fba magazine features richard denapoli
HELPING TRUST CLIENTS NAVIGATE THE FINANCIAL CHALLENGES IN THE CURRENT MARKET AND LEGISLATIVE ENVIRONMENT
By: Richard DeNapoli, J.D., LL.M., CFP®, Managing Director, Chief Trust Officer & Fiduciary Counsel
Florida Banking Magazine - July 2021
Positive news regarding the battle against Covid-19 has provided markets, industries, politicians, and the general public with significant optimism after a rough and volatile year.
Still, the 24-hour news cycle continues to bombard the public with constant noise surrounding cryptocurrencies, "meme" stock, and all the latest market fluctuations. The Biden Administration is also likely to pursue significant legislative changes that may affect our clients' taxes and estate planning. As such, this is an important time to have our clients review and possibly adjust their investment portfolios as well as their estate plans given the current market environment and legislative proposals on the table.
Some of the potential legislative changes that the Biden Administration is pursuing as well as some strategies for our clients are the following:
1. Capital Gains and Dividend Taxes Increases
The Changes here could apply to individuals earning over $400,000 per year. The expected change would tax higher-income individuals on their long-term capital gains and qualified dividends at the same rate as short-term gains, moving the current level of 23.8 percent (a 20 percent tax rate plus the 3.8 percent tax on net investment income) to as high as 43.4 percent (the expected higher ordinary income tax rate of 39.6 percent plus the 3.8 percent tax on net investment income). Clients should monitor the effective date set by Congress if passed and be ready to accelerate asset sales. The Biden proposals also include possible retroactivity of increases to April 28, 2021. Depending on what happens with the effective date of legislation, a family may want to sell its business before the end of the year or sell stock that has appreciated in value if they already planned to sell those assets in the next few years under the current tax law. Otherwise, where a sale is expected far into future, then a client may want to wait our whatever changes the Biden Administration puts into place that might be modified or repealed by a future Republican administration.
2. An Increase in Income Tax Rates for Higher Earning Taxpayers
The current 37 percent rate is proposed to move to 39.6 percent on graduated scale. Democrats claim that significant amounts of income escape the income tax entirely, because some higher income clients have used the strategy of buying assets such as real estate, borrowing against these assets for living expenses and eventually dying without paying income taxes on the gain.
3. A Reduction of the Federal Estate, Gift and Generation-Skipping Tax Exemption from $11,700,000 per Person to $5,300,000 or Perhaps Even Down to $3,500,000, and an Increase in the Estate Tax Rate to 45 Percent and Potentially Higher
Clients should consider using their current $11,700,000 exemption and be wary that a future lower exemption amount could sweep many new people into the estate tax regime. Clients should consult with their estate planning attorney and CPA and may also pursue annual gifting at the current annual exemption gifting of $15,000 per donee.
4. A Repeal of the Step-Up in Basis at Death and Changing the Tax Basis of Inherited Assets to Carryover Basis
When Assets are inherited, the basis is currently "stepped-up" to the date of death of the decedent. This has been in the tax code since 1921. These assets then pass to any beneficiaries generally with a higher basis. Eliminating the step-up would mean assets would be inherited with the same basis as their original purchase cost. As referenced above, clients may want to consider utilizing the current exemption amount of $11,700,000 to gift highly appreciated assets during life. Life insurance and life insurance trusts can be considered to provide liquidity for expected estate taxes in the future. Though this is not expected to make it into the eventual law, another surprise in the Biden budget proposal what the repeal of stepped-up basis requires gain to be recognized at the time of gift or of death, rather than when the recipient later sells the asset.
5. Substantial Cutbacks or the Elimination of Discounting Techniques as well as Real Estate "Like-Kind" Exchanges
Discounting techniques have been a very effective technique have been a very effective technique in the past to reduce asset values by as much as 30-40 percent for gift and estate tax purposes. These involve discounts in the market value of limited liability partnerships or corporations due to minority interests, lack of marketability, etc. For real estate, the Biden plan would limit the present real estate tax break for "like-kind exchanges" that allows real estate investors to defer an unlimited amount of taxation when they exchange real property. Under the plan, the deferral would end for capital gains in excess of $500,000. Clients should monitor the effective date set by Congress if these laws are passed and be ready to accelerate existing planning techniques.
Given the potential legislative changes, now is the time to review and potentially refresh clients' estate plans. It is also the time to review your clients' asset allocation to manage their investment risk going forward and to ensure that it aligns with their current financial circumstances and goals.
Some things to consider in the post Covid-19 market are as follows:
1. Growth Stocks Have Been Hot for Years Now, But Value Stocks Might Be Ready to Shine
Series of factors including a post-pandemic recovery government stimulus checks and infrastructure efforts, may benefit value stocks. Value stocks in 2021 are outperforming growth by one of the widest percentage-point margin since 2001.
2. Market Leadership may be Broader
In 2020, only a handful of stocks led by FAANG were responsible for the return in the S&P 500 leading to one of the shallowest markets in years. Investors are hopeful that 2021 will be more evenly balanced between growth and value and among more stocks.
3. International Has a Relative Valuation Advantage.
After a decade of U.S. stocks outpacing, they international peers, we are beginning to see better performance results from foreign equities. International exposure should remain an important component within a diversified portfolio.
4. Diversification Remains Key Rather Than Following the Latest Hot Trend.
Clients may be interested in the latest cryptocurrency play (i.e., Dogecoin), "meme" stocks (i.e. AMC, Bed Bath & Beyond, GameStop), SPACs, and other newsworthy developments, but these volatile investments might result in large losses rather than expected gains. Though trust clients might decide to invest in these trends in their personal accounts, as fiduciaries we know that historically, a diversified approach has achieved optimal long-term risk adjusted returns and reduces volatility.
At the end of the day, being prepared for legislative changes, having an estate plan that is revisited and updated, and maintaining a diversified portfolio will assist clients in reaching their long-term goals no matter what market and legislative environment investors face.
Read the article in Florida Banking Magazine