Irrespective of where your political sympathies lie, it is generally accepted that if the Republican Party wins the upcoming presidential election and maintains control of the White House and the Senate (“Scenario A”), the status quo regarding income, gift and estate tax planning will continue. If the Democratic Party wins control of the White House and the Senate, as well as maintains control of the House (“Scenario B”), most likely taxes will go up. Depending on who you believe is going to prevail, but particularly if you think it could be the Democrats, there are specific tax planning measures you should be considering.
A. Estate and Gift Tax Planning
– All of the techniques referred to herein are currently in use in the ordinary course of good estate planning. Under Scenario B above, these techniques are in danger of being curtailed next year and any such tax legislation could be retroactive to January 1, 2021. Therefore, they require immediate consideration.
1. Federal Estate and Gift Tax Exemptions – There are currently exemptions from Federal estate, gift and generation-skipping taxes of $11,580,000 per person ($23,160,000 per couple). These amounts are adjusted for inflation until they sunset on December 31, 2025 and revert to $5,490,000 per person ($10,980,000 per couple). Notwithstanding that it is always advisable to use exemptions sooner rather than later and allow assets to grow outside of a couple’s taxable estates, it is imperative that they consider using their exemptions before the possibility of Scenario B occurring, when these exemptions could be greatly reduced or terminated effective as soon as January 2021. Transfers using the exemptions can be made outright or, considering the potential amounts of assets involved, in long-term, virtually perpetual trusts.
2. Discounting Techniques in Conjunction with The Use of Exemptions - Gifting and the use of exemptions are enhanced using assets that can qualify for discounts to market value because of such things as minority interests, lack of marketability, etc. Discounting is extremely advantageous, making it possible for gifts of substantially more underlying value to be made. Discounts can run as high as 30%-40% if using interests in closely held businesses.
3. Deferred Gifting Techniques – Additional discounts can be obtained by various qualified and IRS approved trusts which defer the vesting of the gift. These go by various alphabet soup terminology, such as Grantor Retained Annuity Trusts (“GRATs”), Charitable Lead Annuity Trusts (“CLATs”), Qualified Personal Residence Trusts (“QPRTs”) and Charitable Remainder Trusts (“CRTs”), etc.
4. Family Investment and Business Entities – Under appropriate circumstances, where there are viable business reasons, etc., family investment and business entities can be formed and interests then transferred at varying discounts depending on the nature of the assets.
5. Offshore life Insurance Planning – Accumulation of wealth offshore, either through the use of foreign life insurance or domestic life insurance held by a domestic trust distributing to a foreign trust, should also be considered in specific circumstances.
B. Income Tax Planning – Under Scenario B the potential is for income taxes, including capital gains taxes, to increase whereas under Scenario A, the possibility exists that they might be decreased or at least stay the same. In addition, under Scenario B, it is possible that the use of certain itemized deductions will be curtailed.
1. Income Tax Brackets – Unlike estate tax planning that requires some lead time, there will be time after the November election results to take actions suggested under Scenario B which can be implemented before year- end. In such case, consideration should be given to accelerating income into 2020. Under Scenario A, consideration should be given to deferring income to 2021.
2. Itemized deductions (other than state and local tax deductions, known as “SALT deductions”)- Under Scenario B, consideration should be given to accelerating itemized deductions (other than SALT deductions). Charitable deductions can be accelerated by donations to “donor advised funds” where the funds can be retained and held for distribution in future years. There are also various deferred donation techniques, such as CRTs, CLATs, or private foundations, which produce current charitable deductions which should be considered.
3. Capital Gains – It is always good tax planning to consider offsetting capital losses with capital gains before year-end. In addition, under Scenario B, consideration should be given to realizing additional capital gains in 2020, particularly long-term capital gains; under Scenario A, consideration should be given to deferring any additional capital gains realization beyond normal year-end tax loss harvesting.
4. Roth IRA Conversions – If a possible increase in income tax rates is anticipated, the opportunity to convert traditional IRAs and 401(k)s to a Roth IRA should be considered. Unlike traditional IRAs and 401(k)s, distributions from Roth IRAs are tax-free and there are no required minimum distributions. However, when converting, current income taxes must be paid on the amount converted.
C. State Income Taxes – In addition to election turmoil, certain states are suffering disproportionately from severe budget deficits and have very high income tax rates. If not already done, accelerate consideration of changing residence/domicile to states with no income taxes and no estate or inheritance taxes.