Taxes Archives | Page 4 of 5 | CD Wealth Management

Here’s what we’re watching after the market’s stumble

The Dow Jones and S&P 500 suffered five straight days of losses, the worst weekly performance since June. Different factors may have caused the selling last week: the Delta variant and its impact on slowing economic growth, the Federal Reserve’s tapering and how it may handle inflationary pressures, current stock valuations and potential tax hikes proposed by the Biden administration. Typically, it is something investors don’t see coming — such as a pandemic or global financial crisis — that causes the larger market selloffs, not something that investors already expect.

Market pullbacks should be expected, especially since the largest drawdown year-to-date has been 4.2%. The “textbook correction,” in which stocks pull back at least 10%, is natural and healthy market functioning and behavior. As seen in the chart below, the S&P 500 has been in a recent trading lull, going many sessions without a 1% move — but the lull has been nowhere near what we have seen in the last few years.

Chart showing consecutive trading days without a 1% move since 1993

Contributing to the recent market jitters is the current state of inflation and concerns over how to pay for potential additional infrastructure spending. Prices for consumer goods rose less than expected in August, a sign that inflation may be starting to cool. The consumer price index (CPI), which measures a basket of common products as well as various energy goods, increased 5.3% from a year ago. That’s less than the expected increase of 5.4% and a smaller increase month over month. Energy prices accounted for much of the recent inflation increase; energy is up 25% from a year ago, and gasoline prices have surged 42% over the same period.

Chart showing percent change in CPI over a 12-month period

This week, the House Ways and Means Committee released a more detailed overview of potential tax changes to help pay for the proposed infrastructure and expansion of social programs. The highlights of the current plan are as follows:

* Top marginal tax rate increase from 37% to 39.6%; also, a 3% surtax on individuals with adjusted gross income greater than $5 million.

* Capital gains rate increase from 20% to 25% for “certain high-income individuals.”

* Changing the corporate tax rate from a flat tax to a tiered tax rate, with the proposed top rate at 26.5%.

* Estate and gift tax exemptions would drop back to $5 million (plus inflation adjustments), down from the current $11.7 million per person.

* Eliminating Roth conversions for IRAs and workplace plans for married couples earning more than $450,000 (and for individuals earning more than $400,000).

Chart showing current and proposed tax rates

Remember, these are proposed tax changes that still have a long way to go before becoming law. Changes can and will occur as negotiations continue over the infrastructure spending package. In our opinion, concern about changes in estate tax law is a good reason to consult with estate attorneys to discuss the current plan. Similarly, avoiding potential higher capital gains rates may be a good idea if it makes sense in the context of your overall financial plan. It is important to remember that the proposed tax changes are just that: proposals, not laws. We will be ready and proactive if tax law changes occur for capital gains and Roth IRA contributions.

So, what can we learn from all this? The stock market continues to digest mixed economic messages as well as the impact of the Delta variant, inflationary pressures, and the Federal Reserve’s response to tapering, rates and potential tax hikes. It is important not to focus on one data point or one indicator, but to look at the big picture.

From a portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. Regarding investments, we believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.

Sources: CNBC, The New York Times, Forbes, House Ways and Means Committee, U.S. Bureau of Labor Statistics

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS) an affiliate of Kestra IS. Kestra IS and Kestra AS are not affiliated with CD Wealth Management. Investor Disclosures: https://bit.ly/KF-Disclosures

Strategies for tax savings, no matter what Congress does next

As we near the end of the third quarter, Congress continues to debate infrastructure packages. Many investors are wondering if Congress will pass tax reforms that alter the tax landscape to pay for the new bill. The Biden administration has consistently said it is targeting individuals whose income is greater than $400,000. Our current tax system is considered a progressive system, one in which the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, as seen in the chart below, which is why the current administration remains focused on increasing taxes for those individuals.

chart showing federal tax rates by income

One of the proposals is to raise the long-term capital gains rates on those who make more than $1 million to pay for infrastructure. The current rate for those earners is 20%, and the new rate would be 39.6%, almost double the current rate. The chart below shows the proposed long-term capital gains rates if the new rates were to go into effect. We believe that the chance of any major tax changes passing is still remote, given the current makeup of Congress.

chart showing long-term capital gains tax rates

We continue to look for opportunities to bolster tax savings for our clients, regardless of whether the proposed tax changes pass in Congress, and we want to highlight three strategies below.

Strategy No. 1: Tax Loss Harvesting

Under current tax law, it’s possible to offset current capital gains with capital losses you’ve incurred during the year or carried over from a prior tax return. Capital gains are the profits you realize when you sell an investment for more than paid for it, while capital losses are the losses you realize when you sell an investment for less than you paid for it.

Short-term capital gains are taxed at ordinary income rates, whereas long-term capital gains are taxed at a lower capital gains rate. Being able to reduce the tax on both short- and long-term capital gains by harvesting losses can help offset the gains one incurs from taking profits. Harvesting the loss has no effect on the portfolio value, as one can use the proceeds from the sale to buy a similar investment.

This allows the investor to maintain a similar asset allocation and reduce federal income taxes, as seen in the example below. Throughout the year, we continue to look for opportunities to harvest losses and take profits, all while maintaining the current risk tolerance.

chart explaining the process for tax loss harvesting

Tax-loss harvesting and portfolio rebalancing can provide nice synergies as they play different roles in portfolio management. When we rebalance a portfolio, we are managing risk in the portfolio by selling holdings that have outsized their target holdings and adding those gains to positions that may have had losses or not grown as much. Often in rebalancing, the portfolio will experience sizeable capital gains. That’s where tax-loss harvesting helps reduce the gains and bring the risk of the portfolio back to its target allocation.

Strategy No. 2: Converting to a Roth IRA

A traditional IRA/401K is funded with pre-tax contributions. Future withdrawals from your IRA/401K are then taxed at ordinary income rates. A Roth IRA/401K is funded with after-tax dollars, and the withdrawals are tax-free, if the qualifications are satisfied. Individuals who have most of their retirement assets in a traditional IRA/401K might consider converting a portion of those assets to a Roth retirement account for tax diversification. With tax rates currently at historically favorable levels, now might be an opportune time to do a Roth conversion, since the IRS treats Roth IRA conversions as taxable income.

chart showing when roth iras are beneficial

Strategy No. 3: Increasing Charitable Contributions

The CARES Act, along with additional stimulus at the end of 2020, provided tax relief to those individuals with charitable intent. For 2021, taxpayers can elect on their income tax return to deduct up to 100% of adjusted gross income for cash gifts made to public charities. Also, under the CARES Act, taxpayers can gift long-term appreciated securities to public charities (including donor advised funds) up to 30% of their adjusted gross income while also making cash gifts to public charities totaling up to 60% of adjusted gross income.

chart explaining rules regarding charitable donations

For those who are charitably inclined and over the age of 70½, this year offers an opportunity to donate more to your favorite charity and potentially reduce your taxable income by donating directly from your IRA to a qualified 501(c)3 organization. The maximum dollar amount for any individual from an IRA is limited to $100,000 per year. A married couple can each donate up to $100,000 from their respective IRA.

So, what can we learn from all this? We will continue to monitor the financial plan and the portfolios to look for opportunities to tax-loss harvest, discuss Roth IRA conversions and potentially donate appreciated stock to your favorite charities. We continue to watch economic data closely and monitor the COVID variants’ effect on the global economy, Federal Reserve policy and China’s increased regulations and restrictions.

From a portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time and downturns present opportunities to purchase stocks at a lower value.

Sources: Fidelity, Cambridge Trust, Michael Kitces, Smart Asset, Tax Policy Center, https://www.taxpolicycenter.org/resources/income-measure-used-distributional-analyses-tax-policy-center

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

Capital gains strategies, regardless of Biden’s plan

Last Friday, President Biden unveiled detailed explanations on how the administration plans to pay for the new $6 trillion budget. The biggest surprise in the proposal is that the administration is seeking a retroactive effective date on a capital gains tax rate hike from 20% to 39.6% for households making more than $1 million. If you add in the net investment income tax for high-income earners, this raises the top long-term capital gains tax rate to 43.4%, up from the current 23.8%.

“This proposal would be effective for gains required to be recognized after the date of the announcement,” the Treasury Department said, referring to an address to Congress on April 28. The purpose of the backdating proposal is to avoid a sell-off ahead of the capital-gains rate hike, if it were to be approved.

A historical review of legislation suggests tax-rate decreases are easier to implement on a retroactive basis from a policy and political standpoint. With life’s only certainties being death and taxes, the tax implications of a transaction would ideally be known at the time of the event — and not retroactive.

As we wrote about last week, tax changes are far from certain, and a lot of ideas are being thrown around in Washington. We are approaching our financial planning with maximum flexibility. It is safer to plan for what we know, rather than what we don’t know, and that is our approach. We believe the proposals in their current state will not pass through Congress, but we also cannot begin to predict precisely what will pass.

Having said that, the following are capital gains tax strategies that we already use for your benefit:

1. Donating appreciated securities to charity or a donor advised fund. This is a tax-smart way for those who are charitably inclined to donate money. The market value of the security on the date of donation is a charitable tax deduction, and there are no capital gains taxes on the donated assets.

2. Tax loss harvesting. This strategy involves realizing tax losses on holdings and then using those losses to offset realized gains. Any remaining losses incurred in a year can be carried over to subsequent years and help offset future capital gains.

3. Converting traditional IRA assets to Roth IRA. This works well for those in lower income tax brackets. Investing in stocks with higher growth potential in a Roth IRA will negate any taxation of future capital gains. There are no taxes in the year of the gain, and the money can be withdrawn tax-free at retirement (if certain rules are followed). Also, assets in an inherited Roth IRA are tax-free to beneficiaries upon withdrawal if the five-year rule was met prior to death. This includes capital gains that were realized in the account along the way.

So, what can we learn from all this? Avoiding potentially higher capital gains rates may be a good idea, if it makes sense in the context of your overall financial plan. It is important to remember that the proposed tax changes are just that — proposals, not laws. Changes can and will occur, and there is no guarantee that the proposal or introduced bills will become law. In our opinion, as of today, a wait-and-see approach is the best path until we have further clarity. However, concern about changes in estate tax law is a good reason to consult with estate attorneys to discuss the current plan. We will be ready and proactive if tax law changes occur.

From an investment portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, not making investment decisions based on where we have been.

Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Sources: National Law Review, The Hill, New York Times

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

Keeping an eye on possible tax changes under Biden

There has been much speculation about the possibility of higher taxes on the horizon to pay for the recent stimulus and potential infrastructure bill. President Biden has released a $1.8 trillion American Families Plan (AFP), and a bill has been introduced into Congress titled “For the 99.5% Act.”

Biden’s plan and the proposed Congressional act are far from becoming law. There appears to be very little consensus within Congress about AFP, and if it were to become law, there would be extensive negotiations; the final bill may look drastically different and potentially watered down from the current proposal. We are staying apprised of the tax negotiations so we can be proactive rather than reactive if changes occur. We will be ready to help you.

We do not believe there is extensive planning to be done today in response to the potential bill, but we do want to share some of the potential tax changes that are being discussed. It is likely that taxpayers will have time to implement strategies if they become law.

1. Taxpayers making less than $400,000 per year probably will not see an increase in their taxes. Most of the proposed increases appear to target higher-income households. Many middle- to low-income households may see their tax bills decrease.

2. Under the AFP, taxpayers making more than $400,000 could see their marginal rate increase from 32% (married filing jointly) and 35% (single) to 39.6%. For those who itemize, there may be opportunities to increase charitable deductions and reduce tax liability.

3. Capital gains over $1 million also may be taxed at the 39.6% marginal tax bracket; the proposal creates a fourth capital gains tax bracket. The remaining capital gains rates of 0%, 15% and 20% would still exist.

4. The step up in basis on inherited assets could be removed for estates with gains over $1 million ($2.5 million for married couples). This would not apply to family businesses or farms. If passed, this change would impact estate planning and gifting strategies.

5. Notably absent from the AFP is a provision to lower the estate tax exemption from the current $11.7 million per person ($23.4 million for a married couple). At death, this amount can pass free of federal estate taxes. However, the proposed “For the 99.5% Act” would reduce the federal exemption from $11.7 million to $3.5 million per person. At this point, the current exemption will sunset back to the previous limit of $5.49 million (inflation adjusted) in 2025.

So, what can we learn from all this? It is important to remember that the American Families Plan is only a proposal and the “For the 99.5% Act” is not a law. Changes can and will occur, and there is no guarantee that these proposals will become law. As of today, we believe a wait-and-see approach is the best path forward until we have further clarity. However, concern about changes in estate tax law is a good reason to consult with estate attorneys. We will be ready and proactive if tax law changes occur.

From an investment portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Source: Schwab

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

What would Biden’s tax increases mean for the markets?

Last week, rumors began to swirl about the Biden administration’s proposal for increasing tax rates for the richest Americans from 37% to 39.6% and raising the capital gains tax on people earning more than $1 million from 20% to 39.6%. There is still a long way to go before we see any tax hikes, and as is often the case, the initial market reaction is to sell upon hearing the news. Markets have produced better-than-average returns during past tax increases, as other economic factors are happening that may influence subsequent market behavior. Going back to 1968, there is only a minimal correlation between changes in the capital gains tax rate and market returns, as seen in the chart below.

The next chart further illustrates the point that the market selling last week on the news of potential higher tax rates may be overblown. Since 1950, only one instance of negative market returns in the S&P 500 occurred when taxes were increased. Taxes break down into three buckets: corporate, personal and capital gains. Big tax increases are rare, and only once since 1970 have all three been increased at the same time. (That happened in 1993.) Democrats have slim margins in both houses of Congress, and it is still to be determined how much of the higher tax rate agenda will make it into law. It will take time for Congress to negotiate a major package, and it’s possible that if rates are increased, it may not happen until 2022.

In years with tax increases, the average S&P 500 return since 1950 has been 9%. However, changes to the tax code do not happen in a vacuum; normally, there are other actions in Congress and the economy. As we are seeing today, significant stimulus spending by the government and action from the Federal Reserve following the pandemic shutdowns also may contribute to higher-than-average returns, even when taxes are being raised.

So, what can we learn from all this? Making market decisions based on conjecture of what might happen may be detrimental to long-term performance. The S&P 500 historically has performed well in years of tax increases. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

Given the difficulty of timing the market, the most realistic strategy for a majority of investors is to invest and stay invested over time. Procrastination, or not investing, is worse than bad timing. We continue to view more risk being out of the market than in the market. Riding out future market volatility, in addition to having a diversified portfolio, means staying the course. From an investment perspective, we use trends to help with the strategic and tactical asset allocation and where we see the portfolio heading over the next 5-7 years with short-term adjustments along the way.

It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. With regards to investments, we believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.

Sources: Factset, UBS, Fidelity

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

With a new president, what lies ahead?

A new administration took office this week with a renewed focus on vaccinating millions of Americans and on creating additional stimulus to help those most in need. Last week, President Biden announced a proposed $1.9 trillion economic stimulus package, which would follow the recent $900 billion package passed in December. More Americans are receiving the coronavirus vaccination every day. The successful deployment of vaccines remains the key driver of U.S. economic growth for 2021. If Johnson & Johnson is able to win FDA approval for its vaccine by March, we believe the goal of vaccinating 100 million people by the early fall is attainable. These are positives for the stock market long-term.

The pandemic has forced companies big and small to prioritize and expand their digital footprints. The economy will look very different after the pandemic than it did at the start of 2020. Digital business models are expanding beyond the U.S., as companies in both emerging and developed markets have rapidly expanded their platforms. Small and mid-sized companies, as well as international and emerging markets, can benefit greatly from the technological advancements and the reopening of the economy.

The pandemic also has accelerated shifts in employment, particularly with respect to services sectors that employ low-skilled workers. The share of permanent job losses continues to grow over time, and labor participation rates have yet to recover, as seen in the chart below.

The shock has caused more strain for smaller companies that do not have access to the same capital markets as large companies to raise additional monies to operate their businesses. The Federal Reserve bank and further economic stimulus proposed by the new administration are set to provide an additional bridge of funds for these companies, with the hope of bringing back activity to pre-pandemic levels.

In 2021, much depends on the increase in debt through additional stimulus. Rising debt ratios may put additional pressure on the Federal Reserve Bank to keep debt service payments lower through continued lower rates. The Consumer Price Index, the measure of inflation, increased in December, due to higher gas prices. However, this increase was in line with expectations and was not as high as many were expecting. Investors’ demands for bonds remain high as a source of diversification, and demand for municipal bonds has increased as investors in the highest tax brackets anticipate higher tax rates, making those bonds more attractive.

So, what can we learn from all this? We will continue to stay the course. While we know there will be bumps in the road in 2021, we also know public markets will continue to look forward, anticipating what’s ahead. From an investment perspective, we use the above insights to help with the strategic and tactical asset allocation based on where we see the portfolio heading over the next five to seven years, with short-term adjustments along the way. We are not trying to time the market, but we will try to take advantage when we see where the market is heading. Having a well-balanced, diversified, liquid portfolio and a financial plan are keys to successful investing. The best option is to stick with a broadly diversified portfolio that can help you achieve your own specific financial goals – regardless of market volatility. Long-term fundamentals are what matter.

Sources: Capital Group, Blackrock

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Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

The MSCI Europe Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the developed markets in Europe. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI AC (All Country) Asia ex Japan Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of Asia, excluding Japan. The Dow Jones Industrial Average is a popular indicator of the stock market based on the average closing prices of 30 active U.S. stocks representative of the overall economy. S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. It is not possible to invest directly in an index.

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Presidents and portfolios

We are now a few days from the election, and we are receiving calls and emails from clients who are wondering if they should make changes to their portfolios before the results come in. History suggests election results should not be the primary driver of investment decisions; this is especially true this year, with the pandemic and the fiscal and monetary response from the Federal Reserve driving the markets. While the election certainly will have an impact on the country, we caution against taking drastic action in the world of investing.

Market commentators — and presidents themselves — have cited the stock market’s performance as a measuring stick of White House policies, but the data doesn’t support this, as seen in the chart below.

Instead, the key drivers of stock market performance are the fundamentals of earnings, interest rates, job growth and productivity. Policy changes do have ramifications for financial plans, tax strategy and estate planning, but not when it comes to day-in, day-out asset allocation.

We want you to keep these thoughts in mind as we enter the home stretch of the election:

1. Markets have performed well under both parties. As the light blue bars show in the chart below, the markets have yielded positive returns, no matter which party controls the White House or Congress, over a four-year presidential cycle.

2. Investors are better off staying fully invested. The best-performing portfolio over the past 120 years was one that stayed fully invested through both Democratic and Republican administrations.

3. Monetary policy matters more than who occupies the White House. Historically, presidents have been hurt or helped by monetary policy conditions. Both President Reagan and President Clinton benefited from consistently falling interest rates. Both President George H.W. Bush and President George W. Bush were hurt by Fed tightening, an inverted yield curve and a recession. President Obama benefited from a benign rate environment during his term (minus a brief moment in 2015–2016), and President Trump experienced tighter policy during his first two years, but the last two years have seen rates return to zero. The adage “Don’t fight the Fed” rings true.

4. Don’t confuse politics with market analysis. Some of the best returns in the market came when the presidential approval rating was in the low range of between 36% and 50%.

What does this mean for you?

Investors have prospered in markets during difficult political times. The average return of the S&P 500 since the end of World War II is almost 11%. Staying the course has always made the most sense for investors. Follow your financial plan and ignore the noise.

Remember that market downturns offer the chance to buy stocks at lower prices, which could position a portfolio well for future growth. Again, there are no guarantees that stocks will perform to anyone’s expectations, and decisions could result in losses including a possible loss in principal. However, it may be helpful to remember that some investors use downturns as opportunities to buy stocks that were previously overvalued relative to their perceived earnings potential.

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This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.

S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. You cannot directly invest in the index.The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS) an affiliate of Kestra IS. Kestra IS and Kestra AS are not affiliated with CD Wealth Management.

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3 strategies for tax savings, no matter who wins the election

With the presidential and congressional elections less than three weeks away, many investors are wondering if a new administration and a new Congress might pass tax reforms that alter the current tax landscape. After the Nov. 3 elections, we will get a better sense of the potential for tax reform, but in the interim, we continue to look for opportunities to bolster tax savings for our clients, regardless of who takes office in 2021.

Strategy No. 1: Tax Loss Harvesting

Under current tax law, it’s possible to offset current capital gains with capital losses you’ve incurred during the year or carried over from a prior tax return. Capital gains are the profits you realize when you sell an investment for more than you paid for it, while capital losses are the losses you realize when you sell an investment for less than you paid for it. Short-term capital gains are taxed as ordinary income rates, whereas long-term capital gains are taxed at a lower capital gains rate. The chart above displays the historical gap between maximum individual tax rate and maximum capital gains tax rate, including the 3.8% tax on net investment income.

As seen in the chart, the current spread between the two tax rates is not that wide. However, the ability to reduce the tax on both short-term and long-term capital gains by harvesting losses can help offset the gains one incurs from taking profits. Harvesting the loss has no effect on the portfolio value, as one can use the proceeds from the sale to buy a similar investment. This allows the investor to maintain similar asset allocation and reduce federal income taxes, as seen in the example below. Throughout the year, we continue to look for opportunities to harvest losses and take profits, all while maintaining the current risk tolerance.

Tax-loss harvesting and portfolio rebalancing can provide nice synergies as they play different roles in portfolio management. When we rebalance a portfolio, we are managing risk in the portfolio by selling holdings that have outsized their target holdings and adding those gains to positions that may have losses or not grown as much. Often in rebalancing, the portfolio will experience sizeable capital gains. That’s where tax-loss harvesting helps reduce the gains and brings the risk of the portfolio back to its target allocation.

Strategy No. 2: Converting to a Roth IRA

A traditional IRA/401K is funded with pre-tax contributions. Future withdrawals from your IRA/401K are then taxed at ordinary income rates. A Roth IRA/401K is funded with after-tax dollars and the withdrawals are tax-free, if the qualifications are satisfied. Individuals who have a majority of their retirement assets in traditional IRA/401K might consider converting a portion of those assets to a Roth retirement account for “tax diversification.” With tax rates currently at historically favorable levels, now might be an opportune time to do a Roth conversion as the IRS treats Roth IRA conversions as taxable income.

Strategy No. 3: Increasing charitable contributions

The Tax Cuts and Jobs Act passed in 2017 increased the deduction limit for cash contributions made to public charities to 60% of Adjusted Gross Income from 50%. The CARES Act, passed earlier this year due to the global pandemic, provided additional tax relief to those individuals donating to charity in 2020. For this tax year, taxpayers can elect on their 2020 income tax return to deduct up to 100% of adjusted gross income for cash gifts made to public charities.

Also, under the CARES Act, taxpayers can gift long-term appreciated securities to public charities (including donor advised funds) up to 30% of their adjusted gross income while also making cash gifts to public charities totaling up to 70% of adjusted gross income. For those who are charitably inclined, 2020 offers an opportunity to donate more to your favorite charities and potentially reduce your taxable income.

What does this mean for you?

We will continue to monitor the financial plan and the portfolios to look for opportunities to tax-loss harvest, discuss Roth IRA conversions and potentially donate appreciated stock to your favorite charities. We remain hypervigilant going into the election and will make tweaks to the portfolios when necessary.

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You still have time to make an IRA contribution for 2019

Due to the coronavirus tax filing extension, there’s still time to make a regular IRA contribution for 2019. You have until your tax return due date (not including extensions) to contribute up to $6,000 for 2019 ($7,000 if you were 50 or older on Dec. 31, 2019).

For most taxpayers, the contribution deadline for 2019 is July 15, 2020.

You can contribute to a traditional IRA, a Roth IRA, or both, as long as your total contributions don’t exceed the annual limit (or, if less, 100 percent of your earned income). You also may be able to contribute to an IRA for your spouse for 2019, even if your spouse didn’t have any 2019 income.

Traditional IRA

You can contribute to a traditional IRA for 2019 if you had taxable compensation and you were not age 70½ by Dec. 31, 2019. However, if you or your spouse were covered by an employer-sponsored retirement plan in 2019, then your ability to deduct your contributions may be limited or eliminated, depending on your filing status and modified adjusted gross income (MAGI). (See table below.)

Even if you can’t make a deductible contribution to a traditional IRA, you can always make a nondeductible (after-tax) contribution, regardless of your income level. However, if you’re eligible to contribute to a Roth IRA, in most cases you’ll be better off making nondeductible contributions to a Roth, rather than making them to a traditional IRA.

Income phaseout ranges for determining 2019 deductibility of traditional IRA contributions:

Covered by an employer-sponsored plan and filing as single/head of household:

* Deduction reduced if your MAGI is $64,000-$74,000.

* Deduction eliminated if your MAGI is $74,000 or more.

Covered by an employer-sponsored plan and filing as married filing jointly:

* Deduction reduced if your MAGI is $103,000-$123,000.

* Deduction eliminated if your MAGI is $123,000 or more.

Covered by an employer-sponsored plan and filing as married filing separately:

* Deduction reduced if your MAGI is $0-$10,000.

* Deduction eliminated if your MAGI is $10,000 or more.

Not covered by an employer-sponsored retirement plan, but filing a joint return with a spouse who is covered by a plan:

* Deduction reduced if your MAGI is $193,000-$203,000.

* Deduction eliminated if your MAGI is $203,000 or more.

Roth IRA

You can contribute to a Roth IRA even after reaching 70½ if your MAGI is within certain limits. For 2019, if you file your federal tax return as single or head of household, you can make a full Roth contribution if your income is $122,000 or less.

Your maximum contribution is phased out if your income is between $122,000 and $137,000, and you can’t contribute at all if your income is $137,000 or more. Similarly, if you’re married and file a joint federal tax return, you can make a full Roth contribution if your income is $193,000 or less. Your contribution is phased out if your income is between $193,000 and $203,000, and you can’t contribute at all if your income is $203,000 or more.

And if you’re married filing separately, your contribution phases out with any income over $0, and you can’t contribute at all if your income is $10,000 or more.

Income phaseout ranges for determining 2019 eligibility to contribute to a Roth IRA:

Filing as single/head of household:

* Ability to contribute to a Roth IRA is reduced if your MAGI is $122,000-$137,000.

* Ability to contribute to a Roth IRA is eliminated if your MAGI is $137,000 or more.

Filing as married filing jointly:

* Ability to contribute to a Roth IRA is reduced if your MAGI is $193,000-$203,000.

* Ability to contribute to a Roth IRA is eliminated if your MAGI is $203,000 or more.

Filing as married filing separately:

* Ability to contribute to a Roth IRA is reduced if your MAGI is $0-$10,000.

* Ability to contribute to a Roth IRA is eliminated if your MAGI is $10,000 or more.

Even if you can’t make an annual contribution to a Roth IRA because of the income limits, there’s an easy workaround. You can make a nondeductible contribution to a traditional IRA and then immediately convert that traditional IRA to a Roth IRA. Keep in mind, however, that you’ll need to aggregate all traditional IRAs and SEP/SIMPLE IRAs you own — other than IRAs you’ve inherited — when you calculate the taxable portion of your conversion. (This is sometimes called a “back-door” Roth IRA.)

If you make a contribution — no matter how small — to a Roth IRA for 2019 by your tax return due date and it is your first Roth IRA contribution, your five-year holding period for identifying qualified distributions from all your Roth IRAs (other than inherited accounts) will start on Jan. 1, 2019.

Finally, note that 2019 is the last tax year for which the age 70½ restriction on traditional IRA contributions applies. Due to passage of the SECURE Act in late 2019, beginning with the 2020 tax year, investors over the age of 70½ will be able to contribute to a traditional IRA provided they have compensation equal to at least the amount of the contribution (spousal IRA rules will remain in effect). Keep in mind that if you’re using a back-door Roth IRA strategy for 2019, the age 70½ rule still applies.

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S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. You cannot directly invest in the index.

How Can Tax-Loss Harvesting Help Your Portfolio?

The last few months have definitely been challenging and interesting on many different levels from a stock market perspective. A silver lining in the recent market volatility that many people do not often take advantage of is tax-loss harvesting. What is tax-loss harvesting?

Tax-loss harvesting is where you realize losses in the portfolio with the intention of offsetting realized gains now or in the future to help reduce future tax bills. This works through selling an investment that has underperformed and is losing money and changing to another investment that becomes a tax-winner. Drawdowns in the market, as we saw in February and March, can provide a significant amount of loss that may be harvested.

Many investors wait until year end to attempt tax-loss harvesting, especially in a year like 2019, where we saw very little volatility. However, this year offers an opportunity to capture losses that we haven’t seen since 2008 and 2009.

An investment loss can be used for 2 different scenarios:

1. The losses can be used to offset investment gains either today or in the future. Short-term losses can be used to offset short-term gains, and long-term losses can be used to offset long-term gains. The least effective use of short-term losses is to apply them to long-term gains, but may still be preferable to paying long-term capital gains tax.

2. The losses can help offset $3,000 of income on a joint tax return in one year. Unused losses can be carried forward indefinitely.

When performing tax-loss harvesting, one has to be aware of the wash-sale rule. The wash-sale rule states that if you sell a security, fund or ETF at a loss and buy the same or substantially identical security within 30 days after the sale, the loss will be disallowed for tax purposes. For example, if you own IVV, iShares Core S&P 500 ETF and sell it for a loss, and then purchase SPY, SPDR S&P 500 ETF with the proceeds, the IRS will most likely deem this to be a wash sale violation and, therefore, not be able to take advantage of the realized loss.

Tax-loss harvesting and portfolio rebalancing can provide nice synergies as they play different roles in portfolio management. When we rebalance a portfolio, we are managing risk in the portfolio, by selling holdings that have outsized their target holdings and adding those gains to positions that may have losses or not grown as much. Often in rebalancing, the portfolio will experience sizable capital gains. That’s where tax-loss harvesting helps reduce the gains and bring the risk of the portfolio back to its target allocation.

We will continue to monitor the portfolios and look for opportunities to tax-loss harvest in the future, not just at year-end, but year round.

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Neither Kestra IS nor Kestra AS provide legal or tax advice and are not Certified Public Accounting Firms.