Tim Steffen: Tax-Saving Strategies for a Falling Market

Episode Summary

Executive Summary: Tim Steffen of Baird explains timely tax-planning issues and retirement-account strategies: student loan forgiveness is federally tax-free but may be taxable in some states; IRS enforcement will likely rise gradually, not overnight; tax-loss harvesting can help but should follow investment goals; Roth conversions, backdoor Roths, and after-tax 401(k) contributions can be powerful when used in the right tax bracket and with careful execution; and the SECURE Act’s 10-year inherited IRA rule has reduced the value of stretch IRAs, making proactive planning more important.

Main Topics: Student loan forgiveness tax treatment (Priority: 5/5): Steffen outlines that forgiven student debt is generally taxable, but the American Rescue Plan made federal student-loan forgiveness tax-free through 2025. State tax treatment varies, with Wisconsin cited as taxable while some states conform to federal rules. IRS funding and audit risk (Priority: 5/5): He says the IRS’s new funding should eventually increase audits, but staffing, training, and hiring delays mean the effect will likely take 2-3 years. Audit rates remain very low overall, though self-employed taxpayers, business owners, and valuation-heavy returns face more scrutiny. Tax-loss selling and wash sale rules (Priority: 5/5): Steffen recommends considering tax-loss harvesting only after investment considerations, often during rebalancing. He explains wash sale issues and why actively managed funds are generally easier to swap than index funds or substantially identical ETFs. Roth IRAs and conversion strategy (Priority: 5/5): He compares traditional and Roth accounts, emphasizing that conversions can be powerful when done in lower-bracket years, especially after retirement before RMDs. He stresses paying conversion taxes from outside funds and letting Roth assets compound long term. Backdoor Roths, pro rata rule, and after-tax contributions (Priority: 5/5): He recommends backdoor Roths for eligible high earners but warns that existing IRA balances trigger the pro rata rule. He also explains the mega backdoor Roth via after-tax 401(k) contributions and the importance of avoiding same-year IRA rollovers. Inherited IRAs and SECURE Act changes (Priority: 4/5): Steffen explains that the SECURE Act largely replaced stretch IRAs for adult beneficiaries with a 10-year distribution rule. This reduces tax deferral and flexibility, making Roth conversions and charitable remainder trusts common mitigation tools. Broader tax-planning philosophy (Priority: 3/5): He argues for bunching deductions, especially charitable gifts, and prefers a tax code with fewer deductions and lower rates. He frames the ideal system as simpler and less prone to abuse, though political realities make that unlikely.

Key Arguments: Federal student-loan forgiveness is tax-exempt through 2025, but state taxation depends on where the taxpayer lives. IRS audit activity should rise over time, but not immediately, because hiring and training new staff will take years. The taxpayers most likely to draw IRS attention are self-employed individuals, business owners, and those using aggressive valuations on charitable, estate, or gift assets. Tax-loss harvesting should be driven by portfolio and rebalancing decisions first, with tax benefits as a secondary advantage. Wash sale risk is clearer with stocks and index funds, while actively managed funds are usually easier to swap without being substantially identical. Roth conversions are most attractive when income is temporarily low, taxes can be paid from outside the IRA, and the assets can remain in the Roth for years. Using IRA dollars to pay conversion taxes weakens the strategy because it reduces the amount that can compound tax-free. The backdoor Roth works best for people without other IRA balances; otherwise the pro rata rule can make the conversion partly taxable. After-tax 401(k) contributions become especially valuable when they can be converted into Roth assets, creating the mega backdoor Roth. The SECURE Act’s 10-year rule materially reduces the value of inherited IRAs for adult children and shifts planning responsibility to the account owner. Bunching charitable deductions can help taxpayers who no longer itemize each year because of the higher standard deduction.

Data Points: Federal student-loan forgiveness tax treatment: Tax-exempt through 2025 - American Rescue Plan provision discussed by Steffen Typical student loan forgiveness amount: $10,000 or $20,000 - Federal forgiveness amounts referenced in the discussion IRS funding increase: About $80 billion - Inflation Reduction Act funding for IRS enforcement and operations Expected lead time for IRS impact: 2-3 years - Steffen’s estimate for staffing/training before major audit effects appear Current audit rate: Very, very low - Steffen characterizes the present-day likelihood of audit for most taxpayers Age for traditional IRA RMDs: 72 - Used in the discussion of Roth vs. traditional and retirement sequencing Age for penalty-free traditional IRA withdrawals: 59.5 - Referenced when discussing early distributions and conversions 2022 employee contribution cap: $20,500 - Traditional or Roth employee deferral limit cited for employer plans 2022 employer plan overall limit: $61,000 - Total annual contribution limit for employer retirement plans Approximate additional employer-plan room: About $40,000 - Room beyond employee elective deferrals for employer and after-tax contributions Standard deduction for married couples: Roughly $26,000 - Used in the discussion of deduction bunching Itemizers before/after TCJA: About 30% down to about 10% - Steffen’s estimate of the decline in itemizing taxpayers after the 2017 tax law

Pivotal Quotes: "I think it's reasonable to expect an uptick in audit activity, but it's going to be a while." — Tim Steffen: On the effect of expanded IRS funding and enforcement hiring "The best Roth conversions are those that you can let stay in the Roth for a long time and let it really accrue that tax-free growth." — Tim Steffen: On why timing and long holding periods matter for conversions "You can't separate the cream from the rest of the coffee." — Tim Steffen: Explaining the pro rata rule and why backdoor Roth conversions can become partly taxable

Implications: Listeners should align tax tactics with broader financial goals, not just immediate tax savings. The biggest opportunities are in low-income years, coordinated retirement withdrawals, and careful Roth/backdoor execution. Planning is more important than ever as inherited-IRA rules tighten and IRS scrutiny gradually increases.