The Winds of Change are Blowin' - Pallas Capital Advisors

The Winds of Change are Blowin’

October 2020

SUMMARY

Election years bring with them a chance for major policy changes. Politicians have long used the tax code to “fix” or change the economy, markets, and investor or consumer behavior. This presidential election year will be no different, as President Donald Trump and former Vice President Joe Biden try to convince voters that each is better equipped to lead the nation through the current global health crisis.

Ultimately, regardless of who wins the race, it is important for individuals to be informed about the impact that each candidate’s policies will have on their financial planning objectives, and thus to plan accordingly as election results come in!

INTRODUCTION

Do you remember the classic film “Bill and Ted’s Excellent Adventure” – from way back in 1989? In one of their adventures through history, we watched those odd characters named Bill and Ted get philosophical with Socrates by telling him, “All we are is dust in the wind, dude.”

Well, the winds of change do blow – and sometimes they blow hard. So hard in fact, that you might find yourself saying, “I don’t think we’re in Kansas anymore.” And with 2020 being a U.S. presidential election year – they are blowing once again. In this month’s newsletter, we will examine some of the differences between President Trump and former Vice President Biden’s tax proposals.

A WORD OF CAUTION

We did not verify these tax policy positions with the candidates themselves, however the information that follows is gathered from numerous sources that are publicly available. Time and space do not permit us to cover all of the very important issues to voters – even when limited to those that fall in the category of tax planning. It is important to note that there are other areas of tax policy for both candidates that are not covered in this short newsletter. For the reader, there are a couple of good online resources that are helpful:

The Tax Policy Center: www.taxpolicycenter.org
The Tax Foundation: www.taxfoundation.org

There are others, but both of the resources above claim to provide analysis that is independent, non-partisan, and updated regularly. I encourage you to peruse those websites, as the information is instructive to each candidate’s position on all things tax-related.

A CLOSER LOOK AT ESTATE TAX CHANGES

Under the current law, married couples can transfer assets of $23.16 million without incurring a federal estate tax. Alternatively, couples can gift this amount without paying any federal gift tax during their lifetimes, and any remaining exclusion can be used to offset estate taxes at death.

A key feature of the former Vice President Biden’s proposed tax plan would be a 50% reduction of the exclusion amount for estate and gift taxes, from $11.58 million ($23.16 million for married couples) to the pre-TCJA amount of $5.79 million.
Notably, this lapse of the current estate tax exemption amount back to its pre-TCJA limits is already scheduled to occur in 2026 – after the Tax Cuts and Jobs Act sunsets – but the Biden tax plan would accelerate that reversion back to the old limits in 2021 instead.

The current law states that heirs can receive appreciated assets with a step-up in basis to the asset’s fair market value at the time of death. Therefore, appreciated assets can be transferred at death without a capital gains tax liability.

Biden’s tax plan proposes to eliminate the step-up in basis rules which would impact both higher- and lower-earners potentially facing a significant and problematic tax bill on inherited assets.

A more structured sale or gifting strategy throughout the owner’s lifetime can be a good way to mitigate taxes for the beneficiary should Biden’s plan pass. High net worth individuals should consider using as much of their exemption in 2020 as their circumstances allow. Notably, the IRS is already on record stating that it will not “claw back” previous transfers (by gift or by bequest) of assets if the exemption amount goes back to its pre-TCJA levels.

Other strategies that can be considered to deal with a smaller exemption in the long-term can potentially include the use of Grantor Retained Annuity Trusts (GRATs), Charitable Lead Annuity Trusts (CLATs), and sales to Intentionally Defective Grantor Trusts (IDGTs).

Life insurance could see renewed potential as a tool to provide liquidity and/or mitigate the burden of a high tax liability resulting from the inheritance.

CHANGE IS COMING – BUT HOW SOON?

It is difficult to say how soon either candidate’s tax proposals become law. However, it is likely that if the Executive branch and the U.S. Senate majority are both from the same political party, changes to tax laws will become a reality in 2021.

With that in mind, in addition to gifting and other estate planning strategies previously discussed, there are several income tax planning strategies that individual taxpayers should consider:

Review Roth Conversions: Roth conversions in 2020 can help defend against the potential for higher taxes for you as well as your heirs. If you wait to do the conversion in 2021, you may be dealing with a higher tax bracket than you are in today.
Accelerate Income: If you expect to earn more than $400,000 per year, you may save significant tax dollars if you can accelerate some of your expected income to 2020. For example, if there are bonuses (over and above the $400,000 in income), it may make sense to have them paid out before 2021 to save on ordinary income taxes and Social Security taxes.
Defer Deductions: If tax rates are expected to increase, the strategy is to push deductions to the following year so that you can offset income that would otherwise be taxed at the higher rate.
Accelerate Gains: With a potential increase in the capital gains tax rate, it may make sense for taxpayers with appreciated assets to consider selling before 2021 to lock in the current tax rates.
Defer Unrealized Losses: If you believe that capital gains rates could be significantly higher after this year, consider taking those losses in future years.
Review Business Tax Structure: For the business owner – once again the decision to be taxed as a C Corporation vs. a pass-through entity (S Corp, Partnership, Sole Proprietor) should be reviewed. Both the immediate and long-term impacts of the decision should be carefully considered.

SUMMARY

In 1789 Benjamin Franklin wrote a letter to a French acquaintance stating that “in this world, nothing is certain except death and taxes…” (That pithy saying may not have been original to him, but we will give him the benefit of the doubt.)

As with any election year, voters have a lot of questions about what changes the future will bring. With apologies to Bob Dylan, the answers are rarely found “blowin’ in the wind.” However, a careful look at each candidate’s tax policy should give individuals and business owners some idea of what lies ahead. The prudent planner will take advantage of windows of opportunity – before the winds of change blow those windows shut… at least for now.

At Pallas, we believe the future is bright for those who plan ahead.

Sincerely,

James Landry, ChFC
Chief Operating Officer, Director of Planning
Pallas Capital Advisors

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Pallas Capital Advisors, LLC and its representatives do not provide legal or tax advice. You should consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. The information in these materials may change at any time and without notice. The information contained herein is for informational purposes only, is not personalized investment advice, and should not be construed as a recommendation to purchase or sell any particular security, sector, or strategy to any individual person or entity.

Investment Advice offered through Pallas Capital Advisors, LLC, a registered investment advisor.

The Winds of Change are Blowin’