] security wi increase taxab e required • Reduces current taxab e income minimum distribution (RMD) and AGI (does not app y to Roth amounts in the future vehic es) • Does not avoid the €.•‡ Medicare • Account earnings are tax-deferred surtax
Enroll or increase contributions • Boosts savings that cou d be • Lowers current spendab e cash to a nonqualifed deferred avai ab e in the future, perhaps • Does not avoid €.•‡ Medicare compensation plan (if available post-retirement (depending on surtax from employer) p an features) • Nonqua ifed p an assets are subject • Reduces current taxab e income to c aims of emp oyer’s creditors and AGI • Abi ity to contro timing of distributions is high y restricted • May increase taxab e income in future years as distributions are taken/required; future tax rates are uncertain
Manage the timing of employer • A ows for possibi ity of rea izing • If you retain the company stock granted stock option exercises income in a future year when tota fo owing exercise, you may income may be ower increase risk of overconcentration • Exercising in-the-money options in your portfo io provides you with additiona assets • Exercising options has tax • A ows asset growth with no capita consequences; it may increase out ay your AMT exposure or your exposure to the €.•‡ Medicare surtax on compensation • A successfu stock option exercise strategy ike y requires the assistance of both your tax advisor and fnancia professiona
4 Tax strategies for higher-income taxpayers Should you choose investments that ofer tax deferral?
Whether you’re concerned about higher income tax brackets or the Medicare surtax, investing in certain assets that are tax-deferred can reduce your taxable income from investments and lower your current year tax liability. Tax-deferred is not the same as tax-exempt; that is, at some point in Certain the future, tax-deferred investments will have some type of tax consequence associated with a investments that sale or distribution of the assets. That’s why you’ll want to work closely with your tax advisor to ofer tax deferral project how withdrawals or sales of these assets may afect your future income tax liability. involve more You’ll also want to involve your Financial Advisor. Certain investments that ofer tax deferral complexity— involve more complexity—whether in recordkeeping or regulatory procedures. You’ll want to understand the understand the implications of owning these assets and any additional reporting that may be implications necessary or accompany this ownership. of owning. Some of the tax-deferred investments you can consider include:
Technique Benefts Considerations Invest in a tax-deferred annuity • Income earned within tax-deferred • Annuities can be complex annuities is not taxable until investments distributed • Withdrawals prior to age �½ may • Potential to accumulate more be subject to a penalty for retirement • Contracts may impose surrender • Variable annuities o er tax free charges for early withdrawals reallocations among investment • Distributions of earnings from options nonqualifed annuities may be subject to the •.…— Medicare surtax • Gains do not avoid taxation upon your death; subject to ordinary income tax upon withdrawal • At your death, may result in little to no remainder for heirs
Master limited partnerships (MLPs • In general, distributions are • A limited partner takes into account comprised of taxable and his or her share of partnership deferred income income, gain, deduction and loss, • Qualifying business income may which may be di”cult to predict be eligible for a −‰— deduction • Upon sale of an MLP interest, much of the gain is taxed as ordinary income • More complex than regular stocks and typically involve more extensive tax reporting and recordkeeping
college savings plan • Income earned is not included • To achieve tax benefts, use of funds in calculation of federal income is limited to qualifed education tax or Medicare surtax if not expenses distributed • Investment choices are generally • Distribution of earnings may be limited and may only be changed federal-income-tax-free if used to twice per tax year or when there is pay qualifed education expenses a change of benefciary (consult your tax advisor for state • Nonqualifed withdrawals subject to tax rules) tax and potential Š‰— penalty
The investments discussed may not be suitable for all investors. Investors must make their own decisions based on their speciÿc investment objectives and ÿnancial circumstances. Taxes are only one of many factors that should be taken into consideration when choosing an investment. Asset allocation cannot eliminate the risk of °uctuating prices and uncertain returns. Deferred variable annuities are long-term investments suitable for retirement funding and are subject to market °uctuations and investment risk. Withdrawals of earnings are subject to ordinary income tax. In addition, a federal 10% penalty may apply to withdrawals taken prior to age 59½, and surrender charges generally apply. Master limited partnerships (MLPs) are not appropriate for all investors and are particularly not usually appropriate for retirement-related accounts. Also, an MLP shareholder, i.e., a limited partner unit holder, receives a K-1 instead of a 1099. Investors should contact their tax accountant for further tax implications before investing in MLPs. Please consider the investment objectives, risks, charges, and expenses carefully before investing in a ˛˝˙ savings plan. The oˆcial statement, which contains this and other information, can be obtained by calling your ÿnancial professional. Read it carefully before you invest. The availability of such tax or other beneÿts may be conditioned on meeting certain requirements. ˛˝˙ plans are subject to enrollment, maintenance, administrative and management fees, and expenses. Nonqualiÿed withdrawals are subject to federal and state income tax and a ˇ˘% penalty may apply.
Tax strategies for higher-income taxpayers 5 Technique Benefts Considerations Tax-managed mutual funds or ETFs • Generally designed to have lower • Tax eciency does not guarantee turnover of underlying assets than etter performance actively managed mutual funds, • Investment will fuctuate and may e resulting in lower capital gain worth more or less when redeemed distri utions to unit holders Life insurance with cash alue • Earnings accumulate tax-deferred • Premiums are greater than for • Tax-free withdrawals can e taken term life up to the amount of premiums paid; • Could pay mortality and operational loans can e used for earnings costs for death eneft your heirs do portion to keep tax-free; some not need exceptions apply • Withdrawals a ove premiums paid • In general, payment of policy are taxed as ordinary income proceeds at insured’s death is • If policy ecomes a Modifed income-tax free Endowment Contract (MEC), distri utions are taxed as income frst and recovery of asis second • Loans against policy reduce death enefts; if too large, policy may lapse
Mutual fund investing involves risk. The investment return and principal value of your investment will ˜uctuate, and your shares, when redeemed, may be worth more or less than their original cost. Exchange traded funds are subject to risks similar to those of stocks. Investment returns may ˜uctuate and are subject to market volatility so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost.
Can you change the tax character of income you receive?
Evaluating certain changes to your portfolio may allow you to adjust the way your investment returns are taxed. But these changes may also alter your asset allocation as you consider rebalancing certain asset classes. You’ll want to discuss any changes with your Financial Advisor to help ensure your repositioned asset allocation has you on track toward your investment objectives. You don’t want to derail a long-term plan to avoid a short-term tax liability. If you’re concerned, for example, about the 3.8% Medicare surtax on net investment income, you might think about investing in tax-exempt municipal bonds or consider moving investments that generate taxable income to retirement accounts. Net investment income includes: Net investment income does not include: • Taxable interest • Tax-exempt interest • Dividends • Distributions from IRAs and employer retirement plans • Net capital gains • Income from an active trade or business • Taxable nonqualifed annuity distributions • Veteran and Social Security benefts • Rents and royalties received as passive income • Passive income from partnership interests, including MLPs
In addition, by changing the tax character of some of your investment income, you may also reduce your AGI and taxable income. The table on the following page shows some portfolio changes you may want to consider.
6 Tax strategies for higher-income taxpayers Technique Benefts Considerations Invest in tax-exempt bonds • Tax-exempt interest is excluded • Tax-exempt bonds may not ft from Medicare surtax calculations your asset allocation strate y and federal income taxation • You may not be fully comfortable with the market, infation, and interest rate risks associated with tax-exempt bond investments • Certain municipal bonds may increase your AMT exposure or state income tax • If you are receivin Social Security benefts, tax-exempt interest is included in the calculation of provisional income and may ašect the taxation of your benefts • Tax-exempt interest is included in MAGI for purposes of calculatin Medicare Parts B and D premiums
Consider growth-oriented stocks for • Appreciation is not taxed until you • Limited current cash fow to meet part of our portfolio (individuall , sell the investment everyday expenses through mutual funds, ETFs, • Income taxed is limited to dividends • Your investment is exposed to the and/or advisor programs) received until you sell the stock market risk associated with this • Potential rowth may allow you asset class to accumulate more assets to help achieve your oals Convert traditional, SEP, or • Roth IRA distributions after • In the conversion year, you boost SIMPLE IRA to a Roth IRA reachin a e –ƒ½ and meetin the your MAGI and taxable income fve-year rule are federally income- (which could tri er or increase tax-free Medicare surtaxes) and increase • Future tax-free distributions from your income tax liability a Roth IRA are not considered • Conversion may impact taxation of investment income and will not Social Security benefts or cost increase your MAGI for calculation of Medicare Parts B and D premiums of the Medicare surtax • Withdrawals of converted amounts or earnin s may be subject to a ”‚™ federal tax penalty if taken prior to a e –ƒ½ or does not meet the fve-year rules for contributions and conversions Consider choice of business entit • You are able to choose the tax • Chan in your corporate structure (for business owners) structure that best suits your may increase certain costs and add situation re ulatory requirements • A “C” corporation has a lower • Discuss business entity options top tax rate than an individual with your tax professional who receives income throu h a pass-throu h entity (“S” corporation or partnership) • Earnin s distributed from a pass-throu h entity are not subject to double taxation as with a “C” corporation and may be eli ible for a new deduction equal to Š‚™ of qualifed business income
Carefully review whether your • Income from a nonpassive activity • It may not be possible to chan e business activities are characterized is not subject to the Medicare surtax your level of participation as passive or nonpassive • Losses from a nonpassive activity • Passive income is subject to the are not limited by the passive Medicare surtax activity loss rules • These rules are complex and should • You may be able to chan e your be closely reviewed with your tax level of participation in an activity professional to meet the nonpassive standard
Qualiÿed Roth IRA distributions are not subject to state and local taxation in most states. Qualiÿed Roth IRA distributions are also federally tax-free provided the owner has reached age 59½ and a Roth account meets the ÿve-year rules for contributions and conversions, or meets other requirements. Withdrawals may be subject to a 10% federal tax penalty if distributions are taken prior to age 59½. Tax strategies for higher-income taxpayers 7 How will the timing of gain recognition afect your tax bill?
Developing a tax strategy is important. Incurring a sizable long-term capital gain may push you Tax situations and over one of the thresholds for the Medicare surtax or even into the 20% long-term capital gains tax laws can tax rate. If you are selling a business or signifcant amount of property for a large gain, recognizing change. Consult the gain can signifcantly impact your tax bill. with your tax Work with your tax advisor to project your tax liability and evaluate whether it’s better for your advisor and situation to trigger that income this year, next year, or sometime in the future. Here are some fnancial advisor to examples of strategies that consider the timing of gain recognition: develop the best strategy for Technique Benefts Considerations increasing or Selling an appreciated, long-term • Typically helps diversify a portfolio • Tri ers lon -term capital ains tax decreasing income. concentrated stock position and potentially reduce risk • May incur the “.’š Medicare surtax • You can choose to sell as much on lon -term capital ains or as little as necessary to meet • Could tri er �•š (�“.’š with fnancial oals and control your tax surtax) lon -term capital ains situation tax rate • May provide additional spendable • Lose step up of basis at death for cash fow (dependin on heirs on any shares sold reinvestment or strate y considered) Business or property installment sale • May allow you to control cash fow • Purchaser may not have fexibility and tax liability year-by-year to provide multi-year payments • Risk relatin to ability of purchaser to make all payments required under the installment a reement • In all cases, most e‹ective if you can keep your income below key tax thresholds Establis ing and contributing • May contribute an appreciated, • Charitable deductions may be to a c aritable remainder trust lon -term concentrated position subject to deductibility limits without incurrin current tax • Gift is irrevocable; you no lon er • Generates a tax deduction based on have access to the underlyin assets present value of future ift to charity • You need to be charitably inclined • May increase your income stream • Reduces estate taxes
Like-kind exc ange • May defer ain by exchan in • Must be a property-for-property property for like-kind property exchan e; any money received • Gain or loss is deferred until the would be taxable new property is subsequently sold • The property exchan ed must be “like-kind;” consult your tax advisor • Will not increase current spendable cash or result in additional liquidity, unless money is also received • Available only for real property held for investment or productive use in trade or business
Qualifed Opportunity Fund • Investin your capital ain in a QOF • This tax law still requires some (QOF) investment—provides tax allows for deferral of ain until the clarifcation and QOF may be subject benefts for investing in distressed earlier of the sale of the QOF or to penalty if it does not meet certain communities across t e U.S. December “Š, �•�Ÿ requirements • May provide some tax-free ain • As a newer investment vehicle, reco nition dependin on how access may be limited lon QOF is held • Investment may increase or decrease in value or may be illiquid
8 Tax strategies for higher-income taxpayers What is the most tax-efcient way to make charitable gifts?
Most people make charitable gifts in order to beneft others. If an income tax deduction is available, the donor will beneft, too. However, the way you make your gift can impact the amount of tax savings you receive. Consider the options below before making your next gift.
Technique Benefts Considerations Gift of cash • Simple and fexible form of giving • Taxpayer must itemize to beneft • Charitable deduction o sets up to from a charitable deduction of of AGI (“ of AGI for gifts more than –’ to a donor advised fund, ’ for gifts to a private foundation); the o set applies to �� only
Gift of appreciated stock • Income tax deduction allowed in • Income tax deduction for gift of amount of fair market value of stock, stock held one year or less is if held more than one year generally limited to basis of stock • Taxpayer avoids income tax on the • Taxpayer must itemize to beneft embedded gain in the stock from a charitable deduction • Charitable deduction o sets up to ’ of AGI (� for gifts to a private foundation)
Qualifed Charitable Distribution • QCD is excluded from income • IRA owner must be age ‚½ or (QCD —this is a direct gift to a thereby providing a tax beneft for older to exclude the QCD from charity from an IRA (other than those who do not itemize their income a SEP or SIMPLE IRA deductions • QCD must be made directly to the • QCD will not increase AGI and charity, not to the IRA owner therefore will not impact any • No income tax deduction is allowed AGI-based tax calculations that typically result in increased taxes • Distributions are limited to –, per year per IRA owner • QCD satisfes RMD requirement up to amount of distribution
Gift upon death by naming a • Assets avoid income tax upon • No income tax deduction during charity as benefciary of your distribution to charity lifetime or at death IRAs, annuities, or employer • Assets avoid estate taxation • Assets will not be available for heirs retirement plans
After you have determined the best method to use for your gift, you may also want to consider the use of various charitable vehicles, such as charitable trusts, a private foundation, or a donor advised fund. These vehicles can help meet a variety of fnancial goals in addition to beneftting a charity. If you would like to learn more ask your Financial Advisor for a copy of our report “Charitable Giving Techniques”.
Tax strategies for higher-income taxpayers 9 Are you subject to AMT?
The AMT calculation is separate from the regular taxable income calculation and requires you to add back certain tax deductions and income exclusions to your regular income tax to arrive at your alternative minimum taxable income. Your chances of paying AMT may increase if you have: • Interest from certain private activity municipal bonds (AMT bonds) • High ordinary income or capital gains • Deducted state and local taxes • Exercised and continue to hold incentive stock options (ISOs) Depending on your personal situation, other AMT adjustments may also apply. Even limited exposure to only one or two items that can trigger AMT may subject you to the tax. As a higher- income taxpayer, you should talk with your tax advisor about the possibility of incurring AMT. He or she may be able to do a projection to help evaluate your AMT potential. For more details, ask your Financial Advisor for a copy of our report, “AMT and the Individual Investor.”
Considerations for stock-based benefts
Employees at publicly traded companies may receive a substantial amount of their compensation from stock-based benefts, such as stock options, restricted stock, performance awards, etc. If this is the case, talk with your Financial Advisor about various strategies for managing these valuable benefts. You’ll want to develop a plan to help you avoid stacking up and exercising too many grants in one tax year. You may also want to consider whether there is a beneft to disqualifying dispositions of ISOs in particular years to help reduce your AMT exposure. Overall, you should develop a strategy early in each tax year so you avoid last-minute transactions that could unexpectedly increase your tax liability.
10 Tax strategies for higher-income taxpayers Look beyond taxes with a team approach
Depending on your objectives and net worth, you may want to consider additional techniques, such as other charitable trusts, alternative investments, and insurance strategies. The tax code is now more complicated, and there is even more interplay between taxable income, AGI, tax brackets, and investment taxation. That’s why you may beneft from talking with your entire team of advisors—your tax and legal advisors along with your Financial Advisor—early in the tax year. As a group, you can evaluate how any of the techniques in this report may help you meet your investment, legacy planning, philanthropic, and tax-management goals.
Meet with your tax advisor Call your legal advisor. Talk regularly with your throughout the year. Financial Advisor. Your CPA or tax professional can help Many valuable estate planning Your Financial Advisor can give you prepare a tax projection well before strategies remain viable and meaningful a valuable, independent investment year-end and work with your other alternatives to improve your legacy perspective on various tax and estate advisors to evaluate and implement planning. Some strategies may help strategies you may be considering. strategies that may reduce your overall reduce current year’s or future years’ He or she can also help you evaluate tax liability. taxes and can work in tandem with how certain strategies and investments income tax strategies your tax complement each other and help professional may have suggested. Your maintain your focus on your estate attorney can help identify and long-term goals. explain these strategies.
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