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Tax Planning for The Near Future

Posted by : , , and on : June 3, 2020 | 8:00 am

In a prior FGMK Thought Leadership article published in March, FGMK professionals discussed planning opportunities during a down market. Due to impact of the COVID-19 pandemic, FGMK wants to remind readers of these opportunities. Additionally, taxpayers will want to consider the potential impact the 2020 presidential election may have on such tax planning strategies. This FGMK article highlights elements set forth by former Vice President Joe Biden in his tax plan and the effect his proposals could have on existing and future tax planning.


Democratic Presidential Candidate Joe Biden’s Tax Platform


At the outset, one should recognize that 2020 is a presidential election year. Therefore, a critical component of an analysis of the future tax landscape involves an analysis of the tax plan set forth by former Vice President and Democratic presidential candidate front-runner Joe Biden. His tax platform (the “Biden Plan”) focuses on generating more tax revenue from both high-income and high-net-worth taxpayers. Provided below is a brief summary of his tax platform.


Increase in Corporate Income Taxes.


The Biden Plan would:


    • Raise the corporate rate from 21 percent to 28 percent;
    • Assess a 15% minimum tax on large corporations (C corporations with more than $100 million in book income would pay the greater of normal corporate tax liability and 15 percent of book income); and
    • Repeal the temporary net operating loss (“NOL”) provisions contained in the CARES Act, including:
      • Eliminating the ability to carry back NOLs generated in 2018, 2019 and 2020 for up to five years; and
      • Eliminating the suspension of the 80 percent of taxable income limit for utilizing NOLs in 2018 through 2020.


Raise the Tax Rate on Foreign Profits.


Under current law, C corporations are taxed on the portion of active income earned by their foreign affiliates that exceeds 10 percent of tangible property, known as global intangible low-taxed income (“GILTI”). C corporations are allowed to deduct 50 percent of GILTI and claim a credit for 80 percent of foreign taxes paid on GILTI, creating an effective rate of at least 10.5 percent. Under Biden’s Plan, this deduction would be lowered to 25 percent, creating an effective rate of at least 21 percent (to better align it with the proposed domestic corporate rate of 28 percent).


Increase in Maximum Individual Tax Rate.


The Biden Plan would:


  • Raise the highest personal income rate from 37 percent back up to 39.6 percent; and
  • Cap itemized deductions for the wealthiest Americans at 28 percent.


Reduce Favorable Capital Gains Tax Benefits.


The Biden Plan would:


  • Eliminate favorable long-term tax rates for high-income taxpayers (The proposal would remove the 23.8 percent preferential rate for taxpayers with more than $1 million in taxable income, raising the top rate to 39.6 percent, inclusive of the Net Investment Income Tax); and
  • Eliminate stepped-up basis (Aside from the elimination of the IRS Section 1014 step-up in basis rule, all transfers of property would be treated as realization events, with the donor (by gift) or the decedent (by death) owing capital gains tax on these transfers on the individual income tax return before basis is stepped-up for the recipient); and
  • Eliminate perceived real estate loopholes (The proposal would eliminate the deferral of capital gains taxes when exchanging an asset for property of a “like kind” pursuant to IRC Section 1031; thereby treating such exchanges as taxable events).


Increase Income Subject to the Social Security Tax


The Biden Plan would:


  • Impose a 12.4 percent Old-Age, Survivors, and Disability Insurance (“OASDI” or Social Security) payroll tax on income earned above $400,000, evenly split between employers and employees; and
  • This would result in a “donut hole” in the current Social Security payroll tax, where wages between $137,700, the current wage cap, and $400,000 would not be taxed.


Low- and Middle-Income Tax Relief.


The Biden Plan would:


  • Expand the childcare credit to $8,000;
  • Forgive student loan debt and exclude the forgiven amount from taxation;
  • Expand the Work Opportunity Tax Credit to include military spouses; and
  • Enhance tax breaks for workers who are saving for retirement, i.e. create tax credits for small businesses that offer retirement plans for their workers.


Estate and Gift taxes.


Much of the focus of Biden’s Plan is on the elimination of the step-up in basis discussed above. However, with the need to defray the costs brought forth due to the COVID-19 pandemic, we may see the lapsing of tax benefits provided under the TCJA. Of particular concern is the lapsing of the current $11.48 million lifetime estate/gift tax exemption, which is scheduled to sunset at year-end in 2025, thereby returning to the pre-TCJA exemption cap level. It is anticipated that the lifetime exemption provided before TCJA would then be in force providing a reduced exemption of approximately $6 million effective January 1, 2026. However, Biden could also adopt an item from the tax platform proposed by Hillary Clinton in 2016, which would reduce the estate exemption to $3 million and the gift tax exclusion to $1 million.


Importantly, T.D. 9884 prevents the possible “clawback” of the exemption for those who have used it prior to the December 31, 2025 sunset date. For example, an $11 million gift made in 2020 which uses the current lifetime exemption will not create a tax liability later (such as a death in 2027) should the lifetime exemption be reduced. In essence, the taxpayer may have a “use it or lose it” issue to consider with respect to his or her gift tax planning.


Gift Planning


With the COVID-19 pandemic, there have been both reductions to the financial markets as well as corresponding dramatic decreases in prevailing interest rates. Due to these changes, there is a great opportunity to consider employing gift, retirement and income tax strategies. Having set forth many of the elements of Biden’s Plan, the following summarizes the tax planning opportunities currently available and identifies the potential impact of the Biden Plan, where applicable.


Outright gifts.


A successful gifting program depends heavily on the future performance of the gifted assets. With the current reduction in the stock market, gifts of marketable securities may be considered, particularly if there is an expectation of future appreciation.


      • Choosing the right assets. The tax basis received by the donee is the lower of the donor’s basis or the fair market value (“FMV”) of the asset upon date of gift. It is important to choose assets with an FMV higher than the donor’s cost basis to preserve the donor’s tax basis, particularly if there is an anticipated sale of the donated asset.
      • Gifts to children. As stated above, transfers made now may reap tremendous rewards upon a market rebound. The following strategies may be considered when making gifts to minor children.
        • Uniform Transfer to Minors Act (“UTMA”) Gifts. These gifts allow the transfer of property to a minor, subject to the management of a custodian. In Illinois, it provides the power to manage a particular piece of property on behalf of the minor until the minor reaches age 21. The transfer is an irrevocable gift, and the minor receives legal title to the custodial property. This may be problematic if age 21 is considered too young for receipt of this property.
        • Transfer made to Section 529 plans. Clients may wish to consider making substantial contributions to these plans to capture a market rebound. Each spouse can contribute up to $75,000 to each child absent of gift tax (known as a back-loaded 529 plan). This results in substantial value being provided to meet an important parental need.
        • Gifts in trusts. Minor’s trusts (also known as Section 2503(c) trusts) provide grantors better control over access to trust assets. These trusts can be designed to meet needs beyond education and are commonly used to ensure the grantor’s “legacy” on behalf of the trust beneficiaries is managed according to the grantor’s wishes. These are particularly excellent vehicles for gifts made to grandchildren.
      • IMPORTANT: Realized capital gains under the Biden Plan. The Biden Plan could result in a capital gain recognition upon the transfer of the asset via gift. Gifts would be treated much like sales. This is similar to the Canadian tax regime currently in force. Therefore, taxpayers should strongly consider implementing gifting programs sooner rather than later, particularly if the goal is to gift lower basis capital assets.


Split Interest Trusts.


These trusts provide a fixed annuity either to the grantor (grantor retained annuity trusts or “GRATs”) or to a charity (charitable lead annuity trust or “CLATs”). With the low interest rate environment, there is an opportunity to take advantage of investment arbitrage, particularly if there is confidence that a market rebound will take place. The low Section 7520 rate (the June Section 7520 rate is at a historical low of 0.6 percent) creates a low threshold needed to provide value to the family upon the conclusion of the GRAT or CLAT term. Simply stated, if the split-interest trust can beat a 0.6 percent after-tax investment return, then this excess can pass to designated beneficiaries free of gift tax.


      • Zero-out GRATS. The value of a gift to this trust is the amount transferred less the present value of the annuity retained by the grantor. Zero-out GRATs have the present value of the grantor annuity equal the amount transferred to the GRAT. This results in the grantor being treated as having made no taxable gift to the ultimate beneficiaries of the GRAT; thus, having the full investment arbitrage (i.e., the trust investment performance above the 0.6 percent discount rate) passing to the beneficiaries completely free of gift tax.
      • “Dead GRATs”. GRATs whose investment return has underperformed the prevailing Section 7520 rate (resulting in no remainder interest passing to beneficiaries), may be candidates for a new GRAT rollover. This would allow the use of the current (and more favorable) 0.6 percent Section 7520 rate. This is particularly important for GRATs currently funded with assets that have a high appreciation potential. To accomplish this, the following steps would be taken.
        • Create a new GRAT with the 0.6 percent interest rate;
        • Substitute the “Dead GRAT” asset with cash;
        • Fund the new GRAT with the investment asset from the old GRAT; and
        • Ensure the new GRAT has a “substitution provision” that will maximize the investment return of the new GRAT (pursuant to the “dead cat” discussion provided below).
      • CLATs and an income tax charitable deduction. Properly drafted CLATs will provide donors the opportunity to claim the full charitable deduction upon the funding of the CLAT. This, in turn, creates an opportunity to accelerate this charitable deduction for amounts earmarked to the designated charity in future years.
      • IMPORTANT: An administrative “substitution defect” would be a recommended provision in either GRATs or CLATs.
        • This defect would empower the grantor/donor to bank favorable market performance and enhance the investment arbitrage by permitting the exchange of appreciated stock held in trust for cash if there is a “dead cat bounce” in the market (i.e., a short-term market rally).
        • Furthermore, trust investment performance is taxed to the grantor which further leverages the gifts made to GRATs.
        • As stated above, the grantor defect provides an acceleration of a charitable deduction; however, the CLAT income would be taxed to the grantor each year. The donor would consult with the tax advisors to mitigate any tax repercussion of a CLAT.


Loans to Family


In lieu of gifts, the low interest rate environment provides an opportunity to make loans to family at a minimal interest rate cost. Forgiveness of loans constitutes a “cash gift” which is easy to report on the requisite gift tax form.


Sales to Grantor Defective Trusts.


This strategy provides an opportunity to transfer the “future value” from the sold assets to the trust beneficiaries.


      • The creation of an intentionally defective grantor trust (“IDGT”) prevents any capital gain recognition related to this transaction upon the sale of the asset to the trust.
        • This strategy begins with an initial “seed” gift to the IDGT (generally 10 percent of the property to be sold to the trust), which provides the needed “trust collateral” to establish this as a bona fide sale to the trust.
        • It is followed by a subsequent sale of the property to the trust in exchange for a promissory note from the trust with interest payable at the Applicable Federal Rate (“AFR”) for the term of the promissory note.
          • With the current low interest rate environment, it mitigates the underlying economic cost to the trust beneficiaries. Specifically, the June 2020 long-term AFR is at 1.01 percent. This provides a great opportunity to pass significant value to trust beneficiaries with a very low loan cost.
          • Since the trust is a grantor trust, there is no income tax recognition related to the payment of this interest.
          • The note itself can be structured as a balloon note or a self-canceling installment note (“SCIN”) that may further leverage the value of the transaction in favor of the trust beneficiaries. Again, under the current low interest rate environment, it dramatically mitigates the loan payments the trust would be required to pay.
          • For those who have implemented this strategy, consideration should be given to refinancing the existing note to enjoy the lower AFR rates. It is important to note that the refinance of the note must have economic substance, that is, aside from the lowering rate, provisions should be added to provide some benefit to the lender. Examples of this are inclusions or increases in late payment or default penalties to best demonstrate a bone fide agreement meriting benefits on both sides of the loan.
      • IMPORTANT. The Biden Plan would eliminate the capital gains saving otherwise offered by this strategy. The transfer of the assets to the IDGT would create a capital gain recognition under his plan, making this another timing-sensitive planning opportunity.


Generation Skipping Trusts (“GST”).


This gift tax strategy provides great value for transfers made to multiple generation trust vehicles.


  • Grandchildren trusts. As stated above, a well-drafted minor’s trust (i.e., a Section 2503(c) trust) can be structured to qualify for both the $15,000 annual gift tax exclusion and the $15,000 GST annual exclusion providing great benefits at no gift tax cost. A trust vehicle will ensure that the personal “legacy” held by the grantor is enforced through the trust instrument.
  • Dynasty trusts. These trusts provide strong trust beneficiary rights without having the trust estate taxable to any of the trust beneficiaries. These trusts are designed to stay in force for each generation until the trust estate is exhausted. Again, this creates a great planning opportunity for gifts which are expected to appreciate in the future.


Income Tax Planning


Harvesting Tax Losses.


The market downturn may provide an opportunity to harvest “market losers” in order to restructure the portfolio. The following are important strategies to consider.


  • Wash sales. Wash sales prevent the recognition of a capital loss if substantially identical securities are purchased within 30 days before or after the sale of the loss position. Avoid the wash sale rules by purchasing different securities that have the same investment return profile as your current holdings.
  • Losses held in non-grantor trusts. Losses held in non-grantor trusts can only be offset by gains held by that trust. Some taxpayers may consider liquidating trusts incurring substantial losses to free up these losses for the benefit of trust beneficiaries.
  • Gains held in non-grantor trusts. Most states adopt the Principal and Income Act which, as a default rule, prevents the distribution of trust capital gains to trust beneficiaries. However, many trusts have a provision that overrides this act and allows trustees to distribute trust capital gains. Now is the time to review your trust documents to ensure that this provision is in the trust. If not, then the use of either a trust protector, where applicable, or trust decanting can create this needed trustee power.


Employee Benefits Planning


Roth Conversions


The dramatic contraction of the market may create an opportunity to make a Roth conversion to mitigate income tax liability in anticipation of a market “pop”. This would be better suited for taxpayers not close to retirement who are situated to enjoy the favorable tax benefits of a Roth account. Even a modest increase in ordinary income tax rates in the future may provide some motivation to implement this strategy. As an example, Roth IRAs provide the following benefits:


  • Any growth in the Roth account is tax-free;
  • Distributions upon retirement are received tax-free;
  • Unlike traditional IRAs, there is no required minimum withdrawal for either the plan participant or the spouse for their joint lifetimes, meaning that the account can grow untouched until the death of the surviving spouse; and
  • Upon death, the Roth IRA beneficiaries can continue holding the Roth IRA for a period of ten years before withdrawal from the Roth is required. Again, the Roth distribution is completely tax free for these beneficiaries as well.


Health Savings Account (“HSA”).


HSAs may serve as a good investment vehicle in a down market. HSAs can provide a vehicle for savings for medical emergencies and provide long term coverage as well.


      • Depending upon the status of the existing HSA, individuals may be able to contribute up to $3,550 for individuals and up to $7,100 for families in 2020.
        • Those over age 55 can contribute an additional $1,000 per year.
      • Many advisors consider HSAs as better savings vehicles for retirement than IRAs, because of the number of tax benefits offered by these accounts.
        • Pre-tax contributions can be made to these plans;
        • HSAs can grow tax free; and
        • If the account is used for medical expenses while employed, then those distributions are tax-free. This tax-free benefit can be extended for spousal use as well.
      • In response to the COVID-19 pandemic, in Notice 2020-15, the IRS said that health plans that are deemed high-deductible health plans can pay for coronavirus-related testing and treatment without jeopardizing the favorable tax benefits associated with the plan.


Personal Financial and Asset Protection Planning


Finally, one should always consider personal financial and asset protection planning strategies.


      • Mortgage refinance. The low interest rate environment means current nonrecourse debt should be evaluated to assess whether refinancing makes sense. Rates have already seen a material drop to under three percent. However, we may see a continual drop of these rates in the near-term future.
      • Asset protection. With the downturn of the market, there is certainly a great deal of anxiety leading to a desire to protect assets. There are a number of strategies that can be pursued for asset protection purposes.
        • Revisit asset ownership. This is of particular importance to those states that permit ownership of marital assets as “tenants by the entirety”. Illinois permits this for personal residences. It presumes an indivisible interest held by each spouse. As such, should one spouse be subject to creditor claims, this asset is protected because of the spousal rights.


          An important planning point is this strategy is not limited to individual owners; that is, residences held in revocable trusts can use this ownership strategy as well. Of course, qualified legal counsel is strongly recommended to ensure proper implementation of this strategy.
        • Domestic asset protection trusts. Since the late 1990s, several states have enacted statutes allowing for the creation of Domestic Asset Protection Trusts, or "DAPTs." A DAPT is an irrevocable trust under which (a) the person creating the trust can be a beneficiary; and (b) under certain conditions, the assets of the trust cannot be reached by that person's creditors. Illinois does not have DAPT statutes. Therefore, if there is a need to do this, then states well suited to provide this asset protection (such as South Dakota and Nevada) would be warranted.


We hope that this guidance provides value to you, particularly during this time of uncertainty. FGMK is here to assist you as you navigate the new market conditions. Even in times of downturn, opportunities for successful tax planning present themselves. If we can be of further service, we are always happy to answer any questions you may have.


Charles F. Schultz III



Jeffrey T. Conrad



Kamal K Battu




The summary information in this document is being provided for education purposes only. Recipients may not rely  on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.


About FGMK


FGMK is a leading professional services firm providing assurance, tax and advisory services to privately held businesses, global public companies, entrepreneurs, high-net-worth individuals and not-for-profit organizations. FGMK is among the largest accounting firms in Chicago and one of the top ranked accounting firms in the United States. For over 50 years, FGMK has recommended strategies that give our clients a competitive edge. Our value proposition is to offer clients a hands-on operating model, with our most senior professionals actively involved in client service delivery.