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David Gardner For the Camera
David GardnerFor the Camera

With the election (mostly) behind us, our crystal ball has become a little less cloudy about income taxes. President-elect Joe Biden’s plan, if enacted, would have resulted in significant changes especially for higher-income earners. With the Democratic majority in the House diminished and the Senate likely in Republican hands pending the Georgia runoffs, Biden will be challenged to push through his original agenda.

The political landscape may indeed change two years from now. But if you study past midterm elections, the president’s party consistently loses seats in the House and often in the Senate. We may be looking at a divided federal government for the next four years. It’s true that with parties sharing power in 1986, tax reform was enacted with support of then-Senators Joe Biden and Mitch McConnell (yes, they go back that far). But unless they can craft a deal this time, changes in tax law will be slight.

A wrinkle in this story is one key provision of the Tax Cuts and Job Act passed in 2017. Starting in just over five years we are set to revert to much of the same individual tax structure as we had before 2018. What’s more, with a $3.1 trillion deficit last fiscal year, and Medicare and Social Security underfunded, there will be further pressure to boost tax rates. If taxes may be going up, what strategies should we put in place? The answer is to accelerate your taxable income. It may seem strange, but paying taxes now rather than later may make sense for you. Here’s how you do it.

Favor Roth accounts. Depositing funds into a Roth 401(k) and 403(b) is an act of faith. You’re paying taxes today to avoid them tomorrow. With Roth retirement plans you don’t get the upfront tax deduction, but you get tax-free growth and withdrawals. Unless you’re in the 32 percent bracket or higher (earning above approximately $180,000 if single or $360,000 if married), your marginal tax rate may be lower now than when you retire.

There is one little understood fact about Roth accounts. When you maximize Roth contributions, you are saving more than maxing out a traditional account. Don’t believe me? Let’s say you save the maximum $26,000 (if you’re at least 50) into your traditional 401(k). These are pre-tax dollars, so if you expect to pay 25 percent federal and 4.5 percent state taxes you only are left about $18,300 when you withdraw the funds. If on the other hand you put $26,000 into your Roth retirement account, that money is all yours. Plus anyone with a traditional IRA and most with retirement plans can do a Roth conversion, which is moving pre-tax dollars into the tax-free category in exchange for paying taxes on the converted amount today.

Exercise stock options. When you exercise nonqualified stock options (NSOs), you are choosing to pay ordinary income tax on the discount you receive. If you have 1,000 NSOs vesting for Twitter at an exercise price of $5, with the stock now trading at $45 you would pay tax on $40,000 of income when you buy the shares. By choosing when you exercise options, you can control when you want to be taxed. If you have Incentive Stock Options (ISOs), the calculations can be more complex but if you exercise and sell the shares within the same year the tax treatment is identical as with NSOs.

Finally think twice about signing up for a nonqualified deferred compensation plan with a private employer or a 457(b) plan with a nonprofit (not a government agency). They usually have expensive investment options and cumbersome, inflexible withdrawal provisions. With taxes in ascendancy, it may now be more important to save taxes later than to save them now.

David Gardner is a certified financial planner practicing in Boulder County. The opinions expressed by the author are his own and are not intended to serve as specific financial, accounting, or tax advice.

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