Sympathy for the Wealthy: Strategies to Combat Prospective Tax Increases

Sympathy for the Wealthy: Strategies to Combat Prospective Tax Increases

A dear friend celebrated his birthday the other day – he’s nearing 50 now, but is still younger than me, somehow.

He lives in a European financial capital, so his card was delivered via Facebook. I posted a famous picture of Frank Sinatra, swinging onto a helicopter pad with drink in hand, and wrote: “He wishes he had your style and joy of life.” My pal got rich the hard way, you see, and boy, does he enjoy it.

This freewheeling delight is rare among the wealthy. Some inherit and don’t appreciate it. Nervous ambition drives many to success, leading only to further anxious efforts, without pause to enjoy the view. It certainly keeps the economy humming, and while some would cite the Google entry on narcissistic personality disorder, others see the stuff of greatness. We think it’s best not to judge.

Whatever the deal, it isn’t easy being rich. You’re on everyone’s dartboard – even your wealthy neighbors may think you’re Old Man Potter, depending how you treat the staff. Politicians have mixed feelings: they want your campaign contributions, but that just tips them off: you’ve got excess income on hand (apparently) and maybe the tax man should drop by for a chat.

There’s an election scheduled for November and the candidates have nailed down most of their planks. Joe Biden wants to raise taxes on the wealthy – income, capital gains and estate most certainly, though reports that he plans to tax the wheels on your Range Rover may be exaggerated. President Trump wants more tax cuts, he says, but with the pandemic draining coffers nationwide, he may be blowing in the wind.

Years ago, my prosperous birthday boy held forth on these issues. When it comes to tax cuts, he’s a nonbeliever. “They never stay cut. The politicians need money, they whip up the crowds and its off with our heads. That’s what you should plan for.” He’s a fine spokesman for the planning industry, bless him, and a darn good insurance customer, too.

He better be: he has a wife and two young daughters, to say nothing of assets stretching from Central Europe to the Midwest. Taxes will rise, sooner or later, and there’s no need for sensationalism or panic. Just get yourself ready, pronto.

The tools are readily at hand to protect high-net-worth clients from the taxman. First, they can give it away. The lifetime individual estate and gift tax exemption is currently $11.58 million, and couples can gift twice that amount. This elevated exemption expires at midnight, December 31, 2025, or even sooner if the Democrats have their way.

Any largesse over these amounts incurs a 40% tax. This is actually five percentage points higher than the pre-Trump tax reform levy, suggesting a moderate attitude in the White House towards taxation, rather than true hostility. In tough times, rates could change quickly, so opportunities should be seized.

Candidate Biden wants to boost the capital gains tax and eliminate the step-up in basis. We think that even a Republican administration or Congressional majority might consider these steps if budgetary pressures rise too high. The step-up is often seen as anachronistic, even to low-tax pundits, and capital gains levies are a politically painless way to raise revenue – only the rich are perceived to suffer, whatever the broader reality.

The best response is to liquidate appreciated assets. The capital gains rate stands at 20% – keep in mind, Biden’s proposal would nearly double it. Selling topped-out securities is a simple enough response, but given the dreadful decline of many portfolios, it may be hard to execute. This strategy can be implemented any time before year end, so there is still time for recovery gains to appear.

Certain shares have appreciated during the corona crisis and some have even excelled. Zoom Technologies has profited from its video conferencing expertise and is currently trading at 193x forward price-to-earnings. Clients holding shares that have fed off the pandemic should be encouraged to liquidate before the boom ends and the bloom falls from the rose.

A seemingly drastic tax-mitigation idea involves moving to a more tax-friendly state. Residents of Massachusetts, California, Minnesota, New Jersey and other tax-heavy states have long been counseled to flee, but the step is usually too far to take for established professionals. Lockdown and the success of virtual office arrangements may change all that, and clients in high-tax states should at least be reminded of the option.

Life insurance is a reliable standby for keeping estate taxes in check, allowing the tax-free transfer of considerable wealth to heirs via the death benefit. Unfortunately, the value of these policies is included in the valuation of one’s estate. Several steps are traditionally taken by clients to redress this problem.

First, they can assign life policy ownership to a third party. The original owners are then barred from any interest in the policy: they cannot borrow or take loans on the cash value, change beneficiaries or even pay the premiums – the new owner has sole responsibility and control. IRS rules require the transfer to take place at least three years before the original owner passes away, so the decision should be taken as early as possible.

Establishing an irrevocable life insurance trust, or ILIT, is another good way to sweep life insurance assets off your books. Once ownership passes to the trust, the original holder has no authority over it, and indeed, cannot serve as a trustee in the ILIT, and the trust cannot be altered or cancelled. ILITs work well if no trustworthy individual is available to take on the life policy. Again, the IRS requires the ownership transfer to be completed three years before the original policyholder dies.

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