In terms of tax planning, we must learn from the past and apply it to our future.

Episode 19: Tax-Planning Strategies: A Year-Round Focus

Dean Mioli and Steve Wittenberg are back to share more strategic tax planning tips. They sit down with Leslie Wojcik to discuss five proposed steps tax payers can take during the second half of this year to prepare for the next tax season. Enjoy Episode 19.

If you missed their first podcast, be sure to listen to Episode 14: Tax Talk.

Transcript

Announcer: Hi, everyone. Thanks for joining us back at The Intersection, a podcast that brings you candid conversations with members of our community and leaders in our industry. Enjoy today's episode.

Leslie: Hello and welcome. I'm Leslie Wojcik, head of global communications at SEI, and today we're welcoming back Dean Mioli and Steve Wittenberg to talk tax planning. Gentlemen, welcome.

Dean: Welcome is right, Leslie. How are you?

Steve: Thanks, Leslie.

Dean: I'm great, Dean, as always.

Steve: Thanks, Leslie. Thanks for having me.

Leslie: All right. So, let's get started. I know that you both have a lot to talk about today. In March when you were with us, we discussed the potential effects of the Biden campaign proposed tax legislation. What's changed since then?

Dean: Well, first of all, we have tax season, which was extended by a month. Everyone is busy filing their returns. They're due May 17th, just around the corner here, unless you're on extension until October 15th. Regardless, the tax chatter among politicians and pundits is getting to a fever pitch.

On the prior podcast, we opined about the economy, and the change in the political climate, and funding of these new initiatives, and of course, financing COVID-19 relief. Well, not much has changed over the last month or so, other than more proposals by the Biden administration.

Our clients are hearing the noise, and they're expecting to be meeting with their financial professionals, their tax professionals, to discuss potential strategies. And the big question right now is, what now? What should we be thinking about before the end of 2021? And today, we discuss the five steps we're proposing for tax planning in 2021.

Leslie : So, speaking of those five steps, how can taxpayers remain active with tax plans throughout the whole year?

Dean: I think we need to start with a comprehensive review of your individual income tax return. This is a great time to try to develop that baseline. Where do I stand? Now, one thing to keep in mind is planning is a multi-year exercise, so there's things that we're thinking about maybe doing in '21 versus '22, but we're also starting to set up that mid-year review with our tax professionals. One thing that comes up is the difference between a tax preparer and someone who is a tax planner. So, Steve, why don't you take one of those two, and I'll take the other one?

Steve: Sure, Dean. Yeah, there definitely is a difference. I would expect that most of our clients, at a minimum have a tax preparer, right? This is a person or a company or even a software that is helping you put numbers on paper. It's just meeting the basic filing requirements of the IRS, and maybe your state locality. Their tax preparers are just taking your information and making sure you're complying with the filing requirements. It's very different than having a tax planner navigate this year with you. And you could describe what you were meaning by a tax planner.

Dean: Great part about compliance there, Steve. With a tax planner, what we're looking at is, what can I do differently now that would change my tax complexion? We pulled out my 2020 tax return. Are there things that I can do from an investment income perspective? Do I have some inefficiencies in my investment portfolio? Okay? Should I be handling charitable contributions differently?

This year more than ever is a year to engage planning because we have political and tax volatility. So, if you haven't engaged in the planning process in a few years, this is one of our strongest recommendation, is it's time to talk to a planner about what you're thinking you're going to do.

Steve: Dean, you and I were talking the other day to use 2020 returns as a guide for 2021 and 2022. You said to me, learn from the past to apply for the future. And I know that's... It could be a tagline. And again, I'm going to throw out another cheesy line, but when it comes to estate planning, and you just handle income tax, but with state planning, I like to say what the Boy Scouts say, which is "be prepared." And so you are recommending a lot of planning on the income tax side. On the state planning side, that's what I see a lot of. And what I mean is, you have to look at your personal circumstances now and over the last few years, and take stock of what's changed. If you haven't evaluated the impact of these changes on your estate plan, again, this is the time to do it, in the year of transition. And you need a review by your team of professionals, likely your financial advisor, your state attorney.

But if you're taking stock and looking at it yourself, you need to think about who gets what, when and how. Who has control, who has decision-making power, and is this still, all these factors, still in line with your goals? And just as important will be how the estate tax laws unfold, and whether you're going to be exposed to more estate tax. And we think likely, a lot of people, especially wealthy clients, will. Estate tax rates look like they could change. The estate tax exemption could drop. How will these impact your federal tax position? What should be put in place now so that you could act quickly if the laws change?

And I want to stress the importance of this, because I'm looking back at 2020. We were in the same position last year. We were in an election year, there was similar chatter, and we were having the same conversations with clients. And I can tell you more stories than I think we have time for, but there were so many instances where plans were not executed by December 31st, 2020, because planning execution happened too late in the year.

In my career, 2020 was the first time I saw attorneys working through Christmas Eve and New Year's Eve to get these plans done. And many professionals who were inundated weren't able to get the work done. Fortunately, no law changes have kicked in to effect 2020 to date, but we don't want to see that happen again in 2021, so you'll hear throughout today, we're telling you to act early, start early, get to step 1, 2, 3 early, as early as possible.

So, with that, that was step one. I know it was a little bit long, but how about step two, Dean? I know we're talking about a lot of changes. So, what should people be doing in 2021 now, with the potential law changes?

Dean: Okay. So, you met with your tax professional, you kind of laid out a few ideas, you reviewed your tax return. Maybe there are a few things that you can implement right now if you've found some things you can improve upon. Certainly discuss your near-term plans with your tax professional, what you think you might be doing.

And now it's time to monitor a little bit, keeping an eye on what's going on down in Washington. Okay? This is no slam dunk that the Biden administration is putting forth is going to happen. There could certainly be battles in both the Senate and the house. Let me give you a name. Richard Neal. He's going to be a very popular man over the next six months. It's a name you're going to hear quite a bit because he is chairman of the very powerful House Ways and Means Committee. That's the chief tax writing committee of the nation.

Tax legislation is usually going to come out of this committee. So, what Steve and I are going to be doing for sure is keeping an eye on what's going on, and what we think the likelihood of tax changes are going to be. And you, the consumer, maybe not as much, but I would certainly be keeping an eye on those headlines to see how things are progressing, because likely we might have to call some plays here before year end.

Steve: Yeah, Dean. Over the last couple of months, since you said the House, we saw senators like Bernie Sanders, Senator Van Hollen, they were introducing... I'm using air quotes... introducing The 99.5% Act and The Corporate Tax Dodging Prevention Act. And these are taxes, if passed, that will impact the Uber wealthy, raise big revenue to help battle everything that we were talking about earlier. COVID relief, other initiatives.

And then we see President Biden. He signed into law The American Rescue Plan, which provided immediate relief to Americans. This is coming at a cost, and the government needs to raise revenue. It was followed up just this past week with President Biden's address, and he talked about The American Families Plan, introducing ideas to stimulate economic growth.

In all of these instances, they're simply plans. It goes back to chatter. And we're talking about it, but right now they technically don't hold much weight because nothing has been presented yet. No tax bills have been presented in the House, no tax law changes have been voted into law. So, until we see official bills and discussion around that, you're right. We have to monitor this. But we do expect changes, both on the individual tax side and the estate tax change proposal side, maybe later this year, possibly into next year.

So, we see the value of tracking, because if you track it, you will be able to plan faster and be on top of it. With planning, Dean, and tracking this, what would you suggest? What do you see as maybe an idea?

Dean: Well, one that's certainly on the radar for many of the advisors that I'm talking with, and certainly in some instances with their clients, is the Roth conversion, by far, is one of the most popular planning techniques under discussion.

General tax planning would say, defer income into future years and accelerate deductions. But this is an unusual year because we could have higher tax rates next year. So, one of the discussion items is, do I do Roth conversions this year? And what does that look like? What are the things I need to consider? And the biggest factor in doing a Roth conversion is what tax rate you're in now, versus what you think you will be in the future.

Of course, it is hard to look into the future and have definitive knowledge as to what your future tax rate's going to be, but if you have probability of being in a higher tax rate in the future, Roth conversions can make a lot of sense now, and they might not necessarily come at a tax cost.

A quick example. We were working with an advisor and an end client. And one of the services that we do is that we reviewed 1040s, and when we looked at their 1040 for 2019, we noticed that it had a very large NOL, which stands for net operating loss carry forward. So, I asked the advisor, "Have you brought up Roth conversions?" And he said, "No, I haven't." And I said, "Well, how big are their IRAs?" They had a $2 million traditional IRA. The net operating loss carry forward was over $2 million. I said, "Well, interesting. What we have here, when we're looking at your tax return, is we could use this net operating loss to cover the cost of the Roth conversion." Essentially, a tax-free Roth conversion of tremendous magnitude, $2 million.

That is an example of why we like to look at tax returns, but it's also highlighting one of the key planning items for '21, which is that Roth conversion. Or other types of accelerating income as well, which could be non-qualified stock options, for instance, exercised this year versus next. Because not only do you have to worry about income tax consequences, they're also talking about payroll tax increases next year. So, there's a couple things going on there that might come into play.

For business owners out there, one way to increase your income is defer business expense. So, what year you put expenses into is a way you can also shift income. The juice is definitely worth the squeeze when it comes to tax planning. Back to you, Steve.

Steve: I like when you say that. You did say to me that in a lot of instances with planning, you shouldn't get hurt by executing something today, or this year. You might get hurt if you wait. This is what I see consistently with our clients. It goes back to my prior story. You wait too long into 2021, you may not be able to get any plans executed if you need to, and we don't want to see that happening again.

On my side of estate planning, to be prepared, if you think you can make a pretty large gift this year, you want to use exemption. There's no harm in beginning those discussions with your attorney to get the nuts and bolts in place for, say, a specific type of trust that you want to execute and gift into. We are seeing an uptick in planning around irrevocable trusts and discussions around utilizing these state exemptions.

And the fear is, if you don't use it, you lose it. A typical example, our client's worth, let's say, $10 to $25 million, but they have a healthy spending lifestyle. They're afraid that they're going to run out of money down the line if they give too much away, but they also don't want to pay the IRS. So, that's a hard balance to overcome. It's a common concern. And fortunately, there are trust techniques out there that you could plan for.

One of which that we're seeing a lot of is a spousal lifetime access trust. It's a SPLAT. This could be drafted to help satisfy various conflicting goals. It allows you to make a meaningful gift, utilizing your exemption, and planning around estate tax, and all of that growth occurs outside your state. What's great about this is you're creating this trust for your spouse, and your spouse will have control and direct access to income and principal. And you, you're married, so you have indirect control, you have indirect access to income and principal. It's a really nice technique to avoid worrying about running out of money down the line.

Of course, it comes with some risks. Every plan comes with some risks. In this case, a divorce or a death of your spouse is a risk that you would appreciate, and you will lose that control and that indirect access that you had at first. But, this is just one example. There are definitely other types of trust techniques to discuss. Start those discussions as soon as possible.

Dean: Absolutely. So, that's step three, start lining up those ideas with your tax professionals, laying out some things that you want to consider. Most tax planning has to be done by year end, December 31st, especially on the income tax side. So, you need to get these things ready to go if you're going to do them. Don't think you can walk into an attorney's office on December 26th. "Hey, I need to do a charitable remainder unitrust." Well, good luck. I don't think you're going to get that done in four days. Very, very unlikely. So, be prepared and get these things ready to go.

Steve: And I would say, at the latest you want to do that and meet with your advisors, your CPA, your tax estate attorney, late summer, early fall. Depending on what we hear in the news and what you're monitoring. If the law changes are happening fast, or look like they're happening fast, meet with them earlier. But for sure, when you start coming back from your late summer vacations, if you haven't connected, start connecting. Get the update from your professionals of where we are in law changes, and what's the new chatter happening out there.

Dean: So, Steve, let's say we get to the fall here and we start to see some definitive things, that the president's ready to get this into Congress, and there's going to be votes taken, and we have a bill in place.

One of the things I love to do, and then I do it every year, but I think this is a year more than ever, is that you want to start doing what's called a tax projection, income tax projection. So, you have your base here, which is 2020, and then you have '21, '22, maybe '23, '24 out there, and there's some great software out there that can do this. And you're doing a little bit of what if. Well, what if this, what if that, and you see how the numbers fall.

And this is where you start to reason together, and you say, "Well, what if I exercise stock options this year?" But let's take into account those potential law changes that you've talked about. What's that going to look like for next year if I decide to wait?

So, when you're making these financial decisions, before I do anything, I like to know what the tax cost is going to be. I don't let the tax tail wag the dog, but I don't want to be surprised, either. I want to know what I'm getting into. Because let's face it, a big mistake with a lot of money is a big problem.

Steve: Absolutely. On the income tax side, running different scenarios and getting the projections in place based on the potential tax law changes is going to be critical. And on the estate tax side, I run similar projections, but the projections are, what if you make this gift? We right-size the gift for our clients. What impact is that going to have on your life? If you give away $5 million today, what will that look like down the line for your spend, and what will that $5 million turn into in 10, 20, 30 years? We know it's going to grow. How much tax are you're going to save by making that gift? Is it enough? Does it make you feel good that you've saved that tax, and oh, by the way, depending on how you want to give it, and who you want to give it to, is it too much, possibly, for that person, for your child, for whomever is receiving the beneficiary? That $5 million might be a nice gift now, what if you wake up in 30 years and that $5 million is $50 million. Is that going to scare off those beneficiaries? Are they going to be prepared for that?

So, those projections, from a numbers perspective, it's not just about the tax, like you said. It goes beyond saving tax and it comes into family planning, gift planning, impact. And I'm talking about family, but it's the same thing for charity. Charitable planning. So, these projections can help you work out the numbers, and almost back into the appropriate gift for what you're trying to accomplish. So, yeah. Do these end-of-year projections, ballpark projections. Get the projections done to help you make final decisions.

Dean: Yeah, I like that term, "right-size." I'm going to use that one. Right-size that gift.

Well, getting back to potential tax law changes and doing projections, let's run a scenario together, Steve. So, here I am, the stock market's done really well over the last 10, 12 years, and this year the market's been doing pretty well. Who knows how it's going to go the rest of the year, but I have some big gains in my taxable portfolio. And my life's changing a little bit. I'm getting ready for retirement, and I got to reposition some stuff, and now I got to handle it.

So, what kind of things should I be thinking about, regarding if there... Let's say there is going to be an increase to the capital gains tax, because right now the top rate is 20%. We have a Medicare surtax of 3.8%. But the Biden administration has talked about raising the capital gains rate for long gains to 39.6%, once your income is over a million dollars, plus the Medicare surtax. Plus, depending if you're in a high income tax state, you could be over 50%.

So, let's talk about some kind of things that are on the table that really... It's like living in a Seinfeld reverso-world here.

Steve: It really is.

Dean: Because up is down, down is up. Because we're thinking way out of the box, here. How do we think around the corner?

Steve: I'll say, the most simple thought hopefully our listeners hear over and over again every year, loss harvesting, capital loss harvesting. Well, this is the Seinfeld reverse year. Maybe this is the capital gain harvesting year, right? Let's execute those trades. Let's balance that portfolio that you were concerned about balancing. And though there's going to be a tax, get the tax at a 20% or 23.8%, as opposed to 30%, 35%, 40% whatever, 50% next year, or in future years. Capital gain harvesting. Probably haven't heard much about that in prior years. So, that is that you should speak to your financial advisor about. Cherry pick, in a way, some of the assets, some of the equities that you want to look at. And again, be prepared. And if you execute that trade December 31st, it's as good as if you made it on May 3rd.

Dean: That's a good one, tax gain harvesting, right? And not only do you get that, but you also get a step up in basis, which could be kind of handy in the future as well. But maybe I don't have an appetite to pay tax, certainly not all at once. Because let's say it's a million-dollar gain this year. That's a $238,000 federal tax bill, and we haven't even talked about estate taxes. I don't want to lose all that principal to tax in one year. Is there anything else that I might want to consider before year end, maybe something in a trust idea? Have anything for me?

Steve: Well, I mean, certainly you talked about irrevocable trust, utilizing your exemption, get some of this potential gain out of your estate, some of these equities out of your estate into an irrevocable trust. It's kind of like kicking the can down the road, maybe, because someone's going to have to pay the tax at some point.

But if these are trusts that aren't going to be accessed for many years, first generation, second generation, maybe by then the political environment changes, and the tax law changes? Who knows. So, what we like to do as part of the planning process is not just bracketing the trust with the right terms, but then you have to pick the right assets to gift into them. Use your exemption to make these large gifts. Put it into the appropriate technique. Make those decisions with your advisors on, how do you fund these gifts? That is one thing that we're seeing a lot of. I also know that you know, people like using stock, equities, for charitable donations. Are you seeing a lot of that on your side?

Dean: Absolutely. Chinese New Year, it's the year of the ox. In the trust world, in our side of the business, it's the year of the CRUP, the char remainder unitrust. You pop the stock inside the CRT and then sell it, you don't lose $238,000 in federal taxes in one shot. The only time tax is paid is when distributions are made to the income beneficiaries, which could be a husband and wife. It could be their children.

Of course, that also will create a charitable deduction as well of some size. Very powerful structure. Of course, that's an irrevocable transfer when you put the stock inside the CRT, so don't expect to get your principal back all at once. So, there's pros and cons to these strategies. Of course, there's some trust costs involved. But it's a very good way to manage the tax volatility of the situation. It's a great way to potentially set up a tax efficient cashflow.

And I tell you right now, there is a lot of modeling going on with these CRTs right now, these CRUPs. So, it is certainly something that if you're contemplating a big sale of an asset at appreciated security, maybe real estate for instance, this has got to be on the agenda. I'm not saying you have to do it, it just needs to be worked through. Does this make sense for me? Do I mind giving this up and putting it into a trust?

Steve: What our audience is hearing is kind of the brainstorming conversations that fall into step five. It's the end-of-the-year planning. It's the actual planning. It's discussing with your team different ideas that meet various goals, and step five implementation.

We talked about monitoring. We talked about meeting with your advisors, doing the projections. But then ultimately implement. Leave time for implementation. We've laid out a kind of a targeted timeline for each of these steps, starting now into the summer, into the fall. But again, the earlier, the better because professionals, the attorneys, need time to discuss these ideas and figure out what works best for you, the client.

There's a ripple effect here. For example, when we talked about funding some of these plans, we talked about equities. We talked about stock. Well, what if you're taking a different type of unique asset that needs a formal valuation, an asset that is not readily marketable? That's going to take some time. You need to get a valuation company to be able to value that asset for gifting purposes. You can't do that December 1st, 15th. You need time to do that. So, creating a plan is great. Making sure you have all the pieces lined up to get it done ahead of time is critical.

Dean: Absolutely. So, let's reiterate the five steps that we talked about. One is, take a comprehensive review of your income tax situation and a quick review of your estate planning. Okay. This year, more than ever, it's time to get these things done.

Step two, keep an eye on what's going on in Washington.

Step three, meet with your advisors, your CPA, your tax professional. Start laying out some of the ideas that you're looking to discuss, potentially to implement, in the fourth quarter.

As things become a little bit clearer in Washington, let's put some pencil to the paper, start running some projections, see where things fall, and then as legislation becomes more finalized, if it does get finalized, it's time to call the play and implement the plan. And you never know, you might have to call an audible before year end.

So, you go to the line of scrimmage, you have a plan in mind, but you might have to call an audible. So, you've got to have some flexibility to your planning. What do you thin, Steve?

Steve: Nailed all five steps. You're absolutely right. I'm going to drill down the same term here, earlier is better. Get going early. Don't wait until Congress decides to vote at the zero hour that everything's going to change, and then start doing planning at that point.

Get this done ahead of time. Do as much as you can up front. Get your team in place, meet with your team, start the communication process, and be ready to go. Worst case, which might be a best case scenario, is nothing changes in 2021 and you have a plan in place for 2022 or 2023. Because taxes are always going to be discussed year-in and year-out. Death and taxes, right?

Dean: The only two certainties that I know of.

Leslie : Yeah. Thank you for your insights. Great five stuff, and we look forward to having you back to share some more stuff.

Steve: Thanks, Leslie.

Announcer: Thanks so much for joining us today. Stay tuned for more conversations with members of our community. Until next time, stay well. And of course, we hope you'll meet us back at The Intersection soon.

Legal Note

Important Information

Neither SEI nor its subsidiaries provide financial estate planning or tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.
Neither SEI nor its subsidiaries provide estate planning services unless you have otherwise separately entered into a written agreement for the provision of certain estate planning services.

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice. This information is for educational purposes only and should not be interpreted as legal opinion or advice.

Glossary:
Tax loss harvesting is a strategy of selling securities at a loss to offset a capital gains tax liability. It is typically used to limit the recognition of short-term capital gains, which are normally taxed at higher federal income tax rates than long-term capital gains, though it is also used for long-term capital gains.
An irrevocable trust is a type of trust where its terms cannot be modified, amended or terminated without the permission of the grantor's named beneficiary or beneficiaries.
A CRUT (charitable remainder unitrust trust) is an irrevocable trust that provides income to a named beneficiary or beneficiaries during the grantor's life and then the remainder of the trust to a charitable cause.
The Spousal Lifetime access Trust (SLAT) is an irrevocable trust where one spouse makes a gift into a trust to benefit the other spouse (and potentially other family members) while removing the assets from their combined estates.