During this discussion led by Ted Zamerski, CFA, CPA/PFS, Tom Gibson, CPA, and David Babinski, a Business Consultant and member of your Family Office Team, examine:
• The Biden tax proposal and the best vs. worst case scenarios;
• Additional national policies that may have a negative effect on your finances;
• Opportunities for growth; and
• Strategies to help you plan and position yourself for the next two years and beyond.

Transcript (edited for clarity)

Ted Zamerski: Good morning, I’m Ted Zamerski, Director of Family Office Services at TSP Family Office. Welcome to today’s discussion: Achieve Financial Success in Light of the Political Change. We’re joined by a couple of familiar faces. We have Tom Gibson, Senior Tax and Financial Strategist at TSP. Thanks for being here, Tom.

Tom Gibson: Good morning Ted.

Zamerski: And also joining us is David Babinski, business consultant and a member of your family office team. As always, a pleasure to have you join us, David.

David Babinski: Good morning, Ted. Good morning, everyone.

Zamerski: Today, we will be discussing a few topics, such as the new negotiation, recapping the Biden proposal, taking a look at some situational scenarios and issues, as well as planning and acting.

Statistically speaking, the odds of the Georgia Senate runoff races both going to the Democrats earlier this month were certainly less than 50/50, but that’s what actually happened. And as each of you know, any senate votes that stay strictly on party lines resulting in a tie would be decided by the vice president, essentially meaning that the Democrats have the voting edge now. However, as we discussed many times, this does not mean it’s time for anyone to panic as we are not likely to see any sweeping tax changes next week.

President Biden has a number of priorities to address in his first 100 days in office. He’s working on a multi-trillion-dollar relief package, securing cabinet appointments, and trying to address the coronavirus vaccine rollout, pledging to have a plan to administer 100 million vaccines within his first 100 days in office. It’s possible that we won’t see anything on his campaign tax proposal until late spring. While there will be discussions and ideas floated, we all know the perils of acting on tax proposals in the debate stage as the final bill voted into law always has changes, frequently radical changes, in its final form versus the proposals reported in the media.

With that in mind, let’s first turn to Tom as he and David discuss the new debate in Congress, which is no longer Republican versus Democrat, and what that could mean for you going forward. Tom?

Gibson: We’re in a situation that we talked about a little bit in October. We have one party that has control of both houses of Congress as well as the White House. And, as Ted mentioned, the Senate is split 50/50, which means if there is a tie, Vice President Harris will be the one casting the deciding vote. I don’t think it’s a big mystery how she’s going to vote if it comes to that. So, the negotiation for this upcoming tax legislation is not really going to be between the Republicans and Democrats. It’s going to be between two wings of the Democratic Party and the Republicans are going to be along for the ride this time.

At this point, normally, I would say contact your congressman or contact your senator and give them your thoughts. I’m not going to discourage you from doing that. But, if you live in a red state or a red district, that’s not going to have quite the punch that it would have typically had. Now, if you live in a red state like Maine or Utah, then by all means call your senator because they tend to be the ones who wobble on the shaft anyway. If you can push them in the right direction, that might be a good thing.

There has been a little bit more clarity about the tax proposals and there have, in fact, been some new proposals since we spoke in October. Let’s go back and look at the broad strokes of the Biden plan, and we will get you caught up on where we are at this point.

Currently for 2021, the FICA limit for W-2 employees and for the FICA component of self-employment tax is currently capped at $142,800. One of the things that Biden’s plan brings into play – the  FICA cap is still going to be at 142,800, but once your W-2 wages, if you receive a W-2, or your wages from self-employment income, if you’re in a partnership that has active income, or if you have a sole proprietorship, once you hit $400,000, you’re going to begin to pay the FICA tax again. There’s what’s called the doughnut hole between 142,800 and once you hit 400,000, you start paying the FICA tax again.

Putting some numbers to that, let’s say you are a $500,000 W-2. You’re going to hit the FICA cap at $142,000 and, at that point, you would have paid $8,854 of FICA tax. And then you’ll rock along until you hit $400,000 and on that last $100,000 – the $500,000, less $400,000 – you’re going to pay an additional $6,200 of FICA tax. Your FICA tax goes from $8,854 up to $15,054 which is 170% more than you would have been paying under the current law.

We’re going to talk about the timing of all this, but if your reasonable compensation can be $400,000 or less, if that’s possible, that would be the optimal place to have it. But there are facts and circumstances that come into play and some of you may not be able to do that, but that would be the optimal situation in regard to the FICA taxes.

The top individual tax rate is currently 37%. That would revert back to, at this point best-case scenario, 39.6%. Representative Ocasio-Cortez and Representative Schakowsky from Illinois are drafting legislation that has a 59% top tax rate.

The top bracket is going to kick off for incomes above $400,000. Currently, the top bracket begins at $628,300. So, it’s going to start sooner, and it’s going to be at a higher percentage. To put this in perspective, in California, for example, if you happen to be in the top federal and state brackets, your tax rate between the federal and state is going to be 52.9%. Now, that’s the best-case scenario. If the Schakowsky-Cortez proposal comes into play, your top rate in California would be 72.3% and that’s not including the 3.8% Obamacare tax on investment income, capital gains, things like that.

Speaking of capital gains, if your income is in excess of $1 million – note, it says income, it doesn’t say taxable income so we’re assuming this is the total income number – long-term capital gains and qualified dividends will be taxed exactly the same way as ordinary income. And again, we’re saying that it’s 39.6% or it’s 59 or it’s somewhere in between. But the preferential treatment that long-term gains, in particular, having enjoyed for decades in the code, is going to go by the wayside.

This next one is really a sea-level change and I’m going to deal with two points together. The Pease Limitation has been in and out of the code since the Clinton administration. It was in under Clinton, came out under Bush, back in under Obama, went away under Trump, and it’s going to come back. The Pease Limitation is a reduction in the value of your itemized deductions when your income exceeds certain threshold levels. If the proposal ends up being similar to what it was during the Obama administration, once your income starts to go north of $400,000, your itemized deductions would be reduced by 3% of every dollar that your income exceeds $400,000. We’ve seen this before. It’s nothing particularly new and there are ways to work around it.

Now, the capping of the tax benefit of itemized deductions at the 28% bracket, that’s something that is new. Essentially what this means is – and you have seen me do this when we’re working on projections at the end of the year; often, I’ll explain to you that we’re backing down through the brackets, going from 37% to 35% to 32% down to 24% and I’ll show you that as we’re doing the projection – that won’t be true any longer. In those higher brackets, everything above the 28% bracket, there’s always going to be some residual tax left that cannot be wiped out with itemized deductions. So, I’m in the top bracket, the 39.6% bracket. I make a $10,000 contribution to my favorite charity. That’s going to shave $2,800 off my tax bill whereas under the current law it would have shaved $3,960 off my tax bill. There’s always going to be some residual tax.

Now, in a great example of smoke and mirrors, they have eliminated the $10,000 cap on state and local taxes. Folks who live in high-tax states have a tendency to get a little bit excited over this. If you couple that with the two points we just discussed, I would curb your enthusiasm because it may well be that, when everything’s said and done, you will be below the $10,000 cap depending on your circumstances.

The qualified business income deduction for the moment remains in the code. However, there’s a bifurcation depending on what type of business you’re in. For those of you who are in what are called specified trades and businesses – that would include physicians, dentists, attorneys, financial planners, CPAs – we’ve got to get your income in fairly tight limits for you to be able to take advantage of the QBI deduction, to get any of it or, in some cases, to get all of it. Otherwise, you’d be phased out. For others who are not in specified trades or businesses – maybe you own a manufacturing company – you can basically make $1.2 million and still be able to take the QBI deduction. Well, that’s going to fall by the wayside. The QBI deduction under the proposals at this point would be completely phased out for income above $400,000.

Now, I just said something I should have said at the outset, and I apologize for not doing so. At this point, these are proposals. These have been gleaned from position papers, from things that were said during the campaign. We don’t have a bill at this point. We don’t have anything that we can analyze at this point. And, as Ted said, when they actually get down to making the sausage, what we have is in all likelihood going to be different than what we’re seeing here.

Finally, there is an expansion of the earned income tax credit for childless workers who are 65 and above. We’re also looking at a fixture of Democratic tax policies, renewable-energy related tax credits. On the corporate side, the biggest change is we currently have a 21% flat corporate rate. The proposals that we have seen would raise that to 28%.

Now, there’s a sea-level change when it comes to estate tax planning as well. David, would you mind speaking a little bit about what the step up in basis is and what this means?

Babinski: Sure, Tom. Again, I do want to echo what you said. These are all just proposals, and they all have different relative scores on whether or not they’re going to be put forward as law. I think if we were just going to try and handicap it right now, the increase from 37% to 39.6%, that’s set to happen. The Tax Cut and Jobs Act was set to sunset in five years, 2026. For that to happen a little earlier is no surprise. The estate tax exemption from $11.48 dropping back to $5 million, plus inflation so let’s call it $6 million, that happening sooner than 2026 is probably a safe bet.

The one Tom just stopped on, the step up in basis, this is a little trickier. There was some representation made on the campaign trail that if your income is less than $400,000, your taxes will not go up. Let’s dive in and peel back this step up in basis at death. A popular estate planning tool is to hold assets in one’s name until it hits your estate and then your basis, or your taxable calculation, would be adjusted to the fair-market value on the date of death.

In a practical example, if you were to leave a piece of real estate to your heirs and you had depreciated that your whole life or rolled it over and rolled it over and carried forward almost no basis, you’d get this step up. Let’s call it a $1 million piece of property. Your heirs hold it for a year or two and then sell it for a $1.1 million. Only the $100,000 of gain from the date of death to the sale would be taxable because it was stepped up at death. That’s why a lot of people hold assets in their name. Stock portfolios, same thing. If you’ve got some very, very appreciated stock, you hold it, you wash it through your estate, it gets a step up, and then your beneficiaries enjoy that new cost basis.

This would eliminate that step up. There’s a lot of planning opportunities that would arise from that, but the maybe unintended consequences could be that this is every estate. So, someone of modest means who potentially owns their home – they’ve owned it for 30-plus years, the mortgage is paid off, they paid practically nothing for it – wants to leave it to the next generation. You have an $80,000 house that was bought for $20,000. They would have taxes on the $20,000 to $80,000 if they were to turn around and sell it because they don’t get that step up in basis. I think this is one of those that we would handicap and hope that it doesn’t come to fruition because it literally changes 100 years of estate planning.

The other point that’s going to come up – and I’ll throw this back to Tom – is that death now the taxable event where now the taxes are due, or do you just inherit the basis and carry it forward until you decide to act? That’s what’s unclear to me. And I think that has an even more profound impact than anything that we’ve talked about so far.

Gibson: On the President’s campaign website, he says that his capital gains proposals would close the loopholes that allow the super wealthy to avoid taxes on capital gains altogether. And Biden has confirmed during campaign events that this means treating death as a realization event.

Now there is another curve that’s thrown into all of this: A proposal by Senator Wyden from Oregon which basically is to tax unrealized capital gains while you’re alive. We’re not talking about your 401(k) or your defined benefit plan or your IRA. We’re talking about your portfolio. This gets into the complexities of this, but we’ll keep it simple and talk about your Merrill Lynch account for the moment. They’re talking about valuing that account at the end of the year, every year, and you would pay tax on the unrealized gains for that year from your investment portfolio. So, you’ve not made the money, you’ve not received the cash, but you’re going to get to pay the tax. The wild card that I’ve not been able to find anything on at this point is if in 2021 you have a gain on your unrealized gain and you pay tax on that and the next year the market goes down and you’ve got a loss, are they going to allow you to take credit for the entire loss or is it still going to be subject to the $3,000 limitation on long-term capital losses that we currently have? I’m afraid it’s going to be the latter of the two.

The other question that comes into play is, if you’re doing this every year and you die, is there going to be tax a second time at the estate level? Again, this is the problem of having proposals versus legislation, although the legislation, as we saw with the PPP funding, could be unclear as to what Congress intended.

Another feature is the childcare credit would increase from $3,000 to $8,000 per child, and it would be capped at $16,000. I was telling Ted earlier, the only people whose income goes up under this proposal are people in the bottom 20% of income earners and it’s due to these new transfer payments. That’s why their income is going up.

They’re also talking about equalizing tax benefits from defined contribution retirement plans. David, this is a little bit more in your wheelhouse, so why don’t you walk us through what that means?

Babinski: Whenever the word equalizes or equalization comes up and you hear the concept of fair mentioned a lot, it’s not fair that if you’re in the highest tax bracket and you put a dollar into your 401(k) that you get to save 37 cents and somebody who’s in a lower tax bracket puts a dollar in and they only get to save 15 cents. The way I read this proposal – and this is another one that I would handicap in the “hopefully, unlikely to pass” – is anyone who puts a dollar into their defined contribution plan, it would not be deductible, but it would enjoy a 26% matching payment or contribution. From where? I have no idea. Is the government going to start making contributions into our retirement plans? Unknown.

But think about it. Whether you’re in the 15%, the 39.6%, or the 59%, you put a dollar in and then 26 cents is added to that account from somewhere. That’s going to grow tax-deferred, you’ll be able to take it out in the future, and it’ll be a taxable event at that time. That’s where they get to this equalization. Everyone who puts in $1,000 is going to have a $12,600 account balance that they can start from and then invest.

Now, intended or unintended consequences, and we’ll get to some best practices later, anyone who is in higher than the 26% tax bracket is going to have a disincentive to participate in these types of plans. And I think, personally, the Roth IRA is going to come screaming back, whether it’s a backdoor Roth, super Roth, or synthetic Roth. But all of a sudden, it’s going to be, “If I don’t get a deduction and I’m just going to get a half benefit, if you will, from some matching contribution I’m going to pay tax on later anyway, why don’t I just put my money into a tax-advantaged situation, have it grow tax-deferred, and, if I follow the rules, it’ll be completely tax-free?”

I think that’s going to be one of the consequences if something like this comes to fruition. Whether it’s for two years, four years, or forever, the contributions into defined contribution plans are going to diminish rapidly in my estimation. But that’s what they mean by equalizing the tax benefits. Everyone’s on the same playing field. We all get the same benefit. And the unintended consequence is the retirement plan industry is going to shrink remarkably.

Gibson: This next one has a couple of unpleasant consequences associated with it. It eliminates real estate industry tax loopholes. What does that mean? Well, the first thing that it very definitely means, and this is explicit, is the elimination of 1031 Exchanges. For those of you who don’t own real estate and who have not utilized this, with a 1031 Exchange, you own a building or rental property, you sell it, and you have a certain amount of time to roll the gain from that sale into a new property. If you do that, no taxes are due. It increases the gain that you’ll have on the subsequent sale, and essentially, you’re kicking the can down the road in hopes of the step up in basis when you die. That’s the game plan here. Well, unfortunately, under the Biden proposals, if it’s passed, 1031 Exchanges are going to go by the wayside. I haven’t been able to figure out at this point if they’re going to try to go back and compute tax on the roll forwards up to this point or if they’re just going to wait until the next sale and then collect the tax at that point. That’s one part and it’s a huge change in real estate investing.

Then there’s a second component. They talk about losses from real estate. Many of you own rental properties and you are familiar with what are called the passive activity loss rules – you have a piece of property, and you are generating a loss, typically it’s due to depreciation, but you have a loss on paper and, because of your level of income, you may not be able to deduct the entire loss. In fact, you may not be able to deduct any of it. But those losses don’t go away, they just roll forward.

Although the plan does not specifically mention like kind exchanges under Section 1031, according to Bloomberg, a Biden campaign official has said that the Biden administration would take aim at the so-called like kind exchanges which allow investors to defer paying taxes on the sale of real estate if capital gains are reinvested in another property. The official also said they would prevent investors from using real estate losses to lower their income tax bills, period. And so, again, this is a big change. It’ll have a big impact on the real estate market.

David, you said something about why you think real estate is such a hot-button issue. Can you revisit that?

Babinski: It was just an observation, but anything to do with real estate tax benefits and strategies is associated with the prior administration, right? There are all these, “At the 11th hour, they threw in these tax breaks for their real estate cronies.” That type of verbiage. So, when you think about it, it’s all guilty by association. Again, these strategies or incentives – let’s call them what they are, incentives –that have been in place for decades are now being attacked because they’re real estate and real estate is associated with the prior administration. And aything the prior administration did, obviously, is bad in the eyes of some of these policy authors.

They’re drilling down pretty deep into some of these esoteric passive activity rules, which are the basis of rental real estate. If it’s a positive cash flow but a tax benefit, I’m in. We have people who are building portfolios off these for that very reason and it changes the economics. They talk about affordable housing and trying to give credits and all this. Well, if your landlords go away, the housing goes away, period. Again, unintended consequences. I think some of this hopefully was headline generating, “This is what we’re going to do.” And when it actually comes down to turning it into a law, it seems one layer deep. It’s going to be so much harder to execute than to just say, “We’re going to close real estate industry tax loopholes.” It sounds good, but how do you do it?

Gibson: And Ted, you asked a great question yesterday about carried interest.

Zamerski: There was a question to whether or not there was any discussion about the carried interest and whether or not that was going to become taxable or if we lose those benefits going forward on the real estate side.

Babinski: Favorable treatment of carried interest applies to real estate as well as a hedge fund manager, that’s where I hear that term a lot. I found on Investopedia that they put together a lot of these summaries, and it literally just says, “Fast fact: The carried interest loophole would disappear and those earning a million or more would pay ordinary income tax rates on investment income.” That’s back to what Tom said before; there are two waterfalls. If you’re over $400,000, there’s a target on your back. And if you’re over $1 million, there’s a guided missile coming at you. Those are the two levels they’re looking at. But in front of that, it literally says, “The carried interest loophole would disappear.” I assume that’s the hedge fund managers, that’s the real estate side, the real estate sponsors. Anything with that favorable tax treatment where your part that you earned by adding the value, your carried interest was treated as a capital gain, it looks like that’s going to be flipped over to income.

Gibson: And one more piece of exciting news. This was actually introduced by Senator Sanders and Senator Gillibrand already and I think it will be reintroduced: A financial transaction tax. There is one piece of legislation, the Wall Street Tax Act of 2019, put forth by Representatives Schatz and DeFazio, proposing a 0.1% tax on all securities transactions. The Sanders-Gillibrand proposal is more complicated and it’s higher. It’s a 0.5% on stocks, 0.1% for bonds, and .005% for derivatives.

There is a carve out, though. If you make less than $75,000 and you’re married filing joint, the tax doesn’t apply. I hate to break it to you, but there’s not a tremendous amount of stock investing going on at that level of income outside of 401(k)s and things like that. This is another issue that is out there and may or may not be addressed in any forthcoming legislation.

Finally, we are going to have the Affordable Care Act with us for the foreseeable future, and premium tax credits are going to be back. I would assume that the attendant penalties for not being covered will probably come back as well in the new bill that went away during the Trump years. And that’s a catch up on where we are.

Zamerski: Tom, this is probably a good point to bring up a question that came up. “Who wrote this policy? And now that you’ve given us this miserable news, are there potential mitigation strategies?”

Gibson: Well, that’s a great question. Policy is written by a number of different people. At this point, again, this is gleaned from the President’s campaign website, from position papers, and from things that have been said on the campaign trail. Once we have definitive legislation, it’ll be much easier to analyze this and start to think about what the mitigation strategies will be.

I want to be really clear about that and I want to repeat something. Now is the time to think and to plan. It is not the time to start making knee-jerk reactions to something that you read in Forbes or something that your neighbor told you. That’s not what you want to do. We need to wait until we actually have a bill or at least drafts and versions of the bill going through the House and Senate. If this is like every other piece of tax legislation, there’s going to be the House version, the Senate version, there’s going to be a conference to reconcile those two, and then we’ll actually have something that they both can vote on.

There are ways to work around a great deal of this. In 30 years, I have seen this movie three times and so we know what to do to work around it. Even if we get the 28% cap, it means that some of the things that we’re doing, although they will still work, obviously it will be a little bit diminished. Some tend to, I think, undervalue the scorecard deductions, undervalue some of the things that we’re doing within your businesses. Those seem like, for lack of a better term, small potatoes. Well, guess what? Those small potatoes just got a lot more valuable because when you have higher tax rates, what they’re talking about capping at this point are things that are below the line. It’s not so much how you’re calculating figures like total income or adjusted gross income; it’s how the tax is calculated that is so markedly different under what we’ve seen up to this point.

Zamerski: We’ve received a couple of questions about timing and whether or not this affects 2021 or 2022 tax bills.

David, I think it depends how the bills come across and when they come across. On our December webinar, we talked about the idea of retroactivity. While we felt changing tax laws retroactive to the election date was highly unlikely, even though we heard that in some of the rhetoric, there’s still the possibility of a new law being retroactive, perhaps to January 1st of this year, maybe January 20th, Inauguration Day.

Generally speaking, when we’ve had laws in the past that were retroactive, although not always, they were usually in favor of the taxpayer, trying to put some cash in their hands more quickly, give them a benefit more quickly. But I would propose that making a tax rate increase retroactive carries a certain amount of political risk. In addition, let’s just say this comes across later this spring or over the summer and your tax rates go up but you have not been withholding from your paychecks for half of the year. Trying to get caught up is going to create some issues and make you behind your payments.

Do you want to share some thoughts on these two points?

Babinski: If history is a guide, if there’s a law change that’s beneficial on the tax side, especially making it retroactive, nobody complains. If there’s something that’s punitive, usually there’s some date in the future that they put a stake in the ground and say, “As of.” That’s why I started this concept of handicapping what’s likely, what’s unlikely, and then, if it is likely or unlikely, if it does pass, when does it come to fruition?

For example, Tom mentioned the unrealized, what we call the mark to market tax. There’s so much infrastructure that needs to be put into place for that, that it could be something that doesn’t’ come to fruition until 2024. They just throw some regs out and give the industry time to come up with that.

The first-time homebuyer credit of $15,000 or the electrical vehicle credit, if they said as of January 1st, 2021, I wouldn’t be surprised. Those are the things that I would see as very likely of being retroactive. The increase in the tax rate if it goes from 37% to 39.6%, that’s a toss-up. That could be for the full calendar year because it’s attacking the people that they want, the $400,000 or more. They could justify that and it’s not that big of a change, but that’s really where we’re going to be keeping a very close eye as this potential legislation starts working its way through.

The tax code is a series of incentives and disincentives, candidly. If it was about revenue, we’d all be filing our tax return on a postcard, and everyone would be sending in their percentage. But it’s not about revenue. It’s about, lately, political football. It’s about incentivizing certain activities and disincentivizing certain activities. If one thing is made retroactive and one thing is set into the future, there will be, quite possibly, a new series of incentives. It’s going to shift similar to how the market is shifting from one industry rotation – they call it sector rotation – where carbon fuels and intangible drilling costs were being incentivized to now the incentive might be solar or wind or carbon capture. We’re not saying that tax strategies are going to go away. We’re saying they’re going to shift from one pocket to the other. And candidly, our job is to stay on top of that and come up with some best practices.

Zamerski: I think looking at the timing of some of these things too, with the withholding, that could be a January of 2022 effective date. But if they do enact the higher tax rates on the capital gains, I could see that easily being effective the date they sign the law because it’s really easy to match up the activity with the cash flow. If you sell something, you have the cash.

David, I want to come back to one thing. We talked about the step up in basis and death possibly being a triggering event. How does that affect the psychology of beneficiaries and families? You can have an estate with illiquid assets, or you’re forced to sell them to pay the tax in a bad market. Certainly, that’s going to have some additional consequences down below even the wealthiest people.

Babinski: That’s always been one of the arguments against the death tax: “We’re going to lose the family farm.” We have an asset on our books that on paper is worth $100s an acre, it might be $1,000s an acre. Some of our clients are carrying farmland at $10, $15, $20 thousand an acre. All of a sudden, you have to come up with cash money to pay tax on that. And for the most part, that’s the only asset and possibly even a mortgaged asset. How do you do that? That’s what I was saying before. This is one of those instances when the children of a family with modest means all of a sudden is forced to sell that asset because they owe tax on $80, $100, $200 thousand and it’s due at death. If that is the triggering event, it becomes a lot more complex than the headline of, “We’re eliminating the step up.”

I remember when I got into this business decades ago, I had a mentor that said, “Listen, the estate tax is voluntary.” We set our clients up with permanent life insurance. It’s a liquid event. At death, you get your check. You fund it like any other known expense, like home insurance or car insurance. You just fund your estate insurance. But it’s the folks that can’t qualify or don’t have the financial means to do that, who are going to get sucked in here and the unintended consequences of middle America owing tax when mom or dad passes away, it’s one of those sea-level changes.

Zamerski: David, whether the glass is half empty or half full, following the recession in 2008, 2009, we had one of the slowest economic recoveries on record. But comparing that to now, given the severe economic impact that we’ve seen from COVID, assuming that the vaccines work, we can get ahead of this, and we can return some normalcy to the U.S. and global economies, I think that there still is the possibility that later this year we could see that pent up demand be unleashed and possibly experience a really good financial environment even in the face of rising taxes.

Babinski: There is a lot of talk about the roaring ’20s. We’re building up a lot of steam. People want to travel. People want to go places. People want to get back to work. People want to go out to eat. So there really could be this resurgence of just basic economic activity.

But as I mentioned before, I try to talk about the tax code as being a series of incentives and disincentives. If this were to come to fruition as pointed out here, and everything was wrapped up and executed at once, I would call this the Prosperity Disincentive Act. Take New York City for example. I read they’re talking about a 10.8% city tax. You would have your federal, your state, and your city tax. If I’m in New York City and I’m going to be hit with 72%, 77%, 78% tax, there’s a point where I’m going to stop working. And if I’m in those higher tax brackets, I can afford to stop working. I’m going to take advantage of that newly found freedom, and I’m going to travel for a certain part of the year. I’m going to work on a hobby or do something or semi-retire. But again, the consequences of that are going to go far deeper than they just don’t have the revenue on my extra $100 or $200 thousand.

Tom, what happens if I decide I’m going to work six months a year and then take six months off?

Gibson: Well, that’s six months you won’t need a receptionist, that’s six months that you won’t need a physician’s assistant, it’s six months you won’t need a hygienist if you’re a dentist. A lot of you will be able to weather that. Again, one of the unfortunate consequences would be a lot of your employees won’t.

As most of you all know, I’ve spent some time in public accounting, moved over to corporate accounting, and was a CFO for a number of years. Next month, we’re going to be talking about, “What do we do now in regard to how we run our businesses?” It has to do with things like what does reasonable compensation look like going forward. How do we cut your overhead? Because, just to be blunt about this, you’re my client and your income is second only to my own income that I’m worried about. Some of the solutions are not going to be pleasant, but they’re necessary just because of the circumstances that we may be facing.

Let me drop back for two seconds because we were talking about when all is this going to be effective. I think the later in the year that we see legislation, the less likely it is to be retroactive back to January 1st. Yesterday, the Biden folks said that they were not even going to take up COVID relief until March. Unless they’re prioritizing the tax bill over COVID relief, which I hope isn’t the case and I would find difficult to believe, it may be June before we get legislation, which might actually be a good thing.

Ted talked about, and David, I think, rightly mentioned, if we get ahead of the virus, we’re going to see people who have been locked up for months suddenly want to get out and have a good time, and travel, and spend money. Yesterday, I got one of those pop ups on my computer. The president said yesterday that they expected 100,000 more COVID deaths in the next month. If you look at how blue states have reacted to COVID, I’m not sure what will happen next. I think depending on how things pan out, we might be looking at more lockdowns and more disruption as opposed to a third- or fourth-quarter rally. We’ll have to see. I hope that is not the case, but that’s the wildcard in all of this. Last year was a crazy year and it’s like 2021 told 2020, “Hold my beer,” because it’s shaping up to be another wild year.

Zamerski: Tom, just staying on that a little bit since we are talking about the potential of shutdowns, the legislation that was just passed at the end of the year is setting up for another round of PPP funding. I know the testing is a little bit different. The use of the funds is pretty much the same. They might have loosened that up a tiny bit, but it’s basically the same as the first time. Even if you’re back to work right now and things look good in the moment, to look at your 2020 gross receipts compared to 2019 and if any quarter of 2020 compared to the same quarter in the prior year, 2019, was off by 25%, you’re eligible for additional funding. You can also look at 2020 as a whole compared to 2019 and use whichever calculation is the best for showing that you had an economic impact.

There are a couple of other pieces that also came out. There was clarification. The IRS had said that if you used PPP funds before to pay expenses, you wouldn’t be able to deduct those expenses. They did clarify that through this congressional act you will be able to use those expenses, so you are going to get the benefit of the deductions. It really will be truly tax-free money to you. You need to apply by March 31st.

And then the EIDL loans that initially came out, and that was some of the first money that came out, they had said to the extent you received any of that, you would not be able to get forgiveness for an equal amount on the PPP. In other words, if you got a $10,000 EIDL grant at the very beginning, when you file for your PPP forgiveness, you are going to have to reduce the forgiven amount by that $10,000. That has been repealed. So, both are fully tax-free as well.

But what are your thoughts, Tom, on planning if right now, today, you’re sitting in your office and things look pretty good, but this is available for the next two months?

Gibson: My advice would be, if you’re eligible, take it. It’s just that simple. You’re going to get to deduct the expenses. Take the money because, I promise you, they’re going to be looking to you for taxes. If you have the opportunity to get additional PPP funds, if you’re eligible, take it.

Zamerski: David, are there any other things that you want to talk about from a planning standpoint?

Babinski: To summarize and put a little bow on the conversation, none of this is law. We don’t have a bill to review. There’s already some talk of infighting. We all know how politics works. It’s us against them when they’re on the campaign trail, but now that you’re actually making the sausage, as you said, the nuances come to play in what could actually get passed and who’s flavor rises to the top.

We don’t have anything to work against right now so the opportunity here is to be ready. Anyone who’s been working with us, we’ve been doing very extensive deep dives into the balance sheet – Where are we now? How are things titled? Who are the beneficiaries? – because that’s really where the changes will be made.

We’ve talked a bit with folks about the resurgence of the family limited partnership. If you don’t have to pass – or if you can’t pass – assets through your estate for a step up, then systematically start to shift ownership but maintain control. I’ve heard attorneys say, “The family limited partnership is going to come back. See where that fits in your situation.”

So, what is the opportunity? Get your arms around your current situation. Take the time to review beneficiaries. Take the time to actually be clear on questions such as, “Is that a revocable trust? Is that an irrevocable trust? What was the motivation when we set this up?”

This would be, as Tom said, about the fourth major estate tax change if it comes through. If you’re still carrying A-B trusts from two iterations ago, those are going to have to be looked at. When I started in this business, Clinton was just coming in and the estate tax exemption was $600,000. Believe it or not, I saw some trusts that said, “The first $600,000 goes to my wife in the B trust.” That’s been changed about 40 times since then. So, that needs to be reviewed.

That’s the opportunity, Ted. To take a look at your overall financial situation, know where you’re starting from, and then, of course, know what your goals are. We talk to people all the time. We say, “Well, how much money do you need in retirement after tax? And what are your goals?” And it’s like, “Well, if we had a time machine and you retired three years ago, you’d still be fine.” But maybe as the top tax bracket approaches 70% or 80%, maybe there are different conversations to have. Right now, Wall Street is flush with cash looking to buy businesses and practices. These are the conversations that are going to come to light, if that makes sense.

Zamerski: Yes, certainly.

And David, not to put the cart in front of the horse and there’s a process that needs to be followed with any sound planning for anyone, but something that we just recently read, there are some changes in the insurance industry as well. Could you address for a moment insurance as a tax planning tool but in particular, the reduction of the guaranteed interest rates that insurance companies are allowed to be able to drop and how that can impact funding a policy, the type of policy that you could use that’s going to allow you now to store more cash because the calculations are changing without it becoming a modified endowment contract?

Babinski: The best worst-kept secret in financial planning and the family office space is that ultra-high-net-worth families use insurance to transfer tens and hundreds of millions of dollars from generation to generation. And the headline, if you read it from the perspective of just normal consumer of financial data, sounded negative. But really, it allows mathematically for a significant amount of additional cash to be put inside of an insurance policy that’s passed on to the next generation tax-free if properly designed.

Insurance isn’t about insurance at that point. Insurance is about having access to large amounts of tax-deferred capital that’s growing, using it, and then passing it to the next generation. I’m not saying it’s quid pro quo. It’s just interesting that they changed the law right when they started talking about how the estate tax might change. The net effect is you can “stuff” a lot more cash into this tax-advantaged bucket than you could before that adjustment was made. We’re already seeing the largest family offices start to allocate a tremendous amount more to that strategy because it’s about protection and then it’s about transferring to the next legacy. Family office really just means looking at your entire overall situation in the context of multiple generations and getting away from the thought of, “I’m going to keep everything.”

When I started to practice financial planning, I talked to people who said, “Oh, my kids don’t even know what I have. Let them figure it out after I’m gone.” And that’s a strategy. But as I’ve come through my career, I’ve realized that the more effective and efficient strategies are families that think multi-generational. Over $10 million in assets might be taxed every year. Well, how many bodies, how many Social Security numbers do you have in your extended family? Let’s start smoothing out those curves so that no one’s paying that. That’s the type of big-picture planning that we’re talking about, Ted.

Zamerski: Thanks, David. There are two things I took away from that that really hit me in a different light. One is, of course, it’s all in the design, right? It’s not the typical policy you read about or hear about or might talk about. There are specific things you need to do, specific types of company you use in that design. And it has to be very deliberate.

And then I connected what you were saying to something Tom mentioned earlier about the possibility of pushing back the timing even on the relief bill. I have a feeling a lot of congressmen are reviewing their estate plans as we speak, and that’s why they’re pushing these other things back.

Babinski: It could be. It’s a good information to have and then to actually use that information as a strategy. That’s why I’m saying if we can just get a snapshot of where we are and where we want to get to, some of these decisions become more apparent as these laws passed through the system.

Zamerski: Thanks. Any final comments from you, Tom, before we wrap up?

Gibson: Just to reiterate something we’ve said a few times already: This is not a time to go out and start doing things, making knee-jerk reactions. Planning? Yes. Evaluating? Yes. Let’s wait until we get a bill and then we’ll begin working on the ways that some of the unfortunate consequences of this, hopefully, can be mitigated.

And another thing. I’ve been following politics since the ’80s. Reagan was the first president I was able to vote for in a presidential election. And it is a mystery to me why you think the government wants to take care of you. I want to be very explicit. This is not a political statement at all because I think this is true across the board. The government is interested in you and your business for exactly the same reason that a tick is interested in a dog. We want to help take care of you. And we’ll do that. We’re going to keep doing what we’ve done for some of you for years. We’re going to work to make sure that you pay the least amount of tax that you legally and ethically can.

Zamerski: Great. Thanks, Tom. If you have questions about your 2021 planning, please give us a call at (772) 257-7888.