With tax day behind us, many people are now looking ahead to the potential impact of tax reform. Although the outcome is far from clear at this point, our emotional response says a lot about our current financial situation, and I’ve observed most people reacting in one (or two) common ways:
If you’re upset - that’s natural, nobody likes taxes. Or, at least, when you are the person paying them.
If you’re concerned or worried - it’s likely that you’ve avoided dealing with a tax-related problem for some time, and now you’re acutely aware that it might get a lot worse.
Ironically, when it comes to investments the factor that most directly affects the tax rate that you’ll pay is…you. That’s because the timing of when you sell investments determines whether gains are taxed as ordinary income, long-term capital gains, or subject to AMT (Alternative Minimum Tax).
Here are some items to consider as tax reform progresses (or not) during 2021:
How might this play out?
Negotiations are likely to follow a long, rancorous debate, and successfully navigating a political minefield means that some of the most unpopular changes are least likely to take effect.
That’s why a repeal of tax cuts resulting from the Tax Cuts and Jobs Act of 2017, or returning to Reagan-era tax rates, is perceived to be far more palatable than entering uncharted territory.
What changes most directly affect individuals?
Increasing the top bracket for ordinary income seems more likely to occur because an increase from 37% back to its prior level of 39.6% isn’t a huge change from a percentage standpoint, but it would be expected to produce substantial tax revenue.
Treating capital gains as ordinary income has also been considered, though this has focused upon those with over $1M in income. This would affect even fewer people, and an increase in the top capital gains rate from 20% to 37% (or 39.6%) is certain to encounter fierce resistance.
While capital gains changes are meant to target the ultra-wealthy, it could also ensnare a broad swath of people with employer stock options during a year where M&A or IPO had occurred. This would be unfortunate because employer stock is earned over many years, but the payout can arrive all at once.
What part of my portfolio could be most affected?
If changes are implemented, the area of greatest concern for investments would likely be concentrated stock positions in taxable (i.e., non-retirement) investment accounts.
Concentrated stock positions often originate from receiving employer stock or inheriting investments from a loved one, and without a plan in place to reduce them they often become an increasingly large concern.
Regardless of your current financial situation or whether tax reform is even implemented, it’s important to make sure that your investments are managed with a focus on investment value (selling at an attractive price) and tax-efficiency, rather than focusing on one at the expense of the other.
If you’d like to identify ways to improve your investments, pick a time here to schedule a 15-minute call.
This blog was written by Jeremy Bohne, Principal & Founder of Paceline Wealth Management. Paceline is a fee-only investment advisor serving clients in the Boston area, and on a remote basis throughout the country. Paceline specializes in helping tech and biotech executives, physicians, and those seeking financial planning services.