Key Takeaways
- Higher alternative minimum tax exemption amounts could make this a better time to exercise incentive stock options.
- Consider “bunching” your charitable giving in one year to increase your itemized deductions.
- Consider making gifts to family and beneficiaries now, under increased federal gift and estate lifetime exemptions.
It’s the fourth quarter, and that means it’s time for investors and entrepreneurs to start making year-end financial planning decisions. These decisions come at the busiest possible time, when your calendar is filled with work, holiday and family commitments. But if you set aside time now to ensure that your choices make the most of tax law changes, you won’t miss out on opportunities to help protect and maximize your wealth.
Here are tips to help you speak with your SVB Private Bank Relationship Manager and your own tax advisor about optimizing your tax situation while seeking to maximize your wealth and earnings.
1. Consider exercising incentive stock options to take advantage of the higher alternative minimum tax exemption.
As year-end approaches, determine if it’s time to exercise any incentive stock options (ISOs) you hold. Exercising an ISO is treated as income solely for the purpose of calculating the alternative minimum tax (AMT) but is ignored for the purpose of calculating the regular federal income tax. The spread between the fair market value of the stock and the option’s strike price is included as income for AMT purposes.
Changes in the Tax Cuts and Jobs Act of 2017 increased the AMT exemption by 30%, meaning you may be able to exercise more stock options before triggering AMT. This is perhaps the most crucial year-end planning consideration because unintended AMT triggers can occur when ISOs and non-qualified stock options (NSOs) are exercised without a comprehensive check for the tax consequences.
Here’s a table comparing the 2021 AMT exemptions to 2020 levels:
Alternative Minimum Tax (AMT) Exemption Amounts
| 2020 | 2021 | |
| Single taxpayer | $72,900 | $73,600 |
| Married taxpayers filing jointly | $113,400 | $114,600 |
Alternative Minimum Tax (AMT) Threshold
| 2020 | 2021 | |
| Single taxpayer | $518,400 | $523,600 |
| Married taxpayers filing jointly | $1,036,800 | $1,047,200 |
Check with your CPA to determine whether you have an opportunity to exercise ISOs without incurring additional tax liability under AMT in 2021. If you are anxious to get the clock ticking for long-term capital gains treatment, regardless of the tax liability, you may consider exercising ISOs early in 2022, since the AMT may not be due until April of the following year.
2. Determine whether your investments meet requirements for qualified small business stock treatment.
Check with your SVB Relationship Manager and your CPA to see if the qualified small business stock (QSBS) exclusion (section 1202 of the Internal Revenue Code) could apply to you. There are strict rules around qualifying for the exemption, but when a stock does qualify, there is an exclusion of up to $10 million or 10 times original cost basis — whichever is greater — of capital gains, including an exclusion from the AMT and the net investment income tax (NIIT). Read SVB’s article about QSBS for more details.
3. Make good use of tax loss harvesting.
Year-end is an ideal time to consider capital gains impacts. When selling a position, investors may realize a capital loss and potentially write off up to $3,000 of collective losses against ordinary income; the rest can be used against any 2021 realized capital gains. Any unused capital losses can be carried forward into future years indefinitely, providing a valuable tax management tool. Be familiar with the wash sale rule, which may disallow the loss if you re-purchase the same or a substantially equal security 30 days before or after the sale date.
In addition, section 1244 losses could be useful if you invested in an early-stage private company and the business had to close down. Those losses are treated as ordinary losses rather than capital losses on your tax return and could result in a greater tax benefit.
4. Maximize charitable giving deductions.
Charitable giving is near the top of almost every deduction list because it’s a great way to give back to the community while benefiting from a tax break. Many of our clients have used charitable deductions to offset income from a liquidity event. The standard deductions have almost doubled compared to 2017 for the two main filing categories, making it tougher for many taxpayers to itemize deductions. If you don’t have enough to itemize your deductions, you’ll end up taking the standard deduction, eliminating your ability to reap the tax benefits of those charitable deductions.
2021 Standard Deduction Thresholds
| Standard deductions | 2020 | 2021 | |
| Single | $12,400 | $12,550 | |
| Married filing jointly (MFJ) | $24,800 | $25,100 | |
| Elderly (over 65) or blind single | Additional $1,650 | Additional $1,700 | |
| Elderly (MFJ and both over 65) | Additional $2,600 | Additional $2,700 | |
| Exemption | Personal exemption | Eliminated | Eliminated |
One way to exceed the threshold is to bunch multiple-year donations into a single year in combination with a donor-advised fund (DAF). Using a DAF allows you to receive the deduction in the year of the donation but stretch grants to charities out of the DAF over multiple years. Instead of making your normal charitable donation of $7,000 each year, you bunch two donations into a single year and make one $14,000 charitable donation in 2021 to a DAF, thereby exceeding the $12,550 standard deduction threshold. With a DAF, you can still recommend grants to charity over a number of years. This also provides a deduction against current year income in years where income may spike due to a liquidity event. For more details, read our article about how DAFs can help maximize your charitable giving.
Another way our clients donate is by giving highly appreciated assets (securities) directly to nonprofit organizations, which in most cases is more effective than making a cash donation. It allows you to contribute more value to the charity than if you sold the shares, paid the applicable capital gains taxes and then donated the remaining cash. When contributing to a DAF, it is important to gift stock with long-term gains. Gifting appreciated securities with short-term capital gains would provide you with a charitable deduction equal to the cost basis of the gift, not the fair market value.
Here’s an example to demonstrate why donating appreciated investments may be a good option for you. Let’s assume you’re in the 37% federal tax bracket and want to donate $100,000 worth of stock with a cost basis of $10,000. In this example, you see that donating the stock results in no capital gains tax and a larger itemized deduction.
| Option 1: Sell stock and donate the cash net proceeds to charity | Option 2: Donate stock directly to the charity | |
| Current fair market value of stock | $100,000 (1000 x $100 per share) | $100,000 (1000 x $100 per share) |
| Long-term capital gains tax paid1 | $18,000 | $0 |
| Amount donated to charity | $82,000 | $100,000 |
| Personal Income tax savings2 | $30,340 | $37,000 |
| (37% x amount donated to charity) | ||
1 Assumes a cost basis of $10,000, that the investment has been held for more than a year and that all realized gains are subject to a 20% long-term capital gains tax rate. This analysis does not take into account any state or local taxes or the Medicare surtax of 3.8%.
If you itemize your taxes, donating to charities from a taxable account can reduce your tax bill. This is particularly true if you can contribute appreciated securities you have held in your account for at least a year. Doing so not only entitles you to a tax deduction (assuming you qualify), but also allows you to eliminate the capital gains tax.
5. Take advantage of increased gift, estate and generation-skipping transfer exemptions
The federal gift, estate and generation-skipping transfer (GST) lifetime tax exemptions for 2021 have increased to $11,700,000 for individuals and $23,400,000 for married couples. It’s important to note that the exemption increases will also adjust for inflation each year until 2025, at which time they will sunset and revert to 2017 levels (adjusted for inflation). While these increases are temporary, they are substantial. You might consider making gifts to children, grandchildren or other beneficiaries who fall within these limits or plan for them to take place over the next several years.
It also makes sense to review your wills and trusts to ensure the final funding amounts are not tied to these higher exemption amounts. Doing so could avoid an unnecessarily high funding of your trust upon passing. It is also possible that these increased exemptions and gift and estate tax laws in general could change with the proposed tax law change in the Build Back Better legislation working its way through Congress. It has been proposed that these changes could become effective January 1, 2022, making it more urgent to take advantage of the increased exemption amounts before the end of 2021.
The annual gift tax exemption for 2021 is $15,000 per person. This means a married couple could give up to $30,000 in annual gifts to an unlimited number of recipients, including minors, in the form of a Uniform Transfers to Minors Act (UTMA) account or a 529 college savings plan. And of course, you might also be able to make unlimited gifts on behalf of someone else for amounts paid directly to educational institutions for tuition and to medical providers for healthcare. Check with your tax advisor to discuss your situation.
Contributions to a 529 plan would also fall into the annual gifting category and can be front-loaded for up to five years of the annual gift tax exclusion amount ($75,000 for individuals, $150,000 for couples in 2021) without a gift tax consequence.
6. Maximize your retirement plan contributions for continued tax benefit.
Year-end financial decisions should always include a review of retirement plan contributions. For 2021, 401(k), 403(b) and 457 retirement plan contribution limits have all increased modestly. IRA and Roth IRA contribution limits will stay the same as in 2021, at $6,000.
Many investors and early-stage entrepreneurs use self-employed retirement plans as an opportunity to defer income tax liability. The two most popular plans, the self-employed 401(k) plan and the SEP IRA, allow for up to $58,000 of pre-tax contributions in 2021, plus a $6,500 catch-up amount for 401(k) plans only. The deadline to establish a self-employed 401(k) is December 31, although the plan does not have to be funded until your tax filing deadline plus extensions.
There are also other types of retirement savings options, such as defined benefit and cash balance type plans, that allow for significantly higher pre-tax contributions. Here’s a recap of all 2021 retirement plans:
2021 retirement plan annual limits
| Effective deferrals 401(k), 457, and SARSEPs Catch-up contribution |
$19,500 $6,500 |
| Defined contribution (§415(c)(1)(A)) Defined benefit (§415(b)(1)(A)) |
$58,000 $230,000 |
| SIMPLE plan SIMPLE catch-up contribution |
$13,500 $3,000 |
| Maximum includible compensation Highly compensated employee Lookback to 2019 Lookback to 2020 Key employee (top-heavy plan) SEP participation limit |
$290,000 $130,000 $130,000 >$185,000 $650 |
| IRA or Roth IRA contribution limit IRA or Roth IRA catch-up |
$6,000 $1,000 |
| IRA deduction phaseout for active participants Single Married filing jointly Married filing separately Non-active participant married to active participant |
$66,000 - $76,000 $105,000 - $125,000 <$10,000 $198,000 - $208,000 |
| Roth IRA phaseout Single Married filing jointly |
$125,000 - $140,000 $198,000 - $208,000 |
Review tax withholding and estimated payments.
Changes to the federal tax brackets were limited to the annual inflation adjustments that happen every year, called cost-of-living adjustments (COLAs). Apart from that, expect the same basic structure used in 2020, with the same seven tax rates applying to the various brackets. The actual income amounts of the brackets depend on your tax filing status. Make sure your withholding and estimated tax payments match your potential income tax liability to avoid underpayment penalties. Similarly, overpayment of these amounts, in expectation of a large refund, reduces your monthly cash flow and results in an interest free loan to the IRS.
Anticipate the tax law changes proposed in Build Back Better
There have been multiple iterations of proposed tax law changes in President Biden’s Build Back Better bill as it moves through the legislative process. At this time, it looks like most of the individual income tax changes revolve around a 5% surcharge on modified adjusted gross income (MAGI) above $10 million and an extra 3% tax on income above $25 million, as well as increased IRS enforcement.
These are only the latest proposals. This could all change (and likely will) as it winds its way through the House and Senate. It looks like the CBO (Congressional Budget Office) scoring will show a shortfall in funding the expenditures in the legislation, in which case they would need to find additional revenue resources. Currently the following provisions are not in the legislation:
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Reduction of the Gift and Estate Tax lifetime exemption. They would stay at the current exemption ($11.7m) adjusted for inflation.
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Elimination of valuation discounts, e.g. discounts for lack of control and marketability.
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Unfavorable treatment of Grantor trusts.
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Increase in income and capital gains tax rates
With these proposed changes in mind, now would be a good time to talk with your tax and estate planning advisors about:
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Reviewing estate plans and considering year-end lifetime gifts
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Making sure you have documentation to support all deductions and credits on your tax returns
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Possibly accelerating income rather than the usual postponement of income
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Possibly postponing deductions rather than the usual acceleration of deductions
SVB Private Bank is here to help
Although crucial financial decisions for the tax year always come at a time when you’re already busy, it’s critical to take steps now to make sure 2021 is a pivotal year for your long-term financial health. With all the tax law changes, it’s important to know what steps to take now so that you’re ready for 2022 and beyond.
As always, SVB Private Bank is here to help you plan for year-end alongside your tax advisor and legal team.
