Since March 2020, when the world learned just how dangerous the COVID-19 virus could be, we have all been mostly in reactive mode. Offices and schools were closed so we learned to work from home while the kids learned remotely. The markets plummeted so we harvested tax losses and rebalanced portfolios. Tax deadlines changed and stimulus bills were passed, so we sorted through pages of new legislation to help our clients navigate the new rules.
With significant potential changes looming in the tax and estate planning areas, now is the time to shift back into proactive mode. We might not know exactly what changes will be implemented, but it is critical to start thinking about how the proposals might impact you and what you will want to do to prepare.
I had the honor of moderating two different Best Ideas panels at the recent Personal Financial Planning Conference as part of the AICPA Engage. Here are some of the planning ideas our panelists discussed that you might want to consider between now and year-end.
Income tax planning
Most advisors believe that income tax rates will go up in the near future. While we don't know what aspects of the Biden proposals will become law, we may have an opportunity to take advantage of these current lower rates that may not be back for some time. Multi-year tax planning becomes essential in an environment like this. If you can control certain aspects of your income, you need to look ahead to the next few years of projected income so you can minimize your overall tax liability.
Capital gains rates may also rise and the Biden proposals have them almost doubling for taxpayers with income over $1 million. While we typically think of this only impacting taxpayers whose income is always over that threshold, keep in mind a one-year event could also push you into this territory (through the sale of a business or real estate, stock sales, etc). It may make sense to harvest gains in 2021 to take advantage of the lower rate.
Another area that income tax changes might impact is the choice of business entity. The Biden proposal would subject S corporation income to the 3.8% Medicare surtax without having any deduction for Qualified Business Income. This may cause many business owners who have S corps to shift to an LLC or possibly even a C corp, paying tax at the corporate level.
The estate planning area is becoming a focal point for many as we see the fragility of life as a result of the pandemic. The potential changes in the Biden tax proposals are so significant they would change the entire landscape for estate planning. While he has not proposed a reduction in the lifetime exemption from the current level of $11.7 million (that will happen automatically in 2026), the potential of a loss of the “step up in basis at death” and a potential capital gain trigger event at death or gifting assets would change many planning strategies.
A lot of what you should consider doing in the estate planning area is dictated by the size of your estate. If you are well above the exemption amounts, taking advantage of the current high exemption is essential. Moving assets using Spousal Limited Access Trusts, Intentionally Defective Grantor Trusts, and other strategies while they are still available should be considered. Removing future growth of assets from your estate is also a very important goal in estate planning. Grantor Retained Annuity Trusts, Intra Family Loans (at today’s low-interest rates), and other strategies can work well.
We are also seeing more clients who are interested in charitable giving as an important part of their estate and income tax planning. This is often funded with appreciated securities, especially in times of strong market performance as we have seen lately. Charitable trusts should also be considered for specific goals. Charitable Unitrusts provide the ability to shelter large gains and provide an income stream while Charitable Lead Trusts can help to reduce or eliminate estate tax while still having the assets revert to family.
Retirement planning has taken on additional significance as a result of the pandemic. Many of you may have a different perspective on when you will retire and what retirement actually looks like. In fact, many believe that “retirement” is an outdated concept as we simply transition from one aspect of our life to another. Understanding your retirement goals is an important first step in this area. Decisions related to your residence often come into play as well - sell, downsize, consider a Continuing Care Retirement Community, etc.
Planning for your IRA got more complicated with the SECURE ACT a couple of years ago, and potential changes in version 2.0 might be coming. There is bipartisan support for this legislation but it is currently on the back burner. The elimination of the stretch IRA for non-spouse beneficiaries and planning around the 10-year window has become an important part of this planning. Those who are age 70.5 or older should also consider the use of Qualified Charitable Distributions to make up to $100k of charitable contributions directly from your IRA. Potential Roth conversions are another area of planning that might make sense at today's lower tax rates.
It is important to periodically review your insurance coverage, and in light of the pandemic and the potential upcoming changes to the estate tax area, now is a great time to do that. When you review this coverage, be sure to check that the beneficiary designations are up to date and aligned with your desires. As the estate tax exemption has increased in recent years, the need to shift life insurance outside of the estate has diminished. However, if the exemption drops back down to a much lower level, owning life insurance in a trust may make sense again.
The pandemic has also shed a light on the importance of disability insurance. There have been many individuals who were unable to work for significant periods of time as a result of the virus. Be sure to check on your current disability insurance coverage and make sure it is aligned with your current income and cash flow needs.
Many experts have argued the pandemic has changed higher education forever. Will an expensive college education still be something that is highly valued in a world with growing virtual and hybrid learning options?? President Biden’s plan to make community college free for all might also impact many college decisions. All of this may cause you to reconsider how much you should be gifting to children and grandchildren for education and the types of accounts you use for that gifting.
It’s going to be a very busy Fall as we consider the wide variety of planning issues that you should be thinking about now. Starting these discussions sooner rather than later will be very important, even if we do not know what shape the potential tax changes will take until later in the year. You have made it this far through the pandemic in reactive mode, now it’s time to be proactive and start to plan for the future.
- Lyle K Benson Jr., CPA, PFS, CFP
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.
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