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 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.
Year-end planning checklist
- Call your Executive Services Relationship Manager to plan
- Consult with a tax professional and/or financial advisor to understand your entire financial picture
- Explore alternatives such as tax-loss harvesting, charitable giving, and donor advised funds
- Consider how leveraging equity compensation can help support year-end goals
Key considerations for 2021 tax planning
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.
Donor Advised Funds
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.
Qualified Opportunity Funds (QOF)
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 Funds5,6 (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.
Timing is everything
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 firstname.lastname@example.org.
- House Ways and Means Committee, Sec. 138201, “Increase in Top Marginal Individual Income Tax Rate,” https://waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/documents/SubtitleISxS.pdf
- Morgan Stanley, “Proposals for Tax Increases,” https://www.morganstanley.com/cs/pdf/10096403-Selected-Proposals-for-Tax-Increases.pdf
- The Morgan Stanley Global Impact Funding Trust, Inc. (MS GIFT) is an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986, as amended that sponsors a donor advised fund program. MS Global Impact Funding Trust (MS GIFT) is a donor advised fund. Back office administration provided by RenPSG, an unaffiliated charitable gift administrator. Although the statements of fact and data herein have been obtained from, and are based upon, sources that the firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. This material does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The strategies and/or investments discussed in this material may not be appropriate for all investors. Morgan Stanley Smith Barney LLC recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Asset allocation and diversification do not guarantee a profit or protect against a loss. Investing in the market entails the risk of market volatility. The value of all types of investments may increase or decrease over varying time periods. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning, charitable giving, philanthropic planning and other legal matters. While we believe that MS GIFT provides a valuable philanthropic opportunity, contributions to MS GIFT are not appropriate for everyone. Other forms of charitable giving may be more appropriate depending on a donor’s specific situation. Of critical importance to any person considering making a donation to MS GIFT is the fact that any such donation is an irrevocable contribution. Although donors will have certain rights to make recommendations to MS GIFT as described in the Donor Circular & Disclosure Statement, contributions become the legal property of MS GIFT when donated.
- Exchange funds are private placement vehicles that enable holders of concentrated single-stock positions to exchange those stocks for a diversified portfolio. Investors may benefit from greater diversification by exchanging a concentrated stock position for fund shares without triggering a taxable event. These funds are available only to qualified investors and may only be offered by Financial Advisors who are qualified to sell alternative investments. Before investing, investors should consider the following:
• Dividends are pooled
• Investors may forfeit their stock voting rights
• Investment may be illiquid for several years
• Investments may be leveraged or contain derivatives
• Significant early redemption fees may apply
• Changes to the U.S. tax code, which could be retroactive (potentially disallowing the favorable tax treatment of exchange funds)
• Investment risk and potential loss of principal
- Morgan Stanley, Qualified Opportunity Zones – A New Investment Possibility, 2018 PowerPoint Presentation (morganstanley.com).
- Investing in the Qualified Opportunity Funds (QOF) entails the risk of market volatility and possible loss of capital. The value of all types of securities, may increase or decrease over varying periods.
Alternative investments often are speculative and include a high degree of risk. Investors could lose all or a substantial amount of their investment. Alternative investments are suitable only for eligible, long-term investors who are willing to forgo liquidity and put capital at risk for an indefinite period of time. They may be highly illiquid and can engage in leverage and other speculative practices that may increase the volatility and risk of loss. Alternative Investments typically have higher fees than traditional investments. Investors should carefully review and consider potential risks before investing.
Real estate investments are subject to special risks, including interest rate and property value fluctuations, as well as risks related to general and economic conditions.
Alternative investments involve complex tax structures, tax inefficient investing, and delays in distributing important tax information. Individual funds have specific risks related to their investment programs that will vary from fund to fund. Clients should consult their own tax and legal advisors as Morgan Stanley Wealth Management does not provide tax or legal advice.
- Eligibility requirements may apply and certain products and services are not available to all clients
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