Tax & Wealth Planning opportunities in times of turmoil

Jeff Saccacio, CPA, PFS, ChFC, TEP

Head of Wealth Planning + Family Office Services

“I’ll think about that tomorrow. Tomorrow is another day”

Scarlett O’Hara, Gone with the Wind (January 17, 1940)

In unprecedented, turbulent times – with worries about personal and family health, personal and global economics- it’s easy to apply Scarlett’s view to your wealth planning. Global markets have seen massive amounts of wealth evaporate, with market values retreating to 2016 levels. It’s hard to plan for the future when you are there are so many highly charged crises happening simultaneously.

However, if you believe the current situation is yet another shock in a long history of shocks that markets eventually recover from, in this case a result of COVID-19, rather than systemic economic problems, now is a great time for wealth planning. Unique long term planning opportunities are presenting themselves which will yield substantial benefits as things turn around.

Here are some things to think about.

1. Stock Option Planning:  Exercising stock options granted for your work efforts result in income recognition. For non-qualified stock options (NQSO) it results in compensation and for incentive stock options (ISO) income results if you are subject to the alternative minimum tax.  Income is recognized in the year of exercise and is based on the difference between the fair market value of the stock to be received and the exercise price.  Subsequent increase in stock value is recognized as capital gain when you sell the stock.

If you like the prospects of your company longer term and feel its current depressed value is unwarranted, now may be an excellent time to exercise vested options.  It would reduce the compensation you recognize, converting the increase in value back to its norm and above to capital gains taxable at lower preferential rates when you elect to sell the shares (assuming the stock is held for > 1 year).  Lowering the tax bite to acquire the shares.

But before moving forward, there are some things to consider.  First, by exercising the options you will assume the market risk on the stock.  You will have exchanged an option to buy for actual ownership.  Second, you may have also increased your risk by acquiring a concentrated position in a single stock. Finally, it requires you to pay tax now.  The first two considerations may be able to be offset by using appropriate hedging techniques.  The latter, while painful may be much less so when you consider the reduction in taxable income noted above, as well as the fact that waiting to exercise may result in income recognition at a time when tax rates are higher. Remember tax rates increase in 2026 with the sunset of the Tax Cut and Jobs Act (TCJA) – perhaps sooner if we have a change in control of the White House and Congress.

2. Roth IRA Conversions: The recently passed SECURE ACT dramatically changed the landscape for planning for retirement plans (including IRAs).  While that is a subject that should be broadly visited by all those with plan balances, for those considering Roth IRA conversions the current economic downturn presents an opportunity.

Traditional IRAs allow balances to grow tax deferred, subjecting them to tax upon distribution at ordinary income rates, which must start to occur by April 1st following the year in which the owner turns 72 (i.e. “Required Minimum Distributions” or “RMD”).  The SECURE ACT now requires (with very limited exceptions) IRA assets to be distributed within 10 years of the death of the IRA owner.  Gone is the ability to stretch distributions and accompanying taxation over the life expectancy of those inheriting the assets.  The exceptions being the surviving spouse, minor children, chronically ill heirs, disabled heirs and persons 10 years or younger than the IRA owner. A Roth IRA not only grows free from tax, but its distributions are tax-free as well. Additionally, there are no RMD, so balances can be kept in a tax-free investing environment.

Individuals can convert all or a portion of a Traditional IRA to a Roth IRA. The conversion is considered a taxable distribution based upon the fair market value of the portion contributed.  Thereafter, the converted amount gets all beneficial treatment of a Roth IRA. With portfolio values depressed, now might be an opportune time to convert and make the account and all future growth tax free. Especially if you feel the future prospects for the portfolio are bright.

Once again there are things to consider. First, it requires you to pay tax now, albeit on an “undervalued” portfolio - optimally you want funds outside the IRA available to pay the taxes.  Second, if the tax rate in future withdrawal years is the same (or less) than the year of conversion, you will not have saved taxes and in fact would have paid them earlier than necessary. Third, is your time horizon – the longer the better.  Remember we want to keep it in a tax-free environment as long as possible to magnify the benefits of conversion. We also have to consider the change or potential change in tax rates mentioned above.

3. Gifting: The current estate and gift tax rates and lifetime exclusion (i.e. the “basic exclusion amount”) may be the most taxpayer favorable that we will see – at least in our lifetimes.  The top estate tax rate is 40% and exclusion amount per individual is $10M indexed for inflation.  For 2020, the amount stands at $11.58M per person, $23.16M per married couple (as one spouse’s unused exclusion at death is generally usable by the survivor).  The exclusion for generation-skipping transfers is the same but does not allow the transfer of any unused amount to the surviving spouse. Both exclusions can be used for lifetime transfers (gifts) and/or transfers at death (bequests).

The exclusions are scheduled to be reduced to their 2017 levels starting in 2026 with the sunset of the provisions of the TCJA.  The estate tax rate will remain the same, with an exclusion of $5M indexed for inflation (expected to be approximately $6M per individual). It is important to note that several Democratic presidential candidates would seek to reduce the exclusion amount much sooner and to a greater degree – as low as $3.5M in total with only $1M usable for lifetime gifts.  Also, tax rates of up to and in excess of 55% have been discussed.

Since gift and estate taxes are levied based on the fair market value of the item transferred, the market downturn and the looming reduction in the exclusions make now an opportune time to make gifts.  Doing so now allows future appreciation on the assets transferred to be moved without incurring gift or estate tax liability.  The transfers can be made outright or using one of several trust vehicles (some noted below) which would also enhance the creditor protection and stewardship over what is transferred.

But be mindful, you’ll be divorcing yourself from whatever you gift – the use of the asset and any associated cashflows.  So, it’s important to assess the cost-benefit of making the transfer and be comfortable with the impact prior to gifting.

4. Low interest rate planning: Provides fertile ground for planning – especially in the area of intra-family planning.  Intra-family financed investing presents a unique opportunity to wealth shift. As the current market dislocation plays out, investment opportunities with substantial upside will start presenting themselves.  Rather than investing yourself, think strategically and set up a non-regulated “Family Bank Trust” to do it instead.  Quite simply, it’s set up as a multi-generational IDIT for the benefit of your heirs.  Lend it money, locking it in at today’s low interest rate to finance trust investments.

As a point of reference, March mid-term loans (greater than 3, but less than 9 years) must be at a minimum rate of 1.52%, long-term loans (9+ years ) must have a minimum rate of 1.92%. April rates are even lower at .99% and 1.43% for mid-term and long-term loans, respectively. The note can be structured as an interest only, balloon payment note. Because the trust is structured as an IDIT, transactions between you and the trust will have no income tax significance, as you will be considered the same taxpayer.  So, you cannot have a taxable transaction with yourself (i.e. interest payments to you will be non-taxable).  However, the trust will have significance for estate tax purposes and its value will be excluded from your taxable estate.  If done correctly, the assets of the Family Bank Trust will avoid estate tax for many, many generations – 40% more available to benefit your heirs through the generations!

Rather than building your own estate only to confront the challenge of finding a way to transfer it to beneficiaries tax efficiently, the Family Bank Trust will be building wealth outside of your estate for the benefit of your heirs.  Helping finance future business ventures, purchases, and/or lifestyle on a tax incentive, creditor/predator protected basis.

The key point to consider is the trust’s ability to meet the debt service requirements of the note. So, while potentially nominal, cashflow must exist to pay the interest.  This may necessitate making a gift of assets to the trust to help finance the payments, along with any cashflow trust investments generate.

5. Grantor Retained Annuity Trust (GRAT) Transfers: Allow an individual to transfer ownership of an appreciating asset to a trust in exchange for a fixed payment stream (i.e. annuity) over a term of years (generally equal to the transfer date fair market value of the asset plus interest at a federally mandated rate) - essentially shifting post-transfer appreciation  (net of the interest charged) to trust beneficiaries gift and estate tax-free. The payments can be made in cash or in-kind using the property transferred to the trust.

The “Holy Grail” of GRAT assets are those expected to rise sharply (i.e. “explode”) in value – typically closely-held business interests or real estate. Publicly traded securities traditionally don’t have enough “pop” to generate the excess return to make transfer to a GRAT worthwhile.

The current financial turmoil has caused many assets (including publicly traded and concentrated stock positions) to be unfairly devalued, making those expected to rebound attractive candidates for transfer to a GRAT. It provides a low cost, low risk opportunity to transfer appreciation in the value of these assets to selected beneficiaries without parting with the value of the assets themselves.

More likely that not payments will be made in-kind.  This will require valuing the property to ensure it equals the value of the annuity.  If the assets are a basket of publicly traded securities or a concentrated stock position, valuations will be readily available.  Closely-held business interests or real estate will require appraisals – which must be paid for.  Routine for this strategy and not a deal breaker, but something to be considered.

6. Intentionally Defective Irrevocable Trust (IDIT) Sales: Are another wealth shifting technique allowing the tax-free sale of an asset expected to increase in value significantly to a trust. The seller freezes and retains the value of the asset in their estate (via a note) while shifting its appreciation to others gift and estate tax free. Typically, the sale is structured using an interest only, balloon payment note. The interest rate on the note is based the term of the note and the applicable federal rate (i.e. “AFR”) in effect for the month of sale.

Current low interest rates and unreasonably depressed asset values make now an excellent time to implement this technique. It requires little cash flow due to low interest rates and so long as the growth rate on the assets sold exceeds the interest rate on the note, the excess passes in trust gift, estate and generation-skipping transfer tax free. Additionally, the trust is structured so no income tax is due and payable on the interest paid or capital gain on the sale.

As noted with low interest rate planning, the key point to consider is the trust’s ability to meet the debt service requirements of the note.

These are some of the planning ideas you should consider – and there are others. So while it is truly unsettling right now, we must collect ourselves and look toward the future.  We‘re here at Intellectus to help you through these unsettling times and are happy to talk with you about these and other planning opportunities. Please don’t hesitate to reach out to any of us directly to discuss opportunities available to you.

We started with a quote so it’s fitting to end with one - from a man who lived through and provided leadership in challenging times.

“The pessimist sees the difficulty in every opportunity: the optimist sees the opportunity in every difficulty”

Winston Churchill, Prime Minster of the United Kingdom, Statesman


The attached information is presented for illustration purposes only, is not a representation of the recipient’s (or any person’s) actual or projected experience, and does not constitute professional advice or a recommendation to take, or refrain from taking, any action. The information is presented without obtaining specific professional advice from your attorney and/or CPA particularly with respect to tax planning. Intellectus Partners LLC and its affiliates, employees or agents disclaim liability for any consequences of your or others acting or refraining from acting in reliance on the attached information