The Coming Post-Election Tax Code Changes Mandate Timely Planning

Donald Trump has promised to rewrite the U.S. tax code, much like Ronald Reagan did in 1986.  With a Republican House and Senate, a tax code overhaul is likely.  Trump’s plan is likely to include:

  • Reduction in income tax rates for individuals and corporations. If enacted, the U.S. would shift from one of the highest corporate income tax rates in the world, to one of the lowest (from 35% to 15%).  For individuals, the highest tax bracket is now 39.6%, plus the 3.8% net investment tax, for a total of 43.4%.  Under the Trump plan, the highest rate would be 33%.
  • Elimination or significant reduction of estate and gift taxes.
  • Restructuring of tax on offshore income, including deemed repatriation and 10% tax on deferred offshore profits.
  • Elimination or partial repeal of the Affordable Care Act (Obamacare), including repeal of the 3.8% tax on net investment income.
  • Carried interest may be taxed as ordinary income.
  • Income earned through flow-through entities (LLCs and S-Corps) to be taxed at 15% rather than higher individual rates.

Apart from the Trump tax plan, Republican legislators have also offered their own plan which also calls for reduction of taxes.

The above are proposals, not yet law.  We can assist you in anticipating the coming tax changes, and planning ahead.  Some suggestions include:

  • Take charitable deductions now, rather than in 2017, when tax changes could likely make deductions less valuable. The current income tax rates are known and will probably be higher than in 2017.
  • If we can expect reductions in income tax and capital gains tax rates next year, consider whether to utilize tax deductions and losses in 2016 and postpone or defer gains and income until 2017.
  • Consider an enhanced role for life insurance and an Irrevocable Life Insurance Trust (ILIT). Insurance proceeds are not taxable as income to the beneficiary.  Growth within an insurance policy is not subject to income and capital gains tax.  If the estate tax will be repealed, insurance could be completely tax-free.  (State estate taxes may still apply.)  Insurance could thus play an enhanced roll in family planning, legacy planning, liquidity and tax-minimization.  An ILIT would add further benefits, including asset protection, creditor protection and extended wealth management for child beneficiaries.

How to Lower Your Estate Tax Liability on the Federal and State Levels

In early 2013, Congress clarified the estate tax landscape and made permanent certain provisions of estate tax law, such as the exemption from estate tax for the first $5.45 million of one’s estate, indexed annually for inflation. There has been no such clarity on the state levels, which remain a patchwork of different estate tax laws.

On the federal level, in addition to the exemption of $5.45 million each year indexed for inflation, the 40% estate tax rate is, for now, standard.  In addition, portability between spouses of an unused exemption is also now allowed.  Congress can change these laws in the future, as it has in the past.  In addition, in this election year, estate tax rates and exemptions are campaign topics and are subject to revision by a new administration.  However, at least for now, the federal estate tax regime is clear and as a result, we as tax practitioners have a better ability to plan for clients when the law is clear.

However, estate taxes on the state level are much more variable.  In New Jersey, the threshold for estate tax is only $675,000, the lowest in the U.S., and at a huge variance from the $5.45 million federal exemption.  The threshold in Connecticut is $2 million, cut from $3.5 million in 2011.  The threshold in New York is currently $3.125 million, will rise to $4.18 million on April 1, 2016 and to $5.25 million in 2017.  Ultimately, the NYS exemption will be at parity with the federal exemption amount in 2019.  In a significant quirk, a New York tax law anomaly known as “the cliff” sets the estate threshold to zero (i.e., no exemption from estate tax at all) if one’s estate is valued at $3,281,250 or more.  In other words, in New York, there is no estate tax for estates lower than $3.125 million and complete estate tax on the entirety of the estate, with no threshold and no exemption, for any New York estate valued in excess of $3,281,120.

Thus, depending on the value of one’s estate, and one’s residence, one’s estate may owe considerable state estate tax even if it is exempt from federal estate tax.

Some states have no estate tax and no income tax.  For this and other reasons (sunshine?) such states, which include Florida and Nevada, attract migration from high-tax states such as New York, New Jersey and Connecticut.

There are various strategies that one may utilize to lower one’s taxable estate on both federal and state levels.  Some of the strategies proven to reduce estate taxes are:

GRAT – If you contribute assets into a Grantor Retained Annuity Trust, you could receive a regular payment akin to an annuity over many years, and then when the trust term ends, the appreciated assets pass to your heirs, are not considered part of your estate and will not be subject to estate taxes.

QPRT – If you contribute your personal residence into a Qualified Personal Residence Trust, you may still live in the residence for a term of years, and when the trust term ends, the home is removed from your estate while passing to your heirs and will not be subject to estate taxes.

FLP – After contributing your assets into a Family Limited Partnership in return for general and limited partnership interests, you may then, over time, gift your limited partnership interests to your heirs while retaining the general partnership interest (thereby continuing to control the FLP), and thus remove the value of the limited partnership interests from your estate.  FLPs also provide the additional bonus of excellent asset protection.

CRUT – By contributing appreciated assets to a Charitable Remainder Unitrust, you are entitled to a charitable deduction, regular payments from the trust back to you during the trust term, and at the end of the term the assets pass to the charity, are not subject to income tax and are removed from your estate.

ILIT – If you own or control life insurance policies, the IRS deems their death benefit to be in your estate and subject to estate tax, even though you will never receive the death benefit during your life.  If you contribute these life insurance policies to an Irrevocable Life Insurance Trust, you may remove the insurance policies from your estate.  Your family members may receive the death benefit from the trust, free of any estate tax.

Dynasty Trust – Such a trust allows the preservation of assets for one’s immediate and remote descendants, along with offering asset protection from creditors, as well as delay of the estate tax bite for many generations.  The trust can distribute income to beneficiaries, but principal is preserved, asset-protected and grows tax-free.

These strategies are not only for the mega-wealthy.  We have successfully utilized these strategies for clients of means at various levels who are concerned with leaving as much of their hard-earned assets for their heirs with as little as possible going to the IRS and state tax authorities.  These are equally attainable goals with a $5 million estate as they are at $50 million.

Moreover, these strategies are affordable, especially considering the amount of tax savings they offer.

Of course, if you want to move to Florida or Nevada, go for it.  But if you’re considering a move for estate tax reasons, first consider these various strategies to lower your estate tax liability without having to relocate.

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