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TEXT ON SCREEN: PIMCO EDUCATION –TITLE – 2023 Tax Planning Consideration and Opportunities with John Nersesian (10 minutes)

Text on screen: PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

TEXT ON SCREEN: John Nersesian, Head of Advisor Education

Nersesian: Hi everybody. I’m John Nersesian, head of advisor education at PIMCO,

TEXT ON SCREEN: TITLE – 2023 Learning objectives:, LIST – 1. Tax considerations: Ordinary income, ACA taxes, Alternative minimum tax; 2. Tax planning opportunities – Managing taxable income: Higher and lower income years, Retirement contributions, HSAs, QBI deductions

Let’s turn our attention to tax planning for 2023 by starting with ordinary income taxes.

We know that here in the United States, we’re subject to a progressive tax system

TEXT ON SCREEN: TITLE – Ordinary income tax rates; SUBTITLE – Ordinary income tax rates – 2023

IMAGE ON SCREEN: A table shows the federal tax rates for seven income brackets for two types of filers: married-filing jointly, and single. For example, the first row, representing a tax rate of 10%, includes married-filing jointly with income from $0 to $22,000, and single filers having a bracket of $0 to $11,000. The successive rows contain income ranges for the remaining higher tax rate levels: 12%, 22%, 24%, 32%, 35%, and 37%. At the bottom, in the last row, the chart shows that those married-filing-jointly with more than $653,750 in income and single filers making more than $578,125 pay a tax rate of 37% above those levels.

that starts at 10% and rises to a maximum level of 37% for families at $693,000 or more.

There are additional taxes that we need to be conscious of as well, specifically affecting families with incomes above $250,000.

TEXT ON SCREEN: TITLE – Individual income tax rates; SUBTITLE – Affordable Care Act (ACA) taxes

IMAGE ON SCREEN: A table indicates how the Medicare hospital tax of 0.9% affects wages, compensation and self-employment. It also notes how the net investment income tax rate is 3.8%, and affects interest dividends, net capital gains, annuities and rents. Below the table, bullets note the taxes affect married-filing jointly with a modified adjusted gross income above $250,000 and a single filer above $200,000. The bullets also mention how the threholds aren’t subject to the inflation adjustments for tax-year 2023. Also, retirement distributions are not subject to these taxes, but could cause other income to be taxed when exceeding levels for modified AGI. Municipal securities are also not subject to ACA taxes.

These are typically referred to as ACA taxes, or otherwise known as Obamacare taxes. There are two components.

The first is the Medicare hospital tax of 0.9%. Now, this is levied against active forms of compensation. Think about my biweekly paycheck or my annual cash bonus. The net investment income tax of 3.8% is once again levied for families with incomes above $250,000 on passive forms of compensation.

Think traditional investment activities such as net realized capital gains, interest, dividend payments, and real estate activities.

Once again, both of these taxes affect families at $250,000 and above and are applied above and beyond their ordinary federal income tax rates.

There’s another tax that investors need to be conscious of although its bite is not nearly as sharp as it once was. It’s the alternative minimum tax,

TEXT ON SCREEN: TITLE – Alternative minimum tax; SUBTITLE – Exemptions and brackets – 2023 

IMAGE ON SCREEN: The graphic features three tables. The first table shows the exemption level and phase-out range for three different filing statuses for 2023. For married-filing jointly, the exemption is $126,500, with a phase-out range of $1,156,300 to $1,662,300. For married-filing separately, the exemption is $63,250, with a phase-out range of $578,150 to $831,150. For single, the exemption is $81,300, with a phase-out range of $578,150 to $903,350. The second table shows the a tax rate of 26% between $0 and $110,350 for married-filing separately, and $0 and $220,700 for all other filers. A tax rate of 28% applies above those levels. The third table lists some planning considerations: When subject to regular taxes, defer income and accelerate deductions, and when subject to AMT taxes, accelerate income and defer deductions.

and I guess I have good news and bad news.

The bad news is that the alternative minimum tax is still here. The good news is that its reach has been significantly curtailed. Here are the reasons why.

The alternative minimum tax comes with an exemption amount, and that exemption amount today is significantly higher than it's been in past years.

The exemption amount for 2023 is $126,500 for clients who file a joint tax return, and the full amount of that exemption is retained until a client’s income exceeds over $1 million, when a phaseout begins.  

But there’s a second reason that the alternative minimum tax is less likely to affect our clients, and it has to do with the reduction in traditional deductions available under the regular code. Those deductions are more limited today, suggesting that a client’s regular tax bill is likely to exceed their alternative minimum tax bill.

The AMT affected over 5 million taxpayers prior to tax reform. Today that number is closer to 500,000. So while there are still some clients who might be affected by the AMT, the vast majority of clients who were once affected most likely no longer are.

Here’s our first planning opportunity, and it’s to manage taxable income to achieve the very best tax outcomes.

TEXT ON SCREEN: TITLE – Manage taxable income

IMAGE ON SCREEN: The slide shows a table of strategies for a higher tax year. Strategies include: Increase retirement plan contributions, accelerate charitable giving, recognize capital losses, avoid capital gain recognition, and defer retirement account distributions.  

Now, in traditional years, when clients are actively employed, facing a high marginal bracket, the general strategies are to reduce their taxable income and to accelerate their deductions in an attempt to lower their tax liability in the current year.

Clients can accomplish this by contributing more to their retirement accounts, by giving more under the charitable giving premises. They can avoid or can recognize capital losses to offset capital gains that have been realized in their portfolios. And they can defer retirement account distributions up until RMDs as a way of lowering their taxable income and reducing their tax bite in the current year.

But what about clients who find themselves in a temporarily lower marginal bracket? Maybe our client recently retired. Maybe our client changed jobs and found that their income for the year was significantly reduced.

In those circumstances, it may be advantageous for clients to selectively recognize income, to have it realized at a lower marginal rate in the current tax year as opposed to realizing it in years in which their marginal bracket might be higher.

TEXT ON SCREEN: TITLE – Manage taxable income

IMAGE ON SCREEN: The slide shows a table of strategies for a lower tax year. Strategies include: Accelerate income recognition, defer charitable giving, delay pass-through business expenses, recognize capital gains, and consider Roth conversions.

The planning opportunities are counterintuitive. It’s to maybe delay my charitable giving and to save those dollars for another year. It’s to recognize capital gains, to have them taxed at a lesser marginal rate.

Maybe a Roth conversion makes sense as an opportunity to realize the income, subject to a lower marginal rate today, in exchange for tax-free compounding over multiple years.

One way to lower clients’ taxable income, of course, is to contribute to their retirement accounts. At a minimum, clients who participate in employer sponsored 401(k)s should be contributing the amount that is matched.

This is a free opportunity for clients to build resources for their retirement preparedness.

TEXT ON SCREEN: Retirement account contribution limits

IMAGE ON SCREEN: A table shows contribution limits for six different types of retirement accounts, along with catch-up contributions amounts for taxpayers 50 and older. For the traditional individual retirement account (IRA) and Roth IRA, the regular contribution amount is $6,500, with a catch-up provision of $1,000. For 401(k) and 403(b) plans, the limit is $22,500, with a catch-up provision of $7,500. For a SIMPLE IRA – short for savings incentive match plan for employees –the limit is $15,500, with a catch up contribution limit of $3,500. For simplified employee pension (SEP) plans, the limit is $66,000, with no catch-up contribution, and for total defined contribution plans, the limit is $66,000, with a catch-up limit of $7,500. The table also lists phase out ranges by adjusted gross income, applicable to traditional IRAs, Roth IRAs, and SEP plans.

Here are the limits that are affecting 2023 taxpayers. Traditional IRA contributions are capped at $6,500 with a $1,000 catch up provision. That same limit applies to Roth accounts as well.

401(k)s and 403(b)s, that amount has been increased to $22,500 with a $7,500 catch up provision. For clients who are maybe self-employed or run their own business, SEP plan contributions extend the opportunity to contribute up to $66,000

And for clients who are looking to aggressively fund their retirement account plans and to maybe lower their taxable income can consider a cash balance plan where contribution limits extend beyond $200,000 as a way of lowering their income and accelerating their retirement savings efforts.

Now, one of the challenges faced by many clients is this choice between a traditional retirement account and a Roth retirement account. We know

TEXT ON SCREEN: TITLE – Choose between traditional and Roth accounts; SUBTITLE – Common individual retirement accounts and employer plan contribution limits

IMAGE ON SCREEN: A horizontally oriented table shows the phase out of the deduction for contributions to traditional and Roth individual retirement accounts for the category of married-filing jointly. In the first row, showing traditional IRAs, for those with a modified adjusted gross income of up to $116,000, the contribution is fully deductible. It’s partially deductible for those with a modified AGI between $116,000 and $136,000. Above that, it’s non-deductible. The next row in the table shows the breakdown of contributions are affected by income for Roth IRAs. The full contribution is allowed up to a modified adjusted income of $136,000. A partial contribution is allowed between $218,000 and $228,000, and no contribution is allowed beyond $228,000.  

that traditional IRAs are subject to AGI limitations, which may make their contributions either deductible in full, partially deductible, or potentially nondeductible.

But for many clients, there’s this challenge or opportunity to choose between a traditional retirement plan and the Roth variety. Let’s review the basics behind this decision.

TEXT ON SCREEN: TITLE – Choose between traditional and Roth accounts; SUBTITLE – Common individual retirement accounts and employer plan contribution limits

IMAGE ON SCREEN: A graphic lists attributes of a traditional individual retirement account and employer plans. Traditional plans include tax-deductible contributions, subject to limits by modified adjusted gross income for IRAs, but 401(k)s don’t have this restriction. These plans also feature tax-deferred growth and taxable withdrawals. They are also subject to required minimum distributions during the owner’s lifetime, and non-spouse beneficiaries generally must liquidate the plan within 10 years.

Traditional retirement accounts provide a unique benefit of an up front income tax deduction, lowering my taxable income for the year and my tax bite in my current taxable year. The money grows on a tax deferred basis, but then of course I pay taxes when these dollars are distributed, beginning at age 59.5 or maybe when RMDs begin at age 73.

TEXT ON SCREEN: TITLE – Choose between traditional and Roth accounts

IMAGE ON SCREEN: A graphic lists attributes of Roth  individual retirement account and employer plans. Contributions are non-deductible, with modified AGI limits for Roth IRAs but no limits for 401(k) contributions. Qualifed withdrawals are tax-free. Also, IRA Roth plans are exempt from required minimum distributions (RMDs) during the owner’s lifetime, but Roth 401(k) owners are subject RMDs. Non-spouse beneficiaries generally must liquidate the plan within 10 years.

The Roth account works in the opposite capacity. Roth plans do not provide an up front deduction, provide me with tax deferred compounding, but then provide tax-free distributions when the money is eventually distributed.

Another benefit of the Roth plan, which may be somewhat less obvious, is that unlike traditional retirement account contributions, Roth plans are not subject to RMDs, affording savers and families the opportunity to continue to compound these dollars that may not be required for retirement funding and to allow these dollars to compound on a tax-free basis for an extended period of time.

Another retirement vehicle that is maybe less well known and used to a lesser degree is the HSA. Now, full disclosure, the HSA contribution limits are significantly lower than other opportunities.

TEXT ON SCREEN: TITLE – Contribute to health savings account (HSA)

IMAGE ON SCREEN: A slide shows shows three bullets that list the features or requirements of contributing to a health savings account. The maximum family contribution for tax-year 2023 is $7,750, with $1,000 catch up at age 55 or older. Account owners must have a high deductible health plan for the year they make contributions, and they can’t contribute if they’re enrolled in Medicare. The HSA can cover current medical expenses such as deductibles and premiums, and helps provide additional tax advantages savings beyond 401(k)s and IRAs.

The maximum contribution limit for 2023 is $7,750 per family. There’s a $1,000 catch up provision that begins at age 55.

But the HSA provides the best of many worlds.

TEXT ON SCREEN: TITLE – Contribute to health savings account (HSA)

IMAGE ON SCREEN: An image shows the benefits of contributing to a health savings account, with a check mark above each one, reading from left to right. The benefits are as follows: Contributions are tax deductible, growth is tax-deferred, and withdrawals are tax free.

It provides an up front income tax deduction, lowering my tax bill in the year of the contribution.

It provides tax deferred compounding and growth for the monies that are left in the account and then when eventually distributed for qualifying medical expenses, these distributions are tax free.

The HSA can be a very effective supplemental retirement savings plan beyond traditional IRAs and 401(k) plans.

For those of us who work with a unique cohort, the closely held business owner, specifically pass through entities, S corporations, sole proprietorships, those who are self-employed, those individuals calculate their tax liability under their S corp return, but they’re entitled to receive, under TCJA, a 20% deduction on their net income before it’s applied to their personal tax return.

TEXT ON SCREEN: TITLE – Maximize section 199A deduction for business owners; SUBTITLE – Qualified business income (QBI) deduction: Sec 199A

IMAGE ON SCREEN: The slide shows a bulleted list detailing information on the deduction for qualified business income, or QBI, also referred to as a Section 199A deduction. The tax code provides a 20% deduction for qualified business income through 2025. It’s available to owners of pass-through entitites, such as parterships, S-corps, sole proprietorships, and real estate investment trusts. The deduction is claimed on the owner’s 1040, with no need to itemize. Specialized service businesses such as lawyers and accountants are subject to a phaseout for joint taxable income between $364,200 and $464,200. All businesses above those levels are subject to a phased-in cap. The purpose of the QBI deduction is to provide a benefit similar to the C-corporation tax rate reduction, which was lowered to 21%, from 35%.

This is known as the 199A, or the QBI, the qualified business income deduction, available to these unique individuals. There’s a catch. For specialized service businesses, there is an AGI limitation that may reduce that 20% deduction.

Managing client income for these affected individuals is critically important to maximize that deduction. Clients will want to look at retirement account contributions, deductions available to the closely held business owner, charitable contributions, and other methods to manage their income in an attempt to avoid the AGI phase out that would typically accompany this 20% QBI deduction.

TEXT ON SCREEN: To learn more visit pimco.com/advisoreducation or speak with your Account Manager       

Text on screen: PIMCO

Disclaimer

IMPORTANT NOTICE 

Please note that this video contains the opinions of the manager as of the date recorded and may not have been updated to reflect real time market developments. All opinions are subject to change without notice.

There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. 

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