Year-End Tax Planning: Opportunities Abound, but Revisit Your Values and Goals Before Proceeding

As the end of 2020 nears, we highlight year-end planning opportunities to consider in order to maximize your long-term goals, with your values at the forefront.

As wealth planners, we spend a lot of time talking to clients about taxes, but we spend even more time talking with families about values and how to ensure that their planning best reflects those values. We find that these conversations are the most fruitful. Sometimes, they serve as confirmation that the planning that has been done reinforces their values and furthers their family and philanthropic objectives. Other times, the discussion reveals a disconnect between a client’s values and objectives and the planning that has been put in place.

As the discussions and predictions about the election’s effect on taxes have reached a fever pitch, we have found ourselves giving different advice to different clients, and that is exactly what should happen when planning is rooted in each client’s individual values. For many clients, long discussions have made it clear that utilizing their full gift tax exemption through gifts to trusts for descendants is exactly in line with their goal to provide supplemental support and funds to generations to come. The fact that this planning is also tax-efficient and will help reduce estate tax is an added benefit.

Other clients may feel pressure to gift their full exemption by year-end, but our discussions reveal that doing so actually undermines the goals they are trying to achieve with their planning. Many have been through this scenario before. They made gifts of their full exemption in 2012 in anticipation of a potential change in tax law that did not come to be. As a result of that planning, and strong market performance since 2012, those gifts have appreciated significantly, in some cases doubling or more. Those clients may feel that through earlier planning, they have moved sufficient assets to their descendants for the moment.

If your values lead you down a certain planning path, it is likely the right one for the moment. Following that North Star and blocking out the noise of what others are doing can ensure that your plan continues to further your goals. Whichever plan you put in place, open communication with family members about that plan will ultimately ensure its success.

Year-End Gifting

Use of remaining federal gift and estate tax exemption

In 2020, individuals may give away $11,580,000 (reduced by previous taxable gifts) without incurring a federal gift tax. This exemption amount is scheduled to increase to $11,700,000 per person in 2021. Much speculation has surrounded the possibility of the gift and estate tax exemption being reduced substantially as early as January 1, 2021, if the Democrats took control of both of the White House and the Senate. We will have to wait for the Georgia Senate race results in January to get a better idea of the future tax landscape and how much, if any, tax reform President-elect Joe Biden will be able to achieve. It seems unlikely that we will see sweeping tax legislation, particularly retroactively, in 2021. For now, the current exemption amounts remain until they automatically sunset at the end of 2025.

If you are still inclined to use up some or all of your exemption, sooner is almost always better from a tax perspective because you are removing all future appreciation on gifted assets from your estate. However, the decision to make lifetime gifts is a personal one that should be driven not only by taxes, but also your values and spending needs as well as the gift recipients’ financial situations.

If you would like to transfer assets out of your estate now but are unsure about your future spending needs, consider funding a spousal lifetime access trust (SLAT). This is an irrevocable trust funded for the benefit of the donor’s spouse and descendants. While the donor cannot access the trust assets, his or her spouse is a permissible beneficiary. This provides a safety net of sorts because if the spouse has unforeseen expenses in the future, he or she may request distributions from the trust. These trusts should not be the primary source of your and your spouse’s support, so it is still important to evaluate your balance sheet and spending needs and feel comfortable with the amount you are giving away.

Annual exclusion gifts

Annual exclusion gifts are a great way to benefit children, parents, extended family and even friends. These are the $15,000 (or $30,000 for a married couple) gifts you can make each year to any person without using up any of your lifetime federal gift and estate tax exemption. Annual exclusion gifts can be made outright, to certain types of trusts or to college savings plans. Gifts to college savings plans may be “frontloaded,” meaning you can contribute five years’ worth of annual exclusion gifts ($75,000 for an individual or $150,000 for a married couple) now and treat that gift as being made ratably over the next five years. In some states, such contributions also qualify for a state income tax deduction.

Planning in a Low Interest Rate Environment

If you have exhausted your federal gift and estate tax exemption or are not inclined to make a large irrevocable gift at this time, there are plenty of other opportunities to transfer part of your wealth out of your estate.

GRATs and sales to intentionally defective grantor trusts

Grantor retained annuity trusts (GRATs) and sales to intentionally defective grantor trusts are two ways to transfer appreciation out of your estate without giving up the underlying assets. These techniques allow you to get back the value that you initially contribute, plus statutory interest, over a term of years while passing all appreciation above the interest rate to the remainder beneficiaries free of gift tax.

These are particularly effective planning tools in this low interest rate environment because the “hurdle rate” over which the trust (either the GRAT or the intentionally defective grantor trust) must appreciate in order to transfer assets to the remainder beneficiary is very low. They are also low-risk transactions because you eventually get back the value of your initial contribution; it is only the appreciation you are giving away. Depending on what type of assets you transfer, valuation discounts may be available. Planning with discounts allows you to leverage these planning tools and transfer even more out of your estate gift tax-free.

Intra-family loans

Loans are a great way to provide liquidity to family members (or friends) at almost no cost to you. These loans can be helpful to assist in the purchase of a home, starting a business or just providing some extra funds to help cover expenses.

Interest rates for these noncommercial loans are set by the IRS (the applicable federal rate, or AFR) each month and vary depending on the term of the loan. Interest payments paid to you by the borrower are taxable (unless the loan is made to a grantor trust), but given the low rates, it is likely to be inconsequential. In November, the AFRs are as follows:

  • Short-term loan (0-3 years): 0.13%
  • Mid-term loan (3-9 years): 0.39%
  • Long-term loan (over 9 years): 1.17%

This is a flexible planning technique because you can decide the term of the loan (and thus the interest rate) and whether the loan requires interest only with a balloon payment at maturity or regular principal payments. Loans may be secured or unsecured and can be prepaid without penalty. If you would like to forgive part or all of the loan, you can do so by applying annual exclusion gifts or your gift tax exemption to reduce the principal balance.

Charitable Giving

There are many ways to benefit your favorite charities while also offsetting ordinary income. You can donate cash, appreciated securities or other complex assets, such as an interest in a private business, or fund a private foundation or donor-advised fund.

Deduction limits vary depending on what and how you give, but if your contribution exceeds the deduction limit, you can carry the excess deduction forward for five years. Cash gifts made directly to private charities (excluding donor-advised funds) are deductible against 100% of your adjusted gross income in 2020 as a result of the CARES Act. All other charitable contributions remain subject to their usual deduction limits.

There are many considerations when deciding how to give. Direct gifts, private foundations and donor-advised funds each offer their own unique set of benefits and limitations. There is no one-size-fits-all approach to your philanthropy, so it is important to think through all options to find which charitable vehicle is most aligned with your philanthropic mission and vision. Contact a member of your relationship team if you are interested in learning more about Brown Brothers Harriman’s (BBH) philanthropic advisory services and how we can help your family create a philanthropic legacy.

Income Tax Planning

Tax loss harvesting

Realizing losses in your portfolio now can help offset capital gains tax this year and beyond. Losses incurred by tax loss harvesting can be carried forward indefinitely, and up to $3,000 of your capital loss can be used to offset ordinary income each year.

RMDs waived in 2020

Typically, required minimum distributions (RMDs) must be taken from individual retirement accounts (IRAs) beginning at age 72. These rules apply to traditional IRAs, IRA-based plans such as SEP IRAs and all employer-sponsored plans such as 401(k) and 403(b) plans, but do not apply to Roth IRAs. The CARES Act waived RMDs in 2020, so there is no need to withdraw funds this year. RMDs are included in your taxable income, so if you do not need the funds, it will be more tax-efficient to forgo any withdrawal this year.

Maxing out contributions to retirement accounts

While you are not required to withdraw funds from your retirement accounts this year, it is still a good idea to contribute if you are eligible. In 2020, you can contribute up to $19,500 to an employer-sponsored plan, such as a 401(k), plus an additional $6,500 if you are 50 or over.

You may also contribute up to $6,000 (or $7,000 if you are 50 or over) to a traditional or Roth IRA. If you are not able to fund a Roth IRA because your income exceeds the limit, you may be able to fund a traditional IRA and then convert it to a Roth IRA at very little tax cost. The contribution limits for employer-sponsored plans and IRAs remain the same for 2021.

It is never too early to start saving for the future, and retirement accounts can be a useful way for children or grandchildren to learn about saving and investing. If they are employed, they can of course contribute to their employer-sponsored plan. They can also fund an IRA up to the amount of earned income they have for the year (but subject to the $6,000 limit). If you would like to help a family member save for retirement, you can make a direct contribution to their account (subject to contribution limits) or, if you make annual exclusion or other gifts, they can use a portion of that to contribute on their own.

Bonus depreciation

If you purchased depreciable assets this year as part of your business, such as a plane, machinery or equipment, you may be eligible for a full up-front depreciation deduction. Under the bonus depreciation rules, certain business assets qualify for a 100% depreciation deduction in the first year the asset is placed in service. There are requirements regarding the type of asset purchased and its purpose within your business, so be sure to consult with your accountant if you think you qualify.

Please reach out to a BBH relationship manager or wealth planner if you are interested in learning more about incorporating your values into your estate plan or these year-end planning opportunities.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2020. All rights reserved. PB-04109-2020-11-18

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