These are uncertain times. But taxes seem likely to increase, and perhaps significantly, for those earning more than $400,000 per year or with larger estates at the time of death. For many, this will not be a problem. For others, these tax increases are significant. What planning should be considered before year-end?

If the Democrats take the Georgia Senate seats in January, there will likely be a dramatic increase in estate, gift, income and capital gains taxes. If the Republicans take these seats, the tax increases will likely be more tempered. No one knows what will happen. How do we plan for the worst tax scenario without overreacting?

How bad could it be?

Democratic tax proposals have included:

  • reducing the federal estate tax exemption from $11,600,000 to $3,500,000 with a 40% tax on everything above the exemption amount
  • eliminating the step-up in basis for assets passing at the time of a person’s death
  • increasing income tax rates for those earning over $400,000 to 39.6%.
  • increasing capital gains tax rates from 20% to 39.6% for those earning more than $1 million per year
  • expanding social security tax on incomes over $400,000.
  • phasing out the Section 199A deduction
  • eliminating IRC s. 1031 so-called like-kind exchanges

Further, changes in the law made sometime in 2021 could be applied retroactively dating back to January 1, 2021.

What can be done before year end?

Income Taxes

We simply do not know what will happen with income tax rates in the coming year. We highly recommend that you speak with your CPA and financial planner to discuss your particular situation and potential planning options available to you to reduce your short and long-term income tax exposure. Some options to discuss with your CPA or financial planner:

  • ROTH conversions. Pay the tax on current traditional IRAs now at lower income tax rates, rather than paying at future potentially higher rates.
  • Realize as much income as possible in 2020, rather than waiting until 2021. For small business owners running their books on a cash basis, this means collecting your accounts receivable and getting this deposited in the bank before December 31.
  • Realize capital gains in 2020. If you are already planning on selling stock, real estate, or any other type of asset, get this done by December 31 if you expect this to produce a capital gain. Pay the tax at this year’s lower rate.

Any decisions should be carefully considered and discussed with your financial advisors, including your CPA or financial planner. But action taken now before the end of the year could reduce income tax exposure.

Estate Taxes

A couple with a $15,000,000 estate currently pays no federal estate tax and just under $1,900,000 in Massachusetts estate tax at the time of the second spouse’s death. Proposed changes to estate tax laws would increase this couple’s tax exposure to just over $4,300,000.

What can be done before year-end, in anticipation of these potential changes?

  • Gift assets to family members now (or to trusts for family members), taking advantage of the current high exemption amounts. The IRS has stated that it will not “claw back” gifts that were made utilizing the higher exemptions even if these exemption amounts come down in the future.
  • But doesn’t this mean I am giving up control of the assets I gift away? Yes, it does. That is the problem with a gift; you are “giving it” away. However, there are gift techniques to minimize this problem. For example, you can gift assets to a special trust for the benefit of your spouse and children, with preference to your spouse. Such a gift would remove the assets from your taxable estate. You would retain indirect control of the assets through your spouse.
  • What if taxes don’t increase significantly next year? Will I regret gifting I do before year-end? You should always think carefully before making significant gifts, no matter what the tax climate. However, removing assets from your taxable estate by gifting while you are younger, allowing this asset to grow during your lifetime outside your taxable estate can significantly reduce your estate tax exposure at the time of your death. Further, there are techniques that allow you to “undo a gift” within nine months of making it. This would allow you to make a gift by December 31, 2020 and see what happens in those January Georgia elections and any estate tax reforms in 2021. Under certain circumstances and if appropriate, this gift can then be “unwound” if done within nine months from the date the gift was made.

As stated above, we simply do not know what will happen in the coming months or in the coming year.

We are encouraging our clients with potential tax exposure to get advice now from their various advisors (CPA, financial planner, estate planning attorney, etc.) and to take steps they feel comfortable with after being informed of the options, risks and potential benefits of tax planning before year-end, or thereafter.