Head of Wealth Planning, Wells Fargo Private Bank

In this Wealth Planning Update:

  • Tax planning focus has shifted from estate taxes to income taxes
  • Taking proactive steps now may improve your tax efficiency and positively impact your tax bill
  • Timing of capital gains, tax-advantaged accounts, the Alternative Minimum Tax, and the Medicare surtax are all factors to consider when making tax-based decisions
  • Partnering with your relationship manager, wealth planner, and tax advisor is key to making tax-based decisions that are in line with your overall wealth plan

With spring in full bloom, what comes to mind? The start of the baseball season? Planting flowers and landscaping your yard? Or maybe making plans for summer vacation?

One thing that’s definitely top-of-mind in April is taxes. You might be looking at how much you paid in taxes and wondering what you could have done to lessen that tax bite.

From a traditional planning perspective, the focus for many years was on reducing the estate tax impact for individuals. However, with the federal exemption at $5,450,000 in 2016 ($10,900,000 for married couples) and an estate rate of 40 percent, the emphasis has shifted to income taxes. It’s important to discuss tax efficiency when considering income taxes—taking small steps now can help set you up for success, lessen the impact of trying to take action at the end of the year, and potentially minimize your tax bill.

Five actionable strategies that can help you manage your income tax exposure

1. Rebalance your portfolio with tax-advantaged accounts

Meet with your advisor to make sure you are using your tax-deferred qualified investment accounts as the primary destination for your “tax-inefficient” assets. Taxable bonds and dividend paying equities, for instance, may be most efficiently held in a 401(k) or IRA, while municipal bonds might be best allocated to a non-qualified brokerage account. As always, but especially in today’s higher tax environment, it may be worth maintaining a personal and quantifiable mid- to long-range tax projection to understand how best to allocate your investment assets going forward.

2. Actively manage your income

Income is taxed in the year it is received. If you will be at the same or lower tax bracket next year, it might make sense to defer income. For many taxpayers, this is done primarily through deferral of capital gains, either delaying sales of capital gain property until after December 31, or using the installment method of gain recognition (if applicable). If, however, you will be in a higher tax bracket next year, you may want to accelerate income in 2016 to pay the tax at the lower rate.

Although there are few options to exclude income, a possibility that becomes permanent in 2016 as a result of the passage of the Protecting Americans from Tax Hikes Act of 2015 (PATH) is the opportunity for individuals at least 70½ to exclude from gross income qualified charitable distributions (QCDs) from Individual Retirement Accounts (IRAs). The exclusion cannot exceed $100,000 per taxpayer in any tax year. The amount given to charity counts towards your required minimum distribution; if you are managing your tax bracket this may allow you to avoid a higher bracket since it is excluded from taxable income. (Note: you cannot “double-dip” and also claim a charitable tax deduction for your QCD gift.) A Wells Fargo wealth planner can assist you in determining if this would be advantageous.

3. Keep an eye on the Alternative Minimum Tax (AMT)

Deductions decrease your income tax liability. If you employ the strategy of accelerating deductions, you must be careful you do not inadvertently trigger the AMT. Certain deductions are disallowed when calculating AMT, including state income taxes paid and property taxes. Charitable contributions enjoy deductibility under both income tax and AMT rules (although be mindful of the phase-outs for itemized deductions when adjusted gross income (AGI) exceeds certain thresholds). When creating your 2016 charitable giving strategy, consider the tax impact of pre-paying anticipated or pledged 2017 charitable contributions prior to year-end.

4. Manage timing of capital gain eligible sales

Implementation of the Medicare surtax on unearned income has combined with capital gains tax rates to broaden the number of factors for you to consider when determining whether to sell capital assets. Not only are your general investment goals a factor, the surrounding tax ramifications are also increasingly becoming a factor. Timing of sales is crucial as capital assets held for less than one year are taxed at ordinary income rates (up to 39.6 percent) while long-term capital gains rates are as high as 20 percent. Remember that both long-term and short-term capital gains are, generally speaking, also exposed to the 3.8 percent Medicare surtax if AGI exceeds certain thresholds.

In addition to considering the overall tax impact on any capital asset sales, you may also want to consider adopting a tax bracket management plan. For instance, if you believe you may be in a lower tax bracket in 2017, but must sell your capital assets in 2016, you may wish to effect the sale transaction by means of an installment sale. This strategy would, in many cases, allow you to recognize a significant portion of the gain in future years.

5. Have a holistic discussion with your planning professional

While the strategies above can be effective in helping manage your tax burden, they are not all-inclusive or a destination in and of themselves. A better starting point is a strategic wealth plan tailored for your specific needs and goals. Sit down with your trusted advisors to prioritize your objectives and review them against your current situation to determine which solutions and strategies may be the most appropriate for you.