Year-end strategies: Considerations for tax-loss harvesting and charitable giving and more

No matter what’s going on in the markets, the old adage still rings true: One of the only guarantees in life is taxes. The good news is that, even in tumultuous times, your tax and year-end planning is one area of your personal finances where you have some control—and potentially unique opportunities.

While E*TRADE from Morgan Stanley does not provide tax advice, we can help you build and implement your year-end investment portfolio reallocation strategy, assess your current holdings from a holistic planning perspective, and provide support every step of the way.

As the pandemic continues to evolve, legislation and the geopolitical environment may have an outsized impact on your year-end planning. While there are still so many unknowns, perhaps one of the most pressing considerations are proposed tax law changes that could impact capital gains rates and the estate planning process by lowering certain thresholds applicable to the tax treatment of individuals and trusts and estates. For example, legislative proposals could carry future income tax implications for individuals earning over $400,000, married couples earning over $450,000, and trusts or estates with income over $12,500.^1,2 

Because the proposed legislation would broaden the scope of who is affected by so-called wealth taxes, more people may find themselves looking to consider advanced tax strategies for the first time.

As you begin your year-end tax and financial planning, you may want to consider how these strategies together with your equity compensation may help support your goals.

Tax season may feel far away, but autumn and winter are important planning seasons. Tax-loss harvesting is a year-end exercise that investors can use to help manage investment gains and losses as part of a broader financial plan, but there are many moving parts.

Here are some key considerations:

• The basics: Tax-loss harvesting uses losses in your investment portfolio to help offset any gains and potentially reduce your tax liability. Generally, an investor might work with a tax professional and financial advisor to identify assets to sell at a loss.
• The fine print: Tax-loss harvesting isn’t suitable for everyone, and you should speak with your tax professional to determine whether it’s appropriate for you. If you sell a security at a loss and purchase a substantially identical security within the 61-day period beginning 30 days before the sale date and ending 30 days after the sale date, under the “wash sale rule,” the loss will be disallowed and will be added to the basis of the new stock.

Along with tax-loss harvesting, some investors explore alternative charitable giving and investment strategies to help reduce their capital gains, like contributing cash or appreciated assets to a donor advised fund³ (DAF).

A donor advised fund (DAF) is a public charity structured to offer a simple, tax-advantageous way to support favorite charities. A DAF provides flexibility on where and how you can make charitable gifts. Between the time you make a donation to a DAF and when you finalize your giving strategy, your assets can be invested, with the potential to grow tax-free. Here’s how it works:

• The basics: High earners can make in-kind donations directly to a DAF with a specific stock—for example, donating a portion of equity compensation with unrealized gain instead of selling the shares, generating a taxable gain, and then donating cash to a charity. That way, they can get an immediate income tax deduction, and avoid paying capital gain taxes.
• The fine print: Donors may make irrevocable and nonrefundable gifts of cash, marketable securities, freely transferable restricted stock, and exercised options. While a donor advised fund can give you additional time to determine your ultimate charitable giving plan, any assets in your DAF will have to be invested in the investments offered by the public charity sponsoring the DAF such as separately managed accounts, mutual funds, and exchange-traded funds. Grants to charitable organizations may be made anonymously or by recognizing the Donor.

While less focused on charitable giving, an exchange fund⁴ allows investors to diversify their holdings by exchanging stock positions, often in highly appreciated or restricted stock, for shares of a purpose-built, diversified portfolio. Contributions of appreciated stock to a properly structured exchange fund are not taxable under current federal tax law—but ask your tax professional about any changes or updates you might need to know.

• The basics: An exchange fund can be one method to diversify your holdings, avoid borrowing against your equity, and gain potential tax advantages—since concentrated shares you hold can be swapped for fund shares without triggering a taxable event. Exchange Funds can also be used to support estate planning goals and tax-deferred growth.
• The fine print: Exchange funds are for the long haul: They generally require both a minimum initial contribution and also a minimum holding period—most often, seven years to gain the full diversification benefits—and may also charge management fees.

Another opportunity is to defer recognition of certain eligible capital gains by investing the gain, in a timely manner, into economically distressed areas certified by the US Department of the Treasury as Qualified Opportunity Zones (QOZs). These zones exist in every state and territory, but since investing in them is a relatively new choice, it’s important to discuss the possibility with a tax professional.

• The basics: Qualified Opportunity Funds^5,6 (QOF) are privately managed investment vehicles, organized as corporations or partnerships, which are required to invest/hold at least 90% of their assets in a QOZ property. By investing in underserved communities through these funds, investors can unlock certain federal (and potentially state and/or local) tax benefits.
• The fine print: There are time-based cutoffs and holding requirements to receive the full tax exclusions and benefits available through a QOF. The laws around these investments are very specific, and those interested in QOFs should speak to their tax or legal professionals about meeting requirements and making deadlines.

A final key piece of the puzzle: Don’t wait until the last minute for year-end planning.

Many company insiders and executives have limited trading windows, which may affect plans for charitable donations and tax-loss harvesting. Check your trading restrictions and company policies around equity compensation and reach out to your financial professionals as early as possible to avoid missing any opportunities.

Year-end planning looks a little different for everyone, and it’s essential to make sure to align your choices with your investment portfolio and equity compensation goals. E*TRADE Executive Services is here to help. We have the tools and capabilities if you want to keep control of your assets, donate directly to charity, or update or build a comprehensive estate planning strategy—and your Relationship Manager can help connect you with a wider range of options through a Morgan Stanley Financial Advisor.^7,8

Products and services discussed in this piece are provided through Morgan Stanley Financial Advisors. If you are interested in learning more about Morgan Stanley’s capabilities, please contact the Executive Services team. Visit etrade.com/execservices, or reach out to us directly at 800-838-0908 or executiveservice@etrade.com.