We may not be at the end of the year yet, but now is the time to start end-of-year tax planning. Valerie Escobar, senior wealth advisor, and Michael MacKelvie, wealth advisor, share ways to minimize the amount of taxes you’ll pay for 2023. They’ll cover tax planning strategies like capital gains, tax loss harvesting and Roth conversions to help limit your taxes.

Transcript

Michael MacKelvie: Valerie, we’re here talking about end-of-year tax planning, and we’re not maybe at the end of the year. That’s by design. We hopefully don’t want to be doing this December 31st. And the question, of course, with tax planning is how do we limit taxes as much as possible? And sometimes it’s a question of, “Hey, I can’t maybe fully avoid taxes. So if I’m paying them, how do I minimize that as much as possible? And when do I do that?” That’s what we’re here to talk about today.

All right, Valerie, so this is obviously a big question a lot of folks are dealing with that have stock, this ability to maybe harvest at a 0% rate. Maybe run through that for us real quick if you could because I know that’s a big end-of-year question a lot of folks have.

Valerie Escobar: Absolutely, and it seems to be something of a secret. Some people don’t even realize that it’s possible for people to harvest taxes at 0% cap gains. So when we’re talking about this, there are lots of little nuances, like all things, that we have to think about.

So effectively, what you’re doing is you’re first saying, “Okay, how much in ordinary income did I make?” The lower, the better. So that’s the first secret. So if we’re on a low year, maybe you’ve retired and you have a big concentrated stock position, this is this perfect strategy for you. We look at your ordinary income, then we pour out from our bucket of money, we fill the bucket up with ordinary income money, we pour out a little bit for our either standard deduction, or if we itemize, we pour some of that out. Now we add in, back into the bucket, the capital gains. So how much in capital gains do you have?

If you have under $89,000, that bucket, what it’s filled to, so ordinary income minus standard deduction plus capital gains, if it’s under $89,000 and you’re married filing jointly, you’re in that 0% cap gains bucket number. Right?

Michael: Right.

Valerie: If you’re single and it’s only $44,000, again, 0% cap gains. If you’re above that, then you’re going to pay ordinary or capital gains rate, so 15% or whatever it is. But there is that segment that is at 0%.

If you’re working and you make $200,000, and then you have cap gains on top of it, none of it’s going to be at that 0% rate. So that’s really when we’re really being strategic and saying, “When’s my super-low ordinary income year in which we can take advantage of that?”

Michael: Yeah. Yeah, and it’s a dance of sorts in a lot of ways, right? Because when we’re figuring out should we realize at 0%, there might be an attractive opportunity there from a Roth conversion, which is a whole other conversation of, okay, which one should we choose? But certainly, when that 0% rate presents itself, it’s attractive, especially if you have a low basis, high concentrated stock, maybe you’ve had much appreciation.

Now, of course, another thing you got to be considering as the year goes on, as you get closer to the year, is this idea of tax-loss harvesting, right? So we hear this, I think, tossed around perhaps more than just about anything when it comes to investment, financial planning and taxes within the account. But essentially, tax-loss harvesting is capturing losses with individual securities to offset some other individual security gain.

A famous example, if Coke is down, let’s just say 2,000, and Pepsi is up 2,000, you could offset those two. If you sold both of them at the same time, let’s just say, or just within the year, you would offset that gain and you would do that with the loss to where there would be no taxable impact. The question, of course, is does that make sense for you?

And this is something we always come back to here. People will chase tax savings in lieu of the fundamentals. So you’ll see people just selling maybe stock just to offset some type of gain. The question, of course, again, is does this make sense? And when should you do that?

But that is, in essence, just a quick example of the mechanics of tax-loss harvesting within an account. Of course, there’s nuances to it. There’s questions of when you should do it, how you should do it. We, of course, have helped out clients specifically with their taxable accounts in doing this throughout the year because we don’t want to wait typically until the end. And so, if you’re curious about this right now, it’s not something you typically want to wait until year-end to really dive into. It’s actually something you often look to do throughout the year if you’re going to do it effectively. That’s our stance, at least, when we’re looking to manage taxable accounts.

Now, that being said, there’s another opportunity that might present itself. I already alluded to it somewhat, and that would be what, Valerie?

Valerie: That is Roth conversions. And so, like you said, this is going to be a strategy that you want to look at separately, probably, from that 0% cap gains. Because doing a Roth conversion is going to increase your ordinary income dependent on the kind of IRA you’re converting. So, we’re going to let you talk about the backdoor Roth conversion because that, in general, will include nondeductible IRA contributions. For this, for Roth conversions, in this conversation we’re talking about deductible.

So, what I’m saying is that let’s say you made $50,000 and you put $7,000 into an IRA. You reduce your income on your taxes by that $7,000, and now all of it is effectively tax free that went into that IRA. The IRA then grew to whatever it is today. And you decide, “You know what? I want to move this now $50,000 IRA from that bucket into a Roth,” which means that you’re effectively paying the taxes now, and so that you don’t have to pay it in the future.

So there’s a few different reasons people want to do that. One of them is that they’re anticipating, “You know what? Right now, my tax bracket’s low. The government’s going to increase taxes in the future, so I’d rather just pay for it now.” Second thing is that you’re saying, “Okay, I’m going into this tax-free bucket, so now all my growth from that point on is going to be tax free.” So again, it’s just a matter of that handoff.

One thing to note or that I try to encourage people is to put the most bang for their buck in doing that. So if I convert my $50,000 IRA, I can put all $50,000 into the Roth, but there is going to be a tax liability on that $50,000, it’s ordinary income. So if I can pay for that tax from a different bucket, let’s just say I have cash, then I can get the most into that as possible. It’s not always possible. Some people are just like, “I don’t want to have to send an extra check.” Then, okay, that’s fine. Tax withholding, we’ll put it in there.

And last thing, really quick, to add to that, these Roth conversions, it’s really something that you should look, when you look at the financial plan that I always try to share with clients, is when’s that crossover, right? It’s going to take several years before it’s beneficial to you. So for some clients, maybe it’s not until their late eighties. They’re like, “I’m not going to live that long. That’s silly. Why am I paying my taxes now?” But some people, they’re saying, “That’s okay that it’s a really far ways down the road because I want to do it for my heirs. I want them to inherit a tax-free asset.”

Michael: Yeah. As is the case with all of investing, right? We’re not doing it for today, we’re doing it for tomorrow. And Roth conversions are no exception to that. Typically, you’re saying, “I will trade off a little bit now for the road ahead.” There’s also Social Security that it might be beneficial as far as lowering your provisional income. RMDs from IRAs will affect that.

Valerie: Yeah, great point.

Michael: So, there’s lot of things, there’s a lot of intersecting variables there that, again, come back to that word nuance, make it a little bit more nuanced.

Now, backdoor Roth contributions, this is that nondeductible contribution that one can make and then quickly convert over to a Roth IRA. So this is also another opportunity for somebody, especially, and I actually am setting up a couple of these for clients, they’re kind of in between jobs. They started a new position actually about maybe a quarter or two quarters into this year, and they’re not eligible yet for their 401(k). So, they’re trying to figure out, “Okay, what’s a way for me to maybe get some money into retirement if I’m not eligible for my 401(k) in the meantime?”

And we are actually doing this, we’re setting up a couple IRA contributions that we’re going to be then turning around and converting to Roth. Of course, if you’re just eligible for Roth, you could do that as well. But again, this is going to be something that presents itself for a lot of higher-income earners as a chance to get more money. And of course, there’s this idea of the mega backdoor Roth contributing to after tax and then immediately converting that over into a Roth 401(k). So, you have three contribution options with your 401(k). You have pre-tax, you have Roth, and you have after tax. You can contribute to the after-tax bucket and then convert that immediately over to Roth.

That is something that, towards the end of the year, you might have filled up your pre-tax or Roth bucket in your 401(k), and you’re like, “I don’t have anywhere else to contribute money.” You maybe defer a few paychecks into that after tax and convert it over to Roth. So again, there’s some opportunities that will present themselves there as far as backdoor Roth moves and mega backdoor Roth moves, we’ve done plenty of content on that. Now, there’s also this question with withholding, Valerie.

Valerie: So, paychecks, right? We are looking at our paychecks, and we probably signed up on it or decided, “Well, I’m going to withhold whatever.” We did that at the beginning of the year. Oftentimes, and we’re talking specifically, or I guess this tends to apply to executives, that when they have an executive compensation plan, let’s say they have a restricted stock unit that vested. When they vested, their withholding usually is not enough. And so, let’s say that it’s mandatory, that has to be 22%, but really I need to withhold 30%. So really looking at your paycheck and deciding, “Okay, how much have I withheld for the year? What more can I do to make sure I have it enough so I don’t have any tax surprises?”

One thing that I’ve recommended for clients that maybe this applies to them, maybe they have an inherited IRA, and they have to take an RMD from a long time ago that they had to take the RMD that’s annual. We can do a 100% tax withholding and that would take care of some of that tax payment. So just something to really be sure that I’m looking at everything, “Okay, what in capital gains did I have to pay this year if I didn’t do any tax-loss harvesting to offset that? Could I take care of that through my paycheck?” Because that is going to be something that we would avoid penalties, anything like that, if we have a year that we have a lot of taxes due and we didn’t make the payments along the way.

Michael: Yeah, and it’s also easier just to have a little bit come out from each paycheck, right?

Valerie: Absolutely, less painful.

Michael: Each time versus all at once. At least it’s an easier conversation for us when we’re talking to people.

Valerie: That’s true.

Michael: We don’t have to let them know, “Hey, in three, four months, remember you got to have that…”

Valerie: Yes. Sorry about the bad news.

Michael: “You got to put that bill in there for the conversion.” Which something that estate attorneys and I would say tax planning professionals, financial planners have had a field day with, a little segue here, is the gift tax sunset that will be occurring here after 2025. Right now, our estate tax threshold is nearly in the stratosphere, at least historically speaking, unless you go back to a time where there was no estate tax, but we’ll just say modern day here, it’s extremely high and that’s set to sunset.

So, for anybody that’s thinking about gifting a significant amount of money to the next generation, this is very applicable to your situation. So in 2026, it’s set to potentially get halved. I’ve seen quite a bit of numbers on this. The question, of course, what will it be at the end of the day? But right, now the effective number for the federal estate tax exemption is $12,920,000 for the individual, and then $25,840,000 for the married couple. That is set, from my understanding, to potentially get halved.

Of course, these things have a tendency to move around as the deadline approaches, but from what we’re seeing, this is likely going to go down significantly. So, if you are planning on gifting to the next generation, you might be able to use some of this exemption today, or at least before that change occurs in 2026. So, filling up that gift tax exemption, again, that’s something here in 2023 that you might only have a few more years to take advantage of. So, it’s something that if you’re planning on gifting money to the next generation, you probably want to gift as much as possible. You’re not looking to maybe write more in a check to the IRS than you otherwise have to. So, something to consider as well there, Valerie.

Valerie: Yeah, for sure. And we would all love to be affected by this, but really we’re talking about households that have between that, well, over $25 million, of course. Definitely want to do that. But really, if you have between that $5 million and $25 million area, where you’re going to really lose out if you don’t act before that sunset. And so, that’s really the households that we’re talking about here.

Michael: It feels like an infomercial of sorts. Act now, right?

Valerie: Yeah, yeah. The government is coming after your money. Just kidding.

Michael: Yeah, act now before the sunset. We’ll see if we can run a campaign for that. So then the last piece there of obviously just lumping charitable contributions. I know you wanted to touch on that too, right?

Valerie: Absolutely. Yeah. And so, because we have a standard deduction, we basically get a free tax credit, we’ll call it, that we don’t have to pay taxes on a certain amount of money. And so, if I gift or give to a charity an amount that is less than the standard deduction, so if I only give $10,000 and I use the standard deduction, that $10,000 really didn’t help me on my taxes.

But let’s say that I planned to give $10,000 to this charity every year for the next 10 years. I made a commitment or something. If I give all $10,000 all in that one year, now I have an amount above my standard deduction and that does help my taxes. A lot of times clients will do this strategy in a year that maybe they have a liquidity event. So maybe they sold a business, and they have a lot of funds coming in and they don’t necessarily want to give their charity $100,000 all at once. But they say, “You know what? I can make this beneficial for my taxes, and so I’ll move all the money into what’s called a donor-advised fund.”

So that big chunk is used on your taxes, it reduces it. Within that donor-advised fund, it’s now invested, it can grow. And maybe it’ll grow to $150,000, and so now your charity has benefited by that. Of course, you don’t get to reduce your tax, you don’t get to put a tax deduction of 150, just that original 100, but it’s kind of nice to be extra nice.

Michael: Yeah, for sure. Yeah, definitely.

Valerie: And one other thing just to note, too. We usually, we very often recommend gifting stock because you don’t have to pay the gains on that. We were talking about that earlier. But just remember that there are limitations based on your adjusted gross income, so 30% of your adjusted gross income. So let’s say you made $100,000 AGI, you can only give up to $30,000 of stock for it to count. And if it’s all cash, it’s 60%. So just more fun numbers that you can ask your advisor about; they’d be familiar with this. But just lots of nuance.

Michael: Yeah, a lot of it. Yeah, and I mean, again, being intentional with the monies that you have while you’re living, right? It’s something, it’s a weird transition I’m sure you’ve seen with a lot of clients as they age. They kind of, would say, have a way of zeroing in on that and understanding that in a way that maybe most of us just don’t understand during our working years. And they start gifting, and I know that there’s a tremendous amount of enjoyment out of that. Again, donor-advised funds or lumping contributions can be a great way to do that.

Well, hope you guys enjoyed this episode. Again, this might seem premature talking about end of year tax planning, but of course that’s what planning is, it is premature. So hopefully you guys enjoyed this episode. Make sure to subscribe if you haven’t. We’ll see you soon.

Mariner is the marketing name for the financial services businesses of Mariner Wealth Advisors, LLC and its subsidiaries. Investment advisory services are provided through the brands Mariner Wealth, Mariner Independent, Mariner Institutional, Mariner Ultra, and Mariner Workplace, each of which is a business name of the registered investment advisory entities of Mariner. For additional information about each of the registered investment advisory entities of Mariner, including fees and services, please contact Mariner or refer to each entity’s Form ADV Part 2A, which is available on the Investment Adviser Public Disclosure website. Registration of an investment adviser does not imply a certain level of skill or training.

The views expressed in this podcast is for educational purposes only and do not take into account any individual personal, financial, legal or tax considerations. As such, the information contained herein is not intended to be personal, legal, investment or tax advice. Nothing herein should be relied upon as such, and there is no guarantee that any claims made will come to pass. The opinions are based on information and sources of information deemed to be reliable, but Mariner Wealth Advisors does not warrant the accuracy of the information.

Asset allocation/diversification is a strategy designed to manage risk but it cannot ensure a profit or protect against loss in a declining market.

Roth IRA conversions are complex, and treatment depends on various factors. Before initiating a Roth IRA conversion, please consult with a financial or tax professional and be sure to consider all your available options and the applicable fees and features of each before moving your retirement assets. A distribution from a Roth IRA is tax-free and penalty-tree, provided the five-year aging requirement has been satisfied and one of the following conditions is met: age 59 1/2, disability, qualified first-time home purchase, or death.

CERTIFIED FINANCIAL PLANNER™, CFP® and federally registered CFP (with flame design) marks (collectively, the “CFP® marks”) are professional certification marks granted in the United States by Certified Financial Planner Board of Standards, Inc. (“CFP Board”). The CFP® certification is a voluntary certification; no federal or state law or regulation requires financial planners to hold the CFP® certification.