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Tax Law Changes and Strategy

By now, you've likely heard that the Biden administration is angling for more of our hard-earned cash. Clearly, low tax rates are wonderful for the economy, but politics often drive less optimal paths. Rather than rehash the tax hikes proposed to corporate and personal tax rates, I thought we should review the issues facing estate planning for higher net worth families.

Our firm places incredible emphasis on after-tax returns for clients. Accordingly, we maneuver investments within the tax code, attempting to derive maximum benefit for clients. Believe me, tax deferral in an IRA is the least powerful technique at your disposal, and the taxes on retirement plans can be downright ugly for the super-wealthy. Many investors don't realize that the Step-up in Basis Rule allows cumulative untaxed gains to be forgiven at death. This rule presents the most impactful benefit in the tax code for investors and investment policy must be adapted to utilize it to its fullest. Accordingly, our $1 billion in client portfolios currently contain $350 million in untaxed gain. Bernie Sanders has proposed eliminating the Step-up rule, and this presents a clear tax threat to our clients and me.

Senator Sanders also wants to reduce the tax-free amount estates can leave to heirs. He proposes reducing the per-person amount from the current $11.7mil to $3.5mil. The estate of a deceased couple with $25mil in net worth would pay $6.5mil more in taxes at the second death under Sander’s proposal.

Making the most of the current rules would require prompt and irrevocable action, so be careful. Gifting assets is a straightforward solution. Less so if one wants to retain some control or use of the funds. One solution might be that a husband decides to create a trust for his wife with his separate property, provided that she didn't agree to do the same for him in reciprocity. She might later, and of her own volition, decide to create a trust for him also. These irrevocable trusts might preserve their use of their own funds while shielding the larger current exemption for the kids as beneficiaries of the trusts. Doing this might forego the Step-up rule, but that might be lost anyway if Mr. Sanders has his way, and the 23.8% capital gains tax is preferable to the 40% estate tax which this arrangement might circumvent. Be sure to seek tax counsel because I am not a tax advisor.

Another situation could be presented to an aging mother near 90, with four children and $20 million in assets. Her reduction of the exemption amount from $11.7 to $3.5mil could be painful for the kids. Maybe she should consider establishing a trust for the kids and funding it with $11.7mil in securities and naming her most trusted child as trustee. If her $8.3mil remainder of her $20mil proves insufficient for her needs later in life, nothing prevents the kids from making gifts back to Mom with their annual exclusion amount. The math gets a little wonky if one child cannot or will not participate. There’s always one, isn’t there? Family dynamics make things complicated.

Another thing to consider is the insidious double taxation on IRAs for high-net-worth estates mentioned above. When you couple income tax exposure with estate taxes above the exclusion amount, taxes can consume the vast majority of an IRA in some circumstances, leaving the kids dimes on the dollar. One tax mitigation strategy would be to do a Roth conversion and get the income tax portion paid. At least that value would not then compound the estate tax's second swipe. Again, seek the counsel of a tax advisor for your situation.

From a philosophical standpoint, I have issues with the government harvesting income taxes for a lifetime and then a 40% levy at death. But dynasties can evolve from overly generous tax policy. Given how rich the Carnegies and Rockefellers were in their time, they might own half the country by now were it not for estate taxes keeping those trees chopped down. But a $3.5mil maximum might be cutting the stump to the nub.

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