Will capital gains taxes be higher in 2021?
With the recent election and political uncertainty that has ensued, the question crossing many people’s minds is whether or not capital gains taxes are going to be higher in 2021. In this blog we are going to address how we see 2021 capital taxes, and also discuss some ways to potentially to lower your capital gains tax.
What you will learn
Thank you for visiting our website. We’ll get into whether or not we see capital gains tax rates potentially going up in 2021 in a minute, but first we’d like to take a moment and tell you about what you’ll learn from this blog.
- The most important thing to keep in mind if you want to pay less in capital gains tax
- What capital gains tax is
- Recent political developments and what their impact may be on 2021 capital gains tax rates
- Ways to lower your capital gains tax lawfully
I also wanted to inform you that if you’d rather listen to this article, we’ve taken it upon ourselves to create an audio file for you to enjoy. In this clip I discuss the topic of capital gains tax likely rising in 2021 and ways to potentially lower your capital gains tax in 2021 (insert link).
Without any further ado, let’s get started.
Are capital gains taxes going to be higher in 2021?
2020 is a year to definitely consider your tax options in detail before the end of the year. In our view, capital gains tax rates could rise in 2021, as proposed by many politicians, depending on the ultimate outcome of the recent elections. Nobody knows answer until mid January 2021 and the Georgia run offs. However, we do feel at our firm that a rise from the 2020 capital gains rates is likely to help defer our ballooning US debt obligations along with the trillions of dollars associated with the ongoing pandemic stimulus and funding.
It’s hard to find anyone who likes paying taxes, no matter what their political persuasion. The system is, after all, voluntary after what’s required. You could pay any amount you want over the owed amount. Interestingly, no one I’ve ever heard of has taken that approach yet.
After all, one of the most famous Supreme Court justices, Judge Learned Hand, once said, and I’ll paraphrase:
“Anyone may arrange his affairs so that his taxes shall be as low as possible…Everyone does it, rich and poor, alike.”
A good tax advisor can assist in achieving as low a tax payment under the law, which frankly all folks I’ve ever encountered would like to do.
On the flip side, I was personally a tax attorney in my former life, and I can assure you from my experience that if the IRS comes after you, they will pursue you with far more resources and time than you probably have. That being said, you may want to consult a professional to make sure you execute tax planning strategies correctly.
Since it’s a likelihood that capital gains rates are going to be higher in the future, let’s look at what they actually are and how to potentially manage them so you can pay less capital gains tax in 2021 under the law.
Capital gains tax
What is a capital gain?
Under current law, investors who own appreciated risk assets are awarded generally lower tax exposure upon sale. This is called a capital gain.
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These “risk assets” may include:
- A business
- Investment real estate
- Stock option programs
- Individual stocks and bonds
- Mutual funds
- Exchange traded funds
If you sell after a year, you’re given long term capital gain lower tax rates.
If you sell within that year period, you have short term capital gains, which are taxed as ordinary income, at rates that are higher.
Along with any decision to sell these assets, the tax impact of such sales should be weighed by a client as well. The currently favorable long term capital gain rate applies to all such assets held over a year. It has a maximum Federal tax of 20%, as well as a possible surtax of 3.8%, along with potential state taxes. This is considerably lower than the current 37% maximum ordinary income tax, plus state taxes. The government has decided to reward savers who bought so-called “risk assets” and held them. However if you sell before a year is up, you will be subject to these ordinary income rates upon sale with a gain.
The good news is that long term capital gains do not increase your ordinary income tax under current law. However, they could be added to your adjusted gross income which could lead to the phase out of certain deductions such as for medical expenses. The advice of your tax professional and advisor is paramount.
When planning for sales to buy assets, have a lifestyle retirement income, or any other reason, 2020 is a pivotal year to decide whether to recognize those capital gains now in 2020 or delay them into the future when rates may well be higher.
Ways to pay less in capital gains tax lawfully in 2021
If you want to pay less in capital gains taxes under the law in 2021, here are some strategies you may wish to consider. Bear in mind that none of this can be considered tax advice applicable to any one specific person; for tax planning advice it is suggested that you consult with your tax or financial advisor.
Offsetting capital gains with losses
One consideration when contemplating recurring capital gains in any given year is capital losses. These losses can be used in one of two ways:
- To offset $3,000 of ordinary income per calendar year
- To offset recurring capital gains dollar for dollar
Many factors go into a decision to take such losses. These include the timing of the fund or stock sale, depending on the performance of such, the amount of capital gains in a given year that you wish to offset, and if you believe that tax rates will be higher in the following years. Just be aware of the wash sales rules where you cannot recognize a loss should you rebuy that or a substantially similar asset within 30 days of the sale date.
If you do think rates will be higher next year, you may want to hold on to your losses. You would do so if you believe your losses might potentially be more valuable next year. Capital losses are able to be carried forward for years if you don’t use them up in a given calendar year.
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One of the major tools in the tax bag to potentially reduce your future taxes is a Roth IRA conversion. In brief, you transfer a portion of your existing deductible traditional IRA to a new Roth IRA. You’ll have to pay income taxes on the converted amount in that calendar year with other income – not within the IRA itself, but with other income. However, the great news is that you now have a separate IRA account potentially growing without any income tax and distribution in the future.
While you can use these monies later on for your own tax free income purposes, to help in retirement for example, it’ll also keep you in a lower bracket in retirement, perhaps. One strategy we’ve used in the past is to earmark these monies placed into a new Roth basically for your heirs, thus potentially having enough for many years on a tax free basis under current law. We use this when clients have set aside the new accounts solely for their heirs’ purposes and do not ever intend to utilize it unless there is an emergency need for themselves.
The Roth conversion is a powerful tool if your advisors think that rates will be higher in the future. You may have a low income tax bracket in 2020 due for example loss of income due to the pandemic that affected many Americans. After you convert your IRA to a Roth, you can let the monies accumulate for the future. Please note that you will be paying income tax on them.
Move to a friendlier tax state
Some individuals may elect to move to a state with more favorable tax rates in order to reduce their capital gains taxes in 2021 and future years. This is a highly personal decision that would require consideration of lifestyle and other factors.
Conclusion on ways to pay less capital gains tax in 2021
Long term, we want our clients to maintain tax favored income streams for a comfortable retirement.
We suggest that our clients consider maximizing the Roth plan deductions or look at a Roth IRA if warranted, review taking capital gain losses in 2020 (or next year if a later year would be more favorable), and using the capital gains strategies we’ve talked about to offset as much of our current income tax liabilities as possible in general.
A client should always consult a tax advisor along with a financial professional before making any of these decisions. If you would like to discuss your own situation with our firm, please reach out through the contact form below.