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Do pre-emptive tax planning ahead of Biden changes

The signing of the American Rescue Plan Act of 2021 promises to extend our nation’s 20-year trend of deficit spending and possibly set a new annual deficit record.

Bill Clinton’s four years of balanced budgets were helped by two seldom discussed factors that no longer exist. The Republican-controlled Congress cooperated in increasing taxes and reducing the military budget. He was also helped by the day trading of stocks by amateur investors. During the tech-stock bubble, almost anyone could pick winners to buy in the morning and sell at a gain that night. Their “short-term” gains were taxed at ordinary income rates as much as 50 percent higher than long-term capital gain rates. Perhaps our current administration should find a way to glamorize day trading to help reduce the current annual deficit.

Significant funds from the ARPA will surely flow back into the economy and combine with organic growth of the GDP to generate tax revenue, partially offsetting the carrying cost of our newest debt. What’s missing is the significantly greater revenue higher tax rates would bring. Our politicians understand this and are clearly weighing when our COVID-weary citizenry will accept with minimal hissing being plucked of a larger number of feathers. To make sure the hissing is minimal, the publicized initial target for such increases will be the relatively small percentage of wealthy individuals.

Even if no tax increase hits us in the next few years, automatic increases occur at the end of 2025 when the current rates, which came into play in 2018, reach their sunset. Virtually all tax advisors have accepted the inevitability of taxes increasing. The only open questions seem to be when and how high.

Those advising on tax matters should become familiar with techniques to pre-emptively minimize the effects of tax increases. They can foresee the upcoming tax storm and should help clients make tough decisions today, which should pay dividends tomorrow. This may require looking at the tools and techniques of planning differently.

Reduce retirement plan contributions

Does it make sense to defer income in a low tax bracket when it will probably be taxed at a high rate later? Perhaps some of our clients should get off the tax-deferral hamster wheel, or maybe only contribute enough to capture the “free” money of their company match.

Variable annuities for guaranteed income, not growth

If tax deferral is something to be reconsidered, should annuities be avoided? Maybe tax deferral should take a backseat in favor of the annuity’s most valuable option: guaranteed income. Many annuities sold today have riders to guarantee retirement income forever. A retirement income calculator using Monte Carlo simulations can measure the benefits of guaranteeing income against other income opportunities.

Shelter gains from business sales

Nationwide, a handful of attorneys and accountants have helped clients minimize capital gain tax recognition in the sale of their businesses. Since 2010, a little-known international tax treaty with the country of Malta provided for a Supercharged Cross-Border Roth IRA-like plan. If properly established and administered, this may shelter an unlimited amount of unrecognized gain in the sale of certain assets, such as closely held businesses. Seeking more tax revenue, Congress may look to renegotiate this treaty and make it less favorable. For now, this may shelter business sale gains from taxes, whether the rate is high or low.

Estate planning concepts

Income modeling before gifting: Much has been written about family gifting to reduce potential estate taxes. In the fall of 2019, the IRS announced that gifts under the current gift (and estate) tax exclusion of $11.7 million per person will not be “clawed back” if the exclusion is lowered. Therefore a large gift today receives a significantly larger benefit than if the gift is made after a reduction in the exclusion amount. Before entertaining large gifts, it would be advisable to utilize the previously mentioned income modeling with Monte Carlo simulations. Factors such as longer life expectancies, uncertain investment returns, inflation concerns and long-term care needs require testing the adequacy and long-term security of the donor’s income before irrevocably giving away property that could later provide greater security for the donor.

Insured tax hedging: Life insurance is often illustrated as the least expensive way to pay estate taxes, primarily because the premiums and death benefit can be sheltered from the tax.

For married couples, the primary form of insurance used for this purpose is survivorship (aka second-to-die) life. This is a joint life policy with benefits paid after both insured spouses have died, which is typically when the estate tax is due. The hedging strategy is to pay (in year one) just enough premium to maintain the coverage for a few years until greater certainty may be gained about increasing estate tax costs.

Gain harvesting: The stock market has been very good to those who invest. So good, in fact, that it is gains instead of losses that should be the target of many people’s harvesting. Some stocks have seen gains since the March 2020 lows of more than 100 percent. Over the past 12 years, the S&P 500 has increased at an average annual rate of 14.6 percent.

People have, in many cases, held onto stocks and strategies for far too long to avoid paying taxes on their gains. Perhaps now, while the long-term capital gain rate for most people is just 15 percent, is the time to harvest gains, rebalance portfolios and maybe rethink overall investment strategies.

The pre-emptive opportunity

Washington tells us only that the wealthy will see higher tax rates. Maybe that’s true during our COVID recovery. Maybe it’s also inevitable that we all must share the burden of attempting to close the gap that runaway deficit spending has created. Regardless, like chicken soup, it can’t hurt to take advantage of the almost historically low tax rates we currently enjoy before they’re gone.

How often do tax laws change and we scramble to advise our clients? For once we know what is coming. The only way to win is to get our clients to consider their options, sooner rather than later.

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Tax planning Capital gains taxes Retirement planning Tax rates Biden Administration
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