The end of the year brings many planning considerations and 2022 is no exception. Here, we outline key opportunities as they relate to gifting, income tax planning, retirement planning, and general planning in a high interest rate environment. We also include a year-end punch list based on individual goals. If you have any questions about the planning opportunities discussed here, your Brown Brothers Harriman wealth planner would be happy to discuss them further.
Year-End Gifting
Gift and Estate Tax Exemption
In 2022, individuals may give away $12,060,000 (reduced by previous taxable gifts) without incurring a federal gift tax. This exemption amount is scheduled to increase to $12,920,000 per person in 2023. This exemption may be used to make outright gifts, fund new trusts, or add to existing trusts. Gifts can be made using cash, securities, or complex assets, such as an interest in a privately held business or family limited partnership. You can further leverage your exemption if you gift an asset that qualifies for valuation discounts, such as discounts for lack of marketability and lack of control.
If you are inclined to use up some or all of your exemption, sooner is almost always better from a tax perspective because you remove all future appreciation on gifted assets from your estate. In addition, the current exemption amounts, which were doubled in 2018 as a result of the Tax Cuts and Jobs Act, are scheduled to automatically decrease in 2026. If Congress does not act to eliminate this “sunset,” the exemption amounts will revert to those in place in 2017 (adjusted for inflation). While gifting is an attractive strategy right now given the higher exemption amounts, it is a personal decision that should be driven not only by taxes, but also your values, spending needs, and the gift recipients’ personal and 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 for the benefit of the donor’s spouse (and descendants or other beneficiaries). 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 or 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
Annual exclusion gifts are a great way to benefit children, parents, extended family and even friends. The annual exclusion ($16,000 per donee in 2022, or $32,000 per donee for a married couple) is the amount you can gift to any person once per year 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, to custodial accounts or to college savings plans. Gifts to college savings plans may be “frontloaded,” meaning you can contribute five years’ worth of annual exclusion gifts ($80,000 for an individual or $160,000 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.
The annual exclusion will rise to $17,000 per donee in 2023.
2022 Election Results and Implications With the final results of the 2022 elections almost complete, it appears as though Republicans will have a majority in the House, while Democrats will retain control of the Senate. We focus on who controls each chamber of Congress because significant tax legislation is most likely to be passed when one party holds both chambers of Congress and the White House. While that was the case over the past two years, there was no relevant tax legislation passed, so with the House and Senate split, significant tax legislation in the next couple years is even less likely. For our Massachusetts Clients: Massachusetts voters recently approved a so-called ‘Millionaires Tax’ and beginning in January 2023, residents with annual taxable income over $1 million will be subject to a 4% surtax on that portion of income that exceeds $1 million. |
Direct Payment of Tuition and Medical Expenses
Another gifting technique that does not use any lifetime gift tax exemption is the direct payment of tuition and medical expenses. These payments do not use any of your exemption as long as the payment is made directly to the institution. These payments can be made on anyone’s behalf and are not limited to immediate family members.
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.
Roth IRA Conversion
The current market may provide a good opportunity to convert your traditional IRA or employer-sponsored plan to a Roth. Roths offer many advantages, including no required minimum distributions (RMDs) and tax-free withdrawals (provided certain requirements are met). Amounts converted will be included in your taxable income, but in a down market the total amount subject to tax will be lower, and when the market recovers, the upside will be captured in the Roth account. Be sure to work with an accountant to understand the tax impact of a conversion; it may make sense to convert your account over time to spread out the tax.
Charitable Planning
There are many ways to benefit your favorite charities while also offsetting taxable income. You can donate cash, appreciated securities or other complex assets, such as an interest in a private business. You may also utilize a vehicle such as a private foundation, donor-advised fund, or charitable trust. Gifts of long term appreciated securities are often preferable from an income tax perspective because you avoid paying capital gains tax on those holdings (and receive a charitable contribution deduction) while the charity receives the full benefit of the gift because it is not subject to income tax.
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. In 2022, cash gifts made directly to public charities, including donor advised funds, are deductible against 60% of your adjusted gross income while the limit for non-cash gifts is 30% of adjusted gross income.
There are many considerations when deciding how to give. 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 BBH’s philanthropic advisory services and how we can help your family create a philanthropic legacy.
Retirement Planning
Required Minimum Distributions
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. RMDs are included in your taxable income and may push you into a higher tax bracket. If you do not need the funds in a particular year and are 70 ½ or older, you can make a Qualified Charitable Distribution (QCD) and direct up to $100,000 from your IRA to a qualified charity. Your RMD – and taxable income – will be reduced by the amount of the QCD. Payments must be made directly to the charity from your IRA and may not be made to a donor advised fund or private foundation.
Contribution Limits
In 2022, you can contribute up to $20,500 to an employer-sponsored plan, such as a 401(k) or 403(b), plus an additional $6,500 if you are 50 or over. This amount will increase to $22,500 in 2023, with a $7,500 catch-up contribution.
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 Roth IRA income limits for 2022 are less than $144,000 for single tax filers, and less than $214,000 for those married and filing jointly.) The contribution limit for IRAs in 2023 will increase to $6,500. The catch-up contribution amount will remain $1,000.
The deadline for 2022 IRA contributions is April 18, 2023.
Planning in a High Interest Rate Environment
Inflation and rising interest rates affect so many aspects of our lives – groceries, mortgages, business loans, and so forth – so it comes as no surprise that they affect estate planning strategies as well. Despite high interest rates, however, there are still effective planning techniques you can use to transfer assets on to the next generation and reduce your estate tax exposure.
When the Federal Reserve increases the fed funds rate, there’s usually a corresponding change to other rates, like the applicable federal rates (AFRs) and the 7520 rate (GRAT hurdle rate), which are used for certain estate planning mechanisms. The table below provides some context as to how much these rates have changed over the past year.
November 2021 |
November 2022 |
|---|---|
Short-term: 0.22% |
Short-term: 4.10% |
Mid-term: 1.08% |
Mid-term: 3.97% |
Long-term: 1.86% |
Long-term: 3.92% |
November 2021 |
November 2022 |
|---|---|
1.4% |
4.8% |
Interest rate changes are particularly relevant for estate planning techniques that involve split interest gifts, like those made to Qualified Personal Residence Trusts (QPRTs), Charitable Remainder Trusts (CRTs), and Grantor Retained Annuity Trusts (GRATs), as well as for more standard transactions like intra-family loans. A split interest gift is exactly what it sounds like: you’re splitting the gift into two pieces, one of which you retain and the other you give away. The reason some split interest gifts are more popular as interest rates rise is because of the way the value of the gift is calculated. When interest rates are high, the value of the taxable gift is reduced, for example, in the case of a QPRT. If the taxable gift is lower, less gift tax is due or less exemption is used in making that gift.
Two of the most common techniques implemented during high interest rate environments are QPRTs and CRTs. The way a QPRT operates is that you transfer your home into a trust, retain the right to live in it for a specified period of time, and then gift that property to designated beneficiaries (usually children or other family members). When interest rates are higher, the value of the retained interest to live in the home is higher, which means that the value of the remainder interest (the beneficial interest in the home following the designated term of the QPRT), or taxable gift, is lower. This can be a great planning technique, especially for homes you’d like to keep in the family for generations.
A CRT is an irrevocable trust that provides a stream of payments to one or more individual beneficiaries for a defined period, followed by a gift to charity. Here, the prevailing interest rate is used to calculate the remainder interest, which is the piece going to charity. So higher interest rates result in higher charitable deductions. It’s best to fund CRTs with low basis assets because you won’t recognize gain on the contribution, but the full fair market value of the assets will be used to compute the value of the income interest and the charitable deduction.
Other strategies, like intra-family loans and GRATs, are more popular during periods of low interest rates, but are not necessarily off the table when rates are increasing. With an intra-family loan, you’re making a loan to a family member at rates set forth by the IRS. And while those rates may be higher than they were last year, they’re still lower than the average mortgage rate, for example. So if you have a family member who needs liquidity, this could still be a good option.
GRATs are used to transfer appreciation in assets to named beneficiaries without the imposition of gift tax. They are particularly relevant for those who have used up their exemption and are looking to transfer more wealth out of their estates. Two-year GRATs are the most common, so at a high level, what you’re doing is transferring an asset into a GRAT, paying yourself two annuity payments plus interest at a rate set monthly by the IRS, and to the extent the asset appreciates in value over said interest rate, the appreciation passes to your beneficiaries without a corresponding gift tax liability. Although interest rates are high right now, relatively speaking, we’ve also been in a period of volatility, which can be a great time to fund a GRAT because many assets are undervalued and therefore likely to appreciate significantly moving forward.
While this period of increasing interest rates is not ideal, there may be some planning opportunities available to you and your family. Please reach out to your BBH wealth planner to discuss in more detail.
Interested in Maximizing |
Highly Charitably |
Selling/Holding |
Unsure of Your Goals |
|---|---|---|---|
| Use your remaining estate tax exemption with appropriate techniques | Consider “topping off” cash contributions to charities (up to 100% of your income) or creating a CRT |
Consider gifting an interest in the business prior to sale to a trust to reduce gift/future estate taxes |
Engage in values-based planning with your BBH wealth planner |
Work on implementation of your estate plan; compliance is more important than ever |
Consider using IRA funds (minimum distribution or remaining amount upon death) for charitable giving |
Consider gifting an interest in the business prior to sale to a donor-advised fund or public charity |
After articulating your values, align your planning and your use of resources as appropriate |
Create communication plan; communication is critical to long-term success, where everyone understands purposes and the “why” behind decisions |
Consider engaging next generation in your philanthropy |
Develop and communicate a succession plan for your business |
Consider setting up flexible trust/structure that can adapt as goals evolve |
Neither, Brown Brothers Harriman, its affiliates, nor its financial professionals, render tax or legal advice. Please consult with attorney, accountant, and/or tax advisor for advice concerning your particular circumstances.
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. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. 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. 2022. All rights reserved. PB-05900-2022-11-21
