“Tax the rich, feed the poor, ‘till there are no rich, no more.” Ten Years After’s is one of my all-time favorite tax quotes, recently remembered in Barron’s. Another is Franklin’s “nothing (is) certain, except death and taxes,” though preferring to consider myself an especially astute tax practitioner, I grow more convinced, as I age, of the former than the latter. The Beatles’ “there’s one for you nineteen for me/should 5 per cent appear too small/be thankful I don’t take it all” – lamenting the United Kingdom’s once (and future?) top 95% marginal rate – is up there. But probably my favorite is Tony Soprano’s consigliere’s woeful counsel, about real estate taxes, that “you gotta pay those,” implying far more elasticity in the income tax burden, for those in the know, than the property tax one. At the risk of getting whacked I would respectfully disagree with Tony’s Signor Dante, though we will leave the surprising negotiability of ad valorem taxes in most municipalities to another time, given income tax season is now neigh on full bloom, and we hope to stem your sneezing. This year’s tax tacticians confront some of the most transformational changes in generations, hiding the unprepareds’ cheese so deeply and darkly as to risk considerable nibbling ere it’s found.
The tax rush marches on, with only weeks left until the April 17th filing deadline. As mentioned above and in a recent companion piece, taxpayers are facing some of the biggest changes in many, many years, and those ill-prepared to reformulate strategy may wind up paying far more than the tax reform/tax cut headlines would imply. Last time we looked at changes in personal exemptions (they are gone!), the standard deduction (much higher!), business expenses for employees (also completely gone!), capital gains taxes (not much change), and some other items.
Here we dwell a bit more on estate and gift taxes, look at changes in the so-called kiddie tax, review an important change on IRA ROTH conversions, and look at the many huge changes affecting business owners.
- The estate tax bar is now far higher than before, meaning only the wealthiest need fear leaping it into the pit of confiscation. Couples’ previous exemption – the estate value under which no tax is imposed – has doubled from $11,180,000 to $22,360,000; the respective figures for non-marrieds are half these. But beware those who might believe they can finally die in taxman peace, as the old limit comes back with a vengeance in 2026, perhaps faster under a more progressive future Federal government. Forget not that one-year 2010 “repeal” of the estate tax, benefitting only the lucky few who artfully died on time. And remember estates under the limits may grow beyond them as the years unwind until one’s heavenly reward is finally attained. Wealthy folks are well-advised to study the many tools yet available to freeze estates and control or completely avoid taxes. Pray, however, to find competent (wink, wink) advice, as this remains one of the many tax areas where the well-healed pony up big for expensive “advanced” planning which often falls flat and makes wealth splat. Legion are the inappropriate – if not incompetent – white shoe estate plans commissioned by trusting rich folks. Soprano’s alter ego James Gandalfini’s $30 million avoidable tax “disaster” is a well-publicized example, but I tell you verily, as an informed and quite active practitioner, that such errors are encountered regularly, and seem rather the rule than the exception. Sadly, even very smart investors – and advisors! – don’t have the training or gumption to tell the difference, and far too many estates are autopiloted to the mountainside because of this. By the way, estate, generation skip, and gift taxes are but several faces of the fiendishly complex Federal Transfer Tax, a convoluted and ever-changing system requiring great care to navigate effectively.
- The “kiddie” tax – that charming corner of the Internal Revenue Code where children are transformed from citizens into parental appendages in order to squeeze more tax from the families – has been rendered even more grotesque, er, progressive, now imposing trust tax treatment on assets owned by children. Trust tax brackets are much more compressed, meaning many kids will get to pay top tax rates much faster than their parents. Oh, well, spend it if you got it!
- An IRA/ROTH conversion loophole has been closed, making ROTH conversion timing more critical. For stock investors with IRAs, lower stock prices mean more shares converted for a given tax cost, making bear markets and corrections prime conversion time. Before, one had multiple bites at the apple, in that conversions could be undone up until October 15th of the following tax year, if better tax profiles presented, offering an endless stream of do-overs. No more. Now we are one-and-done. Such “recharacterizations” have been eliminated, raising the tax strategy stakes for paying the tax on traditional IRA money in order to shift to the tax-free ROTH environment.
- Business Taxes have changed dramatically.
- The “regular corporation” C-corp enjoys a huge and permanent drop of 34%, from a top rate of 35% to a flat 21%. There is no longer any corporate AMT, making that particular sword-dance of trade-offing and optimizing two entirely different tax systems – each bent on extracting the maximum plunder – happily now moot.
- Depreciation limits have been expanded, the Section 179 write-off limit has been goosed to $1M, and the overall spending cap grows to $2.5M for equipment.
- Scads of erstwhile breaks shrink or disappear, too numerous to enumerate here. Take particular note, however, that net operating loss (NOL) carrybacks are now prohibited, and that NOLs can now offset only 80% of current or future earnings, forcing some tax to be paid even where a company remains in a net loss position as a going concern.
- For business owners, the doorbuster prize – the Cuban, the Cohiba, the Monte Cristo, to channel Iron Man’s Justin Hammer – is the new “qualified business income” (QBI) bonanza. This huge new break applies to partnerships, S-corps, and Schedule C sole proprietorships (as well as their LLC brethren), plus shareholders in RIETs and owners of publicly traded partnerships like MLPs. The prize is huge – a “deduction” of 20% of (generally) operating profits. In other words, only 80% (generally) of profits are now subject to tax, with the other 20% essentially tax free, on top of the reduced tax bracket rates. Before skipping gleefully to the Ferrari dealership, note that this wonder is enabled by an especially devilishly complex Internal Revenue Code section (199A), and all manner of pitfalls await the unprepared taxpayer and her uninformed preparer. If not adroitly sidestepped, these “anti-gaming” provisions stand to heap up piles of otherwise avoidable tax, dramatically blunting the potential benefits of this “Make America Great Again” initiative.
Given the complexity and scope of the current “tax reform” it is likely that many preparers are not as up to speed as you might wish on the challenges and opportunities presented by the new rules, particularly in the estate tax and QBI areas. If you have not yet, consider a candid conversation with your tax advisor about how the changes affect your tax profile, and what tactics are being used to optimize it. If your confidence is less than robust after such a dialog, strongly consider filing an extension (if not already part of your standing strategy as for many of us) and getting a second opinion or two. Heck, do this even if your preparer has you utterly convinced that all is well…. just on the slim (and strong) chance it ain’t. I call tax the “master wealth skill” – the cutting edge of wealth leadership – because the min/max net worth outcome spreads are so profound. With even more sticky dough on the table this tax reform year, be sure not to leave any stuck there.