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  If the estate tax will be repealed, insurance could be completely tax-free.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.

It’s 2016: What to Do Now About Higher Income Taxes

Higher income, capital gains and estate taxes are now a fact.  The following tax changes were all implemented over the past few years:

  1. Expiration of top 35% income tax rate and reset to 39.6%;
  2. Increase in long-term capital gains rate from 15% to 20%, plus the 3.8% investment tax under the Affordable Care Act (“Obamacare”), for a top long-term capital gains tax rate of 23.8%.  (In many cases an additional 0.9% surtax also applies, making the total capital gains tax 24.7%);
  3. Short-term capital gains are now taxed at 39.6%, plus the Obamacare additional tax of 3.8%, for an effective short-term capital gains rate of 43.4% (again, often, plus 0.9% making the total 44.3%);
  4. Expiration of top 15% rate on qualified dividends and jump to 20%, plus the 3.8% investment tax under the Affordable Care Act, for a top dividend tax rate of 23.8%; ordinary dividends are now taxed at 39.6%;
  5. The gift and estate tax rate increased to 40%.

The 3.8% tax on net investment income is now imposed on joint filers with an AGI greater than $250,000 ($200,000 for single filers) pursuant to the Affordable Care Act.   This additional 3.8% tax is in addition to the already heightened rate that will apply and will be assessed on taxable interest, dividends, rents, some annuities and capital gains including on the sale of real estate.

Congress may also amend other tax laws to eliminate some favorable tax planning strategies.  Clients are therefore advised to engage in tax planning now, in order to have the benefit of “grandfathering” current beneficial tax strategies before additional changes to the tax law.  We can help explain tax changes, how they may effect your specific situation, and how to legally minimize your taxes.

There are various steps that taxpayers should consider now for effective tax minimization:

1.  Avoid capital gains tax via a Charitable Remainder Trust or via international tax planning strategies (e.g., tax advantaged foreign annuities and foreign private placement life insurance).

2.  Convert IRAs, 401(k)s and other retirement plans to Charitable Remainder Unitrust IRAs before the government taxes them.

3.  Engage in income tax planning via tax-compliant strategies that take advantage of favorable reciprocal tax treaties.

4.  Consider a 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 (who will pay income tax on these distributions of income), but principal is preserved, asset-protected and grows tax-free.

5.  Consider a Charitable Remainder Trust.  Contributing appreciated assets, such as stock, family businesses and real estate to a Charitable Remainder Trust is a good way to avoid the increased capital gains tax.  You and your beneficiaries can enjoy distributions from the trust at very low tax-favored rates, and at the end of the trust term, a remainder equal to ten percent of the original contribution to the trust will go to a qualified charity.  You will receive an additional tax benefit: a deduction equal to the present value of the remainder that will be left to charity.  The benefits: a low-tax income stream for you and your beneficiaries, philanthropy of your choice, a charitable deduction and significant capital gains tax minimization.

6.  It is also possible to minimize the tax on appreciated assets by exchanging such assets  in return for a foreign annuity policy.  Capital gains within the annuity policy would not be taxable.  Annuity payments can be deferred until retirement or advanced age, at which point tax would be due on the income component of the annuity payments.  Moreover, the annuity policy and the assets within the policy would be completely asset-protected from future creditors.  For complete tax elimination, a foreign life insurance policy can be incorporated, which would allow one to borrow against the cash value of the policy, completely free of taxation (the amounts borrowed, rather than having to be repaid, would be deducted from the ultimate death benefit).  Such tax strategies involving foreign annuities and foreign life insurance offer the most advanced asset protection from civil creditors, as well as significant tax minimization or even tax elimination.

7.  With respect to the self-employment tax (the equivalent of social security tax for taxpayers who receive income from self-employment or investments instead of wages) which increased from 4.2% to 6.2%, and the 3.8% surtax imposed on investment income (dividends, capital gains and passive rental income), tax compliant strategies exist which enable taxpayers to actively avoid both the self-employment tax and the investment income surtax.  Section 1402 of the Internal Revenue Code and the regulations provide an exemption for distributions of partnership income to limited partners, provided such distributions are not guaranteed payments and provided the limited partners meet certain conditions.  Through the use of multiple layers of limited partnerships, taxpayers may achieve complete exemption from the self-employment tax and the investment income surtax, thereby increasing their net income by as much as ten percent.  In many cases, clients may achieve tax exempt status by simply restructuring their existing family limited partnerships.

8.  Of course, leveraged gifting is a very advantageous ways of lowering one’s tax base.  In addition, consider gifting appreciated investment assets to charity.  If you’ve owned the appreciated investment for longer than one year, you may be able to deduct the full market value and avoid tax on the appreciation.

It should be noted that tax strategies such as those above were utilized to save significant amounts of taxes in several recent highly publicized transactions, including the initial public offering (IPO) of Twitter, the IPO of Facebook, and the sale of Lucasfilm to Disney.  The strategies discussed herein are available to everyone with appreciated assets and estates of all values.  Contact us to discuss your facts and tax minimization techniques.

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