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Education | Oct 24, 2022

Some ‘Just in Case’ Tax Strategies to Consider for the Inflation Reduction Act

Steven Kohler

CFP®, CPFA®

Nancy I. Kunz

CFP®, CPFA® ChFC®, CLU®

Benjamin Franklin famously said, “In this world nothing can be said to be certain, except death and taxes.” True to Franklin’s words, the newly passed Inflation Reduction Act (IRA) includes a number of taxes that are aimed at the wealthy, defined as those earning more than $400,000 per year. A summary in the bill states, “There are no new taxes on families making $400,000 or less and no new taxes on small businesses – we are closing tax loopholes and enforcing the tax code.” If you are among those targeted, then you will have some work to do prior to tax season.

If you earn less than $400,000 per year, then you may not want to relax just yet. Previous plans to tax the wealthy have typically resulted in higher taxes on those below the stated threshold as well. The original wealth tax in 1913, as well as the Alternative Minimum Tax (AMT) created in the late 1960s and deployed again in 1993, eventually cast a much wider net than intended.¹

Some concerns have been raised that the IRS’s increased budget in the Inflation Reduction Act could provide the agency with more firepower to audit the middle-class. Recently, the nonpartisan Joint Committee on Taxation (JCT) warned that in 2023, taxes will increase by $16.7 billion on American taxpayers earning less than $200,000 next year.² Whether the JCT assessment is accurate remains to be seen, but it does emphasize the importance of having a well-planned tax strategy for the new law and seeking the help of tax professionals and financial advisors going forward.

Here are a few ‘just in case’ tax strategies that you may want to discuss with your advisory team.

Bundle Charitable Contributions

The first strategy to consider is a bundling or ‘bunching’ of your charitable contributions, potentially utilizing a Donor Advised Fund. This allows you to maximize available tax benefits by condensing multiple years’ worth of giving into one year. For example, if you planned to donate $10k/year for the next two years, you would put the $20k into a fund all in one year. You can then take the deduction on one return which would cause less phasing out depending on your income level.

These larger charitable contributions made in alternating years can combine with other itemized deductions such as mortgage interest and state and local taxes to increase the likelihood of exceeding the standard deduction, thus providing you with additional tax savings.

Allocate Assets Efficiently

A second strategy involves asset allocation. You want to have your most tax-efficient investments in non-retirement (non-qualified) accounts to lessen taxable dividend income or capital gains distributions that are taxable each year. For this purpose, we lean toward holding passively managed index funds in these types of accounts. These may be ETFs or Mutual Funds that allow you to invest and simply hold the stocks in the index (e.g., Dow Jones Industrial Average or S&P 500).

The lower turnover rate associated with passive investment vehicles means that you can defer payment of capital gains taxes for several years—and when you are taxed, it will likely be at a lower long-term capital gains tax rate. For assets held longer than 12 months, the capital gains tax rate ranges from zero to 20%, depending on your total taxable income. But for actively managed funds held less than 12 months, you’ll have to pay short-term capital gains taxes at your regular income tax rate.

Municipal bond funds (Munis) owned for the purpose of generating income are also more tax-efficient investments to allocate to non-qualified accounts. When it makes sense, the purchase of municipal bonds or funds that generate interest may be exempt from federal taxes and in some cases, state taxes.

Prepare Your Business for the IRA

You will also want to remain vigilant if you own a business. While the Inflation Reduction Act doesn’t include any direct tax increases on small and midsize businesses, some of its provisions have the potential to raise costs for these companies. As small business owners, you may want to consider taking actions such as beefing up record-keeping and scrutinizing all tax credits and tax deductions. With the new law adding 87,000 new IRS agents, you may want to plan as if you could be audited.

Conclusion

It’s possible the tax legislation outlined in the Inflation Reduction Act may not affect you. But based on historical evidence, it’s better to prepare for worst case scenarios regardless of your current tax bracket. If you have any additional questions about the Inflation Reduction Act and how it could impact your tax situation, please feel free to reach out to your DBR & CO advisory team.

Thanks for reading.

This material has been provided for general, informational purposes only, represents only a summary of the topics discussed, and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice or recommendations. Rather, they simply reflect the opinions and views of the author. D. B. Root & Company, LLC. does not provide legal, tax, or accounting advice. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation. There can be no assurance that any particular strategy or investment will prove profitable. This document contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information derived from such sources, and take no responsibility therefore. This document contains certain forward-looking statements signaled by words such as "anticipate," "expect", or "believe" that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the expectations, beliefs, views and opinions expressed in this document will come to pass. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. All investment strategies have the potential for profit or loss. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. The impact of the outbreak of COVID-19 on the economy is highly uncertain. Valuations and economic data may change more rapidly and significantly than under standard market conditions. COVID-19 has and will continue based on economic forecasts to have a material impact on the US and global economy for an unknown period.

Steven Kohler

CFP®, CPFA®

Chief Planning Officer

Nancy I. Kunz

CFP®, CPFA® ChFC®, CLU®

Senior Financial Advisor

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