tax planning

Got Cryptocurrency or NFTs? They Need to Be in Your Estate Plan

Cryptocurrencies and non-fungible tokens (NFTs) are becoming a bigger part of the investment world as more and more people buy these assets. It is important to take these digital assets into account in your estate plan so they will pass to your loved ones at death, just like more traditional assets.  Crypto and NFTs, however, can present challenges to securing, transferring, protecting and gifting family wealth.  New strategies are evolving to address this growing demand for family planning and tax planning with these types of assets.

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There are currently many different cryptocurrencies and NFTs.  Right now, the top cryptocurrencies are Bitcoin, Ethereum, Binance Coin, Tether and Solana, and they make up a large part of the trillion-dollar market value.  An NFT is a unique, collectible, tradable digital asset on the blockchain, sort of like digital art, a photo or a video game avatar, that can only be purchased on an NFT marketplace through a bidding process.  For example, you can purchase virtual land and real estate in the form of NFTs.  In November 2021, someone paid $450,000 to be Snoop Dogg’s neighbor in the metaverse.  Sales of NFTs jumped to more than $17 billion in 2021, demonstrating a growing desire for these collectibles. 

Track Your Cryptocurrency and NFTs

Cryptocurrency is accessed through a private key, which is a series of alphanumeric characters known only to the owner and stored in a digital wallet or in cold storage. Whoever has the private key can buy, sell and use the digital currency.  Your family or fiduciary must know that the cryptocurrency exists, where to find the assets, and what to do with them.  One option is to share the seed phrase and private keys with your fiduciary.  Another option for safe tracking is to place your crypto-assets and NFTs in custody, like a software application or hardware wallet.  Companies offering digital-asset custodian services include Coinbase, BlockFi, Casa, Unchained Capital, Anchorage and Genesis.  A third more old-fashioned option is to make a schedule of your digital assets for your fiduciary and list the login protocols for each account on whatever cryptocurrency exchange you use. 

  • SEE MORE 5 Dumb Crypto Mistakes (And How to Avoid Them)

Similarly, NFTs can only be accessed with a password or personal key.   Like crypto, your passcode or personal key must be shared with your fiduciary in order for it to be passed down.  A digital legacy (an organized, updated list of your digital assets and the relevant related information and passwords a fiduciary will need to access them) can be a good place to keep this information. 

Ultimately, you need to be sure that the details of the ownership of the NFT and cryptocurrency, including the private keys and passwords to access the digital wallets, are accessible to the fiduciary – otherwise, the cryptocurrency and NFTs could be lost forever. 

Cryptocurrency, NFTs and your Estate Plan

It is currently difficult to open cryptocurrency accounts and NFTs in the name of a revocable or irrevocable trust.  However, wallets do exist that allow you to open an account in the name of a trust, or you can try to name a trust as a beneficiary of your account.  This option is only available if the company handling your account allows it.  As of the time of this article, our clients have generally been unsuccessful in naming beneficiaries for crypto accounts.  It is likely that the ability to name a beneficiary will evolve rapidly and could soon be available.

 If there is no trust account and no named beneficiary, then your crypto accounts will pass as part of your probate estate under your will.  You should make sure that your will, trust and durable power of attorney include digital asset powers for the fiduciary handling your estate.  It is also important to know if your state has adopted either the Uniform Fiduciary Access to Digital Assets Act (UFADAA) or the Revised Uniform Fiduciary Access to Digital Assets Act (RUFADAA).  Of the 50 states, 46 have adopted one of these two laws.  UFADAA and RUFADAA make it easier for your loved ones to manage your digital assets both during incapacity and after death.

Conclusion

The estate planning and tax issues surrounding NFTs and cryptocurrency are complex and continue to evolve.  In upcoming articles, we will address the tax issues concerning these assets, as well as some planning techniques.  

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How Taxes Impact Your Wealth Gap

Imagine you’re standing on the bank of a river. The bank you’re standing on represents your current financial status, and the opposite bank is the amount of wealth you need for retirement. The river itself is the difference between how much wealth you currently have and what must be accumulated to reach your retirement goals.

When we look at bridging this wealth gap, it’s important to factor in anything that could get in the way of reaching our goals. That’s why taxes are so important. You can’t have an accurate calculation without understanding how taxes impact your wealth gap. You see, taxation plays a significant role in our ability to accumulate wealth. If you went through your whole life without utilizing any of the tax breaks available to you, you would have built substantially less wealth than someone who understood the Internal Revenue Code (IRC) and took advantage of its many tax-saving benefits.

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In fact, one of my colleagues often calls the Internal Revenue Code “the greatest wealth creation tool in the United States.” He’s not wrong. The IRC is a tool for wealth creation. As such, it can be the difference in whether taxes impact your wealth gap in a negative way. You see, much of the IRC is pages and pages of information on how you can legally minimize taxes. 

Let me be absolutely clear, I am not offering tax advice. Nor am I advocating for illegal or unethical means of avoiding the payment of taxes. You should always consult a professional before employing any of the strategies found within the IRC to ensure that you are compliant with the law.

By the Numbers

The top marginal income tax rate of 37% affects taxpayers with a taxable income of $539,900 or more for single filers. Likewise, it impacts married couples filing jointly, with a taxable income of $647,850 and above. But what does that mean for you? Will taxes increase? Will tax brackets expand, or decrease? The only way to truly opine the answers to these questions is to look back at historical tax brackets. 

In 1984, the lowest bracket was up to $3,400 for married couples. The highest tax bracket began at $162,400 (the 1984 values are the base upon which inflation indexing began). However, the brackets began to spread in the 1990s. In fact, the highest bracket floor in 1994 rose to $250,000 while the lowest bracket ceiling remained around $38,000. So, there began to be a “spread” between the tax rates of high-income earners and those with less income. That spread has become an albatross in the modern era.

Historical Tax Data

To better put into context how taxes impact your wealth gap, let’s look at some of these numbers through a tax rate calculator. Using this calculator, if you were making $50,000 (in today’s dollars) in 1913 you would have paid around 1% in taxes. However, that same $50,000 earnings in 1942 would have landed you in a 20% tax bracket. So, what happened? Well, that would have been about the time that the government needed to fund the war effort for WWII. Since that time, there hasn’t really been a whole lot of movement. If you’re a single filer earning $50K today, you’re going to be taxed at about 22%.

  • SEE MORE Tax Changes and Key Amounts for the 2022 Tax Year

However, most of the clients I work with earn much more taxable income than $50K. So, let’s go with a more realistic figure. We will enter $500K into the calculator. Keep in mind, the effective tax rate made a considerable change between 1937 and 1942. In 1944, a person earning $500K (in today’s dollars) would be taxed at the bracket rate of 51%. That number rose to as high as 58.9% in the early 1980s.

What History Tells Us

Famed historian and co-documentarian of the PBS series Prohibition, Lynn Novick attributes the creation of the federal income tax to Prohibition in the United States. Novick states, “I had no idea how important liquor was to the federal government. It started in the Civil War with the levy on beer and whiskey to help fund the war, and it never really went away. Some 30% to 40% of the government’s income came from the tax on alcohol. So, Prohibitionists realized that the only way they’re going to have a ban was through income tax, which was a progressive cause and was really supposed to distribute wealth and to make things equitable during the robber baron era, where the wealth was being accumulated in a very small segment of the population.”

In 1913, the top tax bracket was 7% on any income over $500,000 ($11 million in today’s dollars). The lowest tax bracket was 1%. But so much has happened since then. We’ve experienced WWI, WWII, the Great Depression and so much more. Each of these events has played a major role in how we are taxed. For instance, the New Deal carried an inflation-adjusted price tag of $856.1 billion in 1933. Then from 1943 to 1982, the average tax bracket for the taxpayer earning $500,000 jumped from 14% to an average of 50% +/-.

Similarly, the Great Recession saw an economic stimulus that totaled $1.8 trillion. As a result, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 maintained the 35% tax rate through 2012. And recently, we saw the largest stimulus package in our nation’s history, with the CARES Act, which checked in at a staggering $3.6 trillion. As we have seen in the past, we could reasonably anticipate another increase in federal income taxes because of this.

Putting It All Together: How Taxes Impact Your Wealth Gap

According to the old adage, there are two certainties in this life: death and taxes. With that in mind, I wanted to get you thinking about how taxes will likely impact your wealth gap. I want you to be confident in your personal plans and direction. You know what you want out of retirement and how long you have to build the wealth that will fund it. Don’t let something like taxes throw off your calculation. 

To ensure that you’re not overpaying on taxes, you should have a CPA helping with your annual tax filings. But that’s not all. You should also be meeting with your CPA and CFP® about proactive strategies to mitigate your tax burden. The less you pay in taxes, the more you can save for retirement. Both will help you to close your retirement wealth gap sooner than later.

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Effective Tax Strategies for the Present and Future

Did you get a surprise when you filed your taxes this year? It’s common for taxpayers to be caught off guard – either owing more than anticipated or receiving an unexpected refund. Though most taxpayers are relieved once taxes are filed, many have little understanding about how to manage their tax situation to enhance their savings and investment strategies.

Many find the process of managing taxes too daunting and simply react to taxes resulting from savings and investment decisions, rather than implementing strategies to minimize their taxes beforehand.

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 In 2020, many investors overreacted during the pandemic and, fearing market volatility would erase investment gains, sold appreciated investments, subjecting them to increased taxes. Others sold assets in 2021 and incurred taxes because they suspected a proposed tax increase would push capital gains rates from 20% into tax rates of 37% or more, though ultimately there wasn’t political support to pass such tax increases.  

To avoid these types of reactive, knee-jerk approaches to decisions, you need a comprehensive tax strategy in place. Once equipped with appropriate strategies – such as those outlined below – taxpayers can adapt their savings and investment decisions and consider taxes as part of the equation.

Savings and Income Tax Advantages

Planning for taxes is meaningful because they influence other overarching financial decisions, including what we purchase, where we live and work, and when and where we can retire comfortably.  Managing taxes effectively requires looking at short-and long-term factors, primarily around savings and spending, investments and legacy planning.  Often taxes can be lowered depending how much is saved and what savings vehicles are used.  Current income tax rates affect our ability or willingness to save – especially in light of incentives offered by qualified retirement plans. For instance, investing in a 401(k) or an IRA can reduce current taxes and provide tax-deferred investment growth until assets are distributed.  Alternatively, a Roth IRA or a Roth 401(k), may result in greater current tax payments but permit tax-free growth and tax-free distributions when funded with after-tax dollars. 

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Choosing between those alternatives requires looking at the overall situation.  An investor in the 24% income tax bracket, for example, who contributes $10,000 to a pre-tax 401(k) plan can save $2,400 in federal taxes, lowering the net overall investment “cost.” A designated Roth 401(k) or Roth IRA, assuming savings at the same $10,000 level, would not provide any current income tax break, but would allow the account owner to later take withdrawals tax-free, provided other parameters are met (e.g., five-year account period and/or meeting other restrictions).

Individuals should compare taxes saved through savings deferral at their current tax rate with those rates likely to apply once tax-deferred assets are to be withdrawn. For example, a married couple or individual with a marginal 24% tax rate who expect to be subject to much higher taxes in retirement (current highest marginal tax rates are 37%), caused by income from a pension or from other sources, may want to pay taxes on income now, and invest the after-tax dollars to produce tax-free distributions later to avoid paying taxes at higher rates.  Alternatively, those expecting income to level off or be reduced once they withdraw funds may be better off with a tax-deferred 401(k) allowing them to retain current income.

Naturally, the situation can change over time, so tax-saving strategies should be revised as circumstances change.

Managing Taxable Investment Accounts

Effectively managed brokerage accounts and other non-qualified, taxable accounts may incorporate a prudent tax-loss harvesting strategy coordinated by investment and tax advisers.  Long-term investors can take advantage of lower capital gains taxes from tax loss harvesting when selling investments to cover current expense and withdrawal needs and particularly when buying and selling investments as part of their long-term investment rebalancing to maintain a desired asset allocation and to keep their portfolio diversified.  

Investment rebalancing usually involves selling appreciated assets and purchasing others at more attractive prices to meet their investment objectives. In the process, selling appreciated assets can increase capital gains taxes. As appreciated assets are sold, investors can find opportunities to also consider selling other investments currently valued at less than their purchase cost, which can be due to temporary market volatility or other reasons related to the individual holding(s).  Selling assets at a loss enables investors to capture a tax benefit.  In effect, it allows them to offset any capital gains incurred from selling the appreciated assets.

Consider, for example, an investor who purchases individual publicly traded stocks. For simplicity, let’s assume 100 shares of a stock were purchased over one year ago at $200 per share (total acquisition price of $20,000) and are sold at a price of $150 per share, (total sales price of $15,000). Ignoring any cost of the sale, it generates a $5,000 long-term capital loss (long-term only when the position was sold after a one-year holding period) which can be used to offset other current year taxable capital gains when other investments are sold at market prices greater than their cost. In situations where total annual losses from all sales exceed gains – e.g., there are not sufficient gains to completely offset total losses – up to $3,000 of such loss can be used to offset ordinary income in the current year. To the extent losses exceed $3,000, (by $2,000 in the example), investors can “bank” those excess losses to offset future gains, which can be carried over only until death under the current law and regardless of whether capital gains tax rates increase in the future.

A careful approach to loss harvesting should be guided by tax and investment professionals to avoid mistakes when managing capital gains and repositioning investments. Savvy investors can use volatile market periods to make strategic investment maneuvers, through selling to capture their available losses, and may consider repurchase of the same or similar position (the same position may be acquired only after 30 days to avoid wash sale rules).  Complications by way of higher taxes can arise from violating wash sale tax rules that effectively disallow a loss if the same security or securities are repurchased within 30 days across various accounts owned by an investor.

In summary, using a tax-effective strategy that looks through a current and future tax lens can keep your savings and investing decisions on the right path for financial success.

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The views expressed within this article are those of the author only and not those of BNY Mellon or any of its subsidiaries or affiliates. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation.
This material is provided for illustrative/educational purposes only. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation.

Tax Changes and Key Amounts for the 2022 Tax Year

Now that this year’s tax filing season is over, it’s time to start thinking about next year’s return. After all, the more tax planning you do, the more money you may be able to save. But proper tax planning requires an awareness of what’s new and changed from last year — and there are plenty of tax law changes and updates for the 2022 tax year that savvy taxpayers need to know about.

Big tax breaks were enacted for the 2021 tax year by the American Rescue Plan Act, which was signed into law in March 2021. But most of those tax law changes expired at the end of 2021. As a result, the child tax credit, child and dependent care credit, earned income credit and other popular tax breaks are different for the 2022 tax year than they were for 2021. Other 2022 tweaks are the result of new rules or annual inflation adjustments. But no matter how, when or why the changes were made, they can hurt or help your bottom line — so you need to be ready for them. To help you out, we pulled together a list of the most important tax law changes and adjustments for 2022 (some related items are grouped together). Use this information now so you can hold on to more of your hard-earned cash next year when it’s time to file your 2022 return.

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Retirees: Here’s How to Pay for 5 Common Expenses and Cut Your Taxes While Doing It

Even though the April 18 income tax deadline has passed, it’s worth exploring how to plan to pay for some common expenses in retirement to receive the most tax benefits, ahead of the next filing deadline in April. 

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One of the most foundational tax-planning questions a retiree faces is how to best pay for expenses while minimizing the tax impact.  Fortunately, the Internal Revenue Service allows several tax-advantaged ways to accomplish this goal, depending on the funding source and type of expense.  

Here are five common expenses in retirement that could cut your tax bill:

Fund a Grandchild’s Education from a 529 Plan

Anyone can contribute to a 529 plan to help pay for a child or grandchild’s education.  This money has several advantages: tax-free growth, tax-free withdrawals if used for qualified education expenses, and no estate taxes due.  Contributions count toward the annual $16,000 per person annual gift tax exclusion limit; however, a unique tax rule for 529 plans allows donors to effectively front-load up to five years’ worth of contributions and avoid gift taxes.

About 30 states offer a state income tax deduction for 529 plan contributions.  For example, Georgia provides a deduction on contributions up to $8,000 per beneficiary to the state’s Path2College 529 plan. 

While people in states without state income tax incentives don’t receive a tax deduction, there may be other long-term benefits.  For example, someone may want to move assets out of their taxable estate, have a concern for higher income tax rates in the future, or simply like the idea of having assets for education earmarked in a separate, designated account for a grandchild or family member.      

Pay for Medical Expenses from a Health Savings Account

HSA contributions are tax-deductible, the funds grow tax-free, and distributions are tax-free if used for qualified medical expenses.  Many retirees during their working years contributed to Health Savings Accounts and used their earned income to pay for healthcare costs to allow the HSA funds to grow.

While people can’t fund an HSA once they begin receiving Medicare, they can use an HSA to pay for out-of-pocket medical expenses such as doctor’s bills and prescriptions.  The funds can even be used to pay for Medicare Parts B and D premiums.

Since HSA distributions for qualified medical expenses are tax-free, retirees with this type of account can reduce their need to take withdrawals to pay for medical costs using other taxed sources, such as IRAs and 401(k)s.  The tax impact over time in retirement could translate into thousands of dollars saved, especially for retirees who aren’t able to offset taxable withdrawals by itemizing their medical costs.  

Pay for Long-Term Care Insurance Premiums from an Annuity

The IRS allows a strategy, called a partial 1035 exchange, to pay for long-term care premiums from a non-qualified annuity without creating a taxable event.  Since the growth in a non-qualified annuity will eventually be taxed as ordinary income, taking a portion each year out of the annuity to pay the long-term care insurance premium can help reduce a retiree’s eventual tax burden.  

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There are a few technical considerations to make sure this works for your situation.  These include the impact of otherwise deducting the LTC premium payments on your taxes, the financial need for the annuity payments, and checking with your annuity company to ensure that they can facilitate this transaction.  It’s also important to note that this exchange will create a pro-rata reduction in your annuity cost basis.  

This strategy can be an effective way to minimize taxes for people who don’t need to tap their annuity yet, and who would otherwise need to take a taxable distribution from a retirement account to pay the premiums.  

Make Charitable Donations from an IRA

Many retirees who contribute to their favorite non-profit organizations don’t receive a tax benefit since their standard deduction exceeds any itemized deductions.  Account owners age 70.5 and older could benefit by using their IRA as the source of their giving, a strategy called a Qualified Charitable Distribution (QCD).

While you do not receive a tax deduction for a QCD, the distribution is not taxed.  Lower top-level income could lead to other benefits, such as lowering Medicare premium surcharges.  Keep in mind that the distribution must be taken directly from your IRA for the amount to be excluded from income.  Account owners can donate up to $100,000 per year from their IRA, and the QCD amount goes toward your annual required minimum distribution.

Make Family Gifts from Investments or Business Interests

Many retirees who give money to a child or grandchild just write a check.  However, if a large portion of their wealth is in a tax-deferred account, a taxable investment portfolio or a business, they may want to consider making this gift from a portion of an appreciated asset or business interest.  

Here’s a simple example.  If you have held Apple stock for years, instead of writing a check for $10,000 as a Christmas gift, give a grandchild the gift of $10,000 of your stock.  While the grandchild will eventually owe taxes on any sale, they can learn about investing by watching the price (hopefully) appreciate, and the capital gains taxes may be comparably lower for them.  The retiree saves money on the capital gains tax and also reduces the size of the estate.

While a tax law provision called “step-up in basis” — which adjusts the value of the assets someone inherits at the owner’s death — could leave heirs with a smaller income tax bill if they later sell the positions, there are good reasons for gift-givers to use appreciated stock or mutual funds instead of cash. They may want to lower the size of their taxable estate, reduce a large position in one or more stocks, or let a young family member gain firsthand experience investing in the stock market.

These five expenses don’t cover every situation for every retiree but considering these recommendations could end up saving a few hundred or a few thousand dollars annually.

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How to Avoid Taxes on Social Security

Where you live, how much money you earn and how carefully you plan could all affect this essential retirement income.