5 Tips to Protect Yourself From Higher Taxes

Is there any doubt that higher taxes are coming?

The federal government has provided Americans with trillions of dollars in stimulus money, and there is likely at least another trillion – probably more – headed our way.

To update an old expression for 2020, “A trillion here, a trillion there… pretty soon you’re talking real money.”

Lots of taxpayer dollars will be needed to help plug that hole, although at this point, even a widespread tax increase kind of seems like an ant blocking a fire hose.

Additionally, President-elect Joe Biden intends to raise taxes on those making more than $400,000 and on corporations, and he also intends to increase taxes on capital gains and dividends for those making $1 million or more.

The current tax rate on long-term capital gains and dividends for most investors is 15%. The highest earners pay as much as 23.8%. Under Biden’s tax proposal, the capital gain rate for those making $1 million would go up to ordinary income tax rates, which, for the top bracket, is 39.6%.

During the campaign, Biden insisted that he would raise taxes only on the wealthy and highest earners. Of course, politicians are known for not always saying what they mean or meaning what they say.

Remember “Read my lips, no new taxes”? Two years later – new taxes.

So it’s possible that more of us than just the top earners will see a tax increase in the next year or so.

Here are several year-end tax moves to make now that could save you big if taxes go higher.

  • Convert to a Roth IRA. If you’re expecting your tax rate to go up in the future, you may want to consider converting your existing IRA to a Roth IRA. The difference is that you’ll pay tax on IRA withdrawals, but not on Roth IRA withdrawals.
    However, in order to make the conversion, you’ll pay tax on the IRA withdrawal this year. That could be a substantial amount, so you’ll have to weigh whether it’s worth it to pay tax on a large lump sum today versus no tax on withdrawals in the future.
  • Take charitable deductions. As part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the stimulus package passed earlier in the year, taxpayers can donate up to $300 for an individual or $600 for a married couple and deduct the donation from their taxes, even if they take the standard deduction.
    If you itemize, you can donate up to 100% of your adjusted gross income as a deduction.
  • Donate appreciated assets. Rather than giving cash, you can save yourself capital gains taxes by donating assets, like stocks that have appreciated in value.
    Let’s say you plan on donating $1,000 to your favorite charity. Instead of writing a check with after-tax money, consider donating $1,000 worth of one of your stocks. You avoid the capital gains tax, and the charity receives the $1,000 worth of stock.

For tips on how to make sure your generous donations to charity are being used wisely, be sure to check out my article on vetting charities.

  • Take capital gains this year. If you’re concerned you’ll pay more in capital gains tax next year than you will this year, it may make sense to capture those gains before year-end. That way, you’ll keep more of the gain rather than sending it to Uncle Sam.
  • Own master limited partnerships (MLPs). MLPs are usually, though not always, oil and gas pipeline companies. They pay distributions, not dividends.
    The major difference is a distribution is considered a return of capital. That means it is not taxed as a dividend in the year it is received. Rather, it lowers your cost basis by the amount received.

For example, if you receive $1 per share in distributions, your cost basis would decline by $1 per share.

Your capital gains will be larger when you sell, but while you own the stock, you will not pay tax on most or all of the distribution until your cost basis is reduced to zero.

An important thing to know about MLPs is that at the end of the year, you receive a K-1 tax statement, not a 1099-DIV. A K-1 can be more complicated, and some accountants charge more for handling a K-1.

You work (or worked) hard for your money. You deserve to keep every dollar that you’re legally entitled to. The tips mentioned above will help you do just that.

Good investing,

— Marc

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Source: Wealthy Retirement