Strategic Financial Planning Ahead of Coming Tax Law Changes

March 4, 2024 – This informative episode of Lifetime Planning focuses on the potential changes looming in the American tax landscape, with Financial Sense Wealth Management's Jim Puplava and Putnam Investment's Chris Hennessey expounding on how best to prepare. Amidst the potential countdown to the sunset of Trump-era tax laws, Jim and Chris cover various aspects of strategic financial planning that listeners may want to consider implementing now.

In discussing how such changes could potentially alter income brackets for middle and upper wage earners, they urge individuals to best prepare for these impending tax adjustments through various options when it comes to estate planning, business tax strategies, capital gain taxes, estate tax liabilities, and more. Jim and Chris also further offer suggestions on using Roth conversions and irrevocable trusts as part of retirement and estate planning.

This episode also underlines the importance of timing in tax planning, discussing how withdrawing and recognizing income at the right moment can make a substantial difference to your tax liabilities. Not only does it provide listeners with a lay of the land on the tax front, but it also emphasizes the role of financial advisors, conveying the importance of informed and proactive measures to secure one's financial legacy in a future where tax laws may dramatically differ.

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Transcript:

Jim Puplava:

Well, we know this is a presidential election year, and that has a lot of meaning for those of us that are taxpayers, because in 2026, the Trump tax laws will sunset. That can mean lower exemptions for estate planning, and it could mean higher tax rates. Well, let's find out what all of this means and how best to plan for it. Joining us on the program is Chris Hennessey. He's professor emeritus of law at Babson College, and he's a member of the business advisory group at. You know, Chris, you and I were talking just before we went on the air. At least in my lifetime, every time we get a new president, the tax laws seem to change. Jimmy Carter changed taxes, Reagan changed taxes. George H. Bush changed taxes. Clinton changed them. George Jr. Changed them, Obama changed them, Trump changed them. It seems like every time we get a presidential election, the tax laws change. So let's talk about what may happen in 2026.

Chris Hennessey:

Sure. That's a good list of people to change them, Jim. Yeah, it's interesting because even if you don't as a party hold all of Congress, maybe you've got just the House or just the Senate. There are ways, particularly in the Senate, through what's called reconciliation, which is what Trump did, where you can still change the tax.

Jim Puplava:

Know, this makes it a little bit difficult. And I'm just thinking, Chris, here from estate planning, because when I got in the business, there was estate taxes due on the death of the first spouse. The tax rates were 70%. The exemption was about 175. So Reagan comes in, he goes, look, we're not going to tax the first spouse that dies. We're going to raise the exemption to 600. We're going to lower the tax rates and made it a little bit more reasonable after a decade of inflation. But we've tried to index that along the way. And one of the things that really strikes me, Chris, in terms of inflation, do you remember in 1994, they got rid of the ability to roll over the gains of your residential home if you bought another one of equal value? But then they said, we're going to give you 250,000 capital gains free if you're single, 500 if you're married? They haven't changed that. And imagine what's happened in real estate. I mean, an average home here in California, in the city I live, is $2 million.

Chris Hennessey:

Yeah, not only that, Jim, but some of these states, like where I used to be a resident in Massachusetts, they've imposed a millionaire's tax on income over a million dollars. And when are you going to get that? The average person, when they sell the house. So it may just be a one time hit. But that's on top of what you just said regarding the federal taxes.

Jim Puplava:

And, you know, from a state point of view, every time, let's say I bought a house for a million, I turn around and sell it for 2 million. The state makes more money because the new property tax value is now based on the market value of the sale. 2 million, right?

Chris Hennessey:

That's right. Exactly right. Yes.

Jim Puplava:

It's one of the reasons we love buying school bonds, because we can look at the school district and take a look at their revenues. But we also know those revenues are going up each year, which is what happens to property taxes. I want to explain to listeners, because when the Trump tax bill was passed, they said it was all to the millionaires, which was not really true because I'm looking, Chris, at tax rates from 2017, which was the last year.

Chris Hennessey:

That's right.

Jim Puplava:

And I'm looking at a married couple. And the reason this is going to be important is for people doing Roth conversions. You hit as a married couple, the 25% tax rate on income of 153,000. Fast forward to today. Under the Trump tax bill, you hit the 24% tax bracket at almost 384,000.

Chris Hennessey:

Yeah, 384, right. Yes, that's exactly right.

Jim Puplava:

And you have a 10% tax rate at twelve. So you have a lot lower tax rates at a higher level of income income. So if we revert back to the Obama tax rates, people's taxes are going to go up. And I'm talking about middle class people, not just rich people.

Chris Hennessey:

Yeah, I got a slide that I use, Jim. I got it right in front of me. It's interesting. So I look at 2024 tax rates like you just went through for a married couple and then projected tax rates when tax cuts and jobs act goes away in 2026. And you look down that slide, Jim, and I know people are listening, so they can't see it visually, but every single bracket goes up.

Taxes go up, 3-3-6-4-9. So all the way down. And so here's something interesting Biden has said. Look, if I'm reelected, I want to keep taxes the same or lower for people under 400,000. Well, he's not going to be able to do that without legislation.

And that's why I think there's going to be a compromise. Now, I'll tell you something else interesting, Jim. I saved an article, how to soak the rich, why lower tax rates do it best. And I'll just mention one thing out of this article. When Donald Trump entered office, the richest 1% of tax filers.

That's 675,000 of income or over paid, about 40% of the income taxes collected. Now, today you go through the most recent data the IRS has put out, which is actually calendar year 2021. That same category is paying 46% under a lower tax rate structure. So we hear all this stuff, Jim, that, oh, the rich made out really well in the Trump tax cuts. They're actually paying more of the tax burden than they were before those tax cuts.

Jim Puplava:

And part of that is they do well from their investing, they do well in their businesses and at lower tax rates. They don't mind paying the taxes. I've seen this happen every single time. This happened under Ronald Reagan when he lowered them. It happened under Bush when he lowered them.

And it happened under Trump when he lowered them. I don't know why. When the opposite party takes office, they raise it and they end up getting lower tax revenues.

Chris Hennessey:

Exactly. The other thing that's interesting, we've been talking about total income relative to marginal tax rates. But a tax increase can take many different forms. Yeah, you can increase marginal rates, but you can also cut back on deductions. We already talked about the reduction in the federal estate and gift tax exclusion.

You could limit, step up to fair market value at death. We know about the salt limit. You and I have talked about that in the past of 10,000. There's a whole bunch of different ways you can come at this. We could raise the wage base for Social Security, payroll taxes.

That's, I think, now about $168,000. So there's a lot of different ways. And it's complicated, which is why I think people today, your clients that are out there, people listening, they should take action now because there's only a window of now less than, what, a year and a half? Right?

Jim Puplava:

Yeah, we're using, especially for our wealthier clients, Chris. We're using the state tax exemption, which is 13,000,006 right now, and we're getting those assets out of the estate. But the other thing, and this is going to affect a lot more people, and I'm talking about people that have worked their entire life. They put money in their 401, they retire, they roll it over to an IRA. We have been converting that over to a Roth IRA.

So it's tax free.

Chris Hennessey:

Now.

Jim Puplava:

I can do that this year, and I'm not going to hit the bigger brackets. And we'll do this to a 24% bracket. But, Chris, I can do that to 384,000. We revert back to Obama. It's going to be somewhere around 153,000.

So this is going to affect a lot of people with Roth conversions in terms of trying to lower their taxes.

Chris Hennessey:

Yeah, absolutely, Jim. And I think this is a good time, this window, to really look at the numbers, look at the Roth conversion. The big picture is interesting. The big picture is that, okay, if rates are going to be higher in 2026, then I'd probably want to try to push income into this year and next year, and I'd push deductions into 2026. So things like charitable deductions, maybe I would pledge, maybe do that in 2026.

You mentioned the Roth conversion. Good time to do that. Because why not take that income now, when my rates are lower? It might involve even the salt limit. So the salt limit of 10,000 should go away.

Now, maybe there'll be some compromise on that, but that would mean full deductibility of state and local taxes in 2026. So I'd want to think about that. And then the business owners, they have this 20% deduction, we call it QBI, but it's a 20% deduction off their profits. Well, that's going to go away, too, in 2026. So they have to think about that relative to their income and deductions and so forth.

Jim Puplava:

You know, the thing that I think is going to be surprising. So let's say, I don't know, whoever wins in 2026, the tax rates Trump expires. So in 2026, we're going to see these higher taxes at lower levels of income. And what most people will do, Chris, and you know, as being in law, most people will file their estimated taxes based on the previous year.

Chris Hennessey:

That's right.

Jim Puplava:

So here they're going to go, and let's say they don't do anything. They're squabbling in 2026. So at the end of the year of 2026, we're now into 2027. They've withheld tax rates under the old Trump tax rates. Then all of a sudden, they go to file their 2026 tax returns, and they're going to get walloped with higher taxes.

There could be a lot of ticked off people because they're under the impression, hey, if I'm under 400,000, this doesn't affect me. I hate to tell you, if you're under 400,000, it's going to affect you a lot.

Chris Hennessey:

It will. And the other one that is going to come back is the alternative minimum tax. I call it Alpha Mike Tango, because it's not an alternative. It's not a minimum and I don't like to say the words alternative tax, but anyway, Jim, when it went away, for all intents and purposes, it only impacts about 200, 250,000 people, taxpayers today. But when it comes back in 2026, it's going to impact 7 million people, particularly in states like California, where the state income tax is high and that is not deductible once you're in AMT.

Jim Puplava:

Chris, what would you be doing now? I mean, right now, this window of opportunity we've got, as you mentioned, almost a year and a half, we're accelerating Roth conversions for our clients that are retired, so they'll end up being tax free income. And we can put a lot into a Roth right now because of where the brackets are. Secondly, for our clients that are very wealthy, and I'm thinking of two or three clients I know that have businesses that are worth a lot of money. We're transferring the stock to irrevocable trust and getting $28 million out of their estate in case it drops. What else would you be recommending doing?

Chris Hennessey:

Well, one simple thing, which is kind of interesting. The standard deduction amount this year for married is $29,200. That's really high. That's going to get cut in half. Single is 14,600.

That'll be cut in half, Jim, in 2026. So one thing people could do this year is they could say, okay, I'm going to do a donor advisor fund, and I'm going to double up this year because I want to get over that standard amount. Now, maybe you wait to do that until 2026, but that's a way you can pick up some additional deduction and save on a marginal tax rate basis. So I would certainly look at that. I would also not forget about something that does not expire, which is the qualified charitable distribution that's age at 70 and a half or older.

But, hey, I got to pull money out of my IRA account at my age. So if I direct that distribution to a public charity, it doesn't count as income. Yet I've satisfied my RMD. So that's another thing. And you mentioned business owners, and I think you're absolutely right, Jim.

Get the value out now, because there's an expression, use it or lose it. In other words, if I don't use up that exemption amount, 13, a little over $13 million this year, 26 million. If I'm married, I'm going to lose that opportunity when it comes down, presumably in 2026. So getting that value into a trust, getting it out of my estate, and then the other thing I look at, if I'm insurable, I look at life insurance, maybe owned by a life insurance trust. It's a great story I tell.

And I'm sure you know this story about Joe Robbie. Joe Robbie, the Miami Dolphins, right? When he died, at his death, his wife had survived him, and at her death, the entire estate was subject to taxation. The Miami football team, the real estate, $47 million was due to the IRS nine months after her death. The kids didn't have the money, so they sold the team and sold the real estate at a discount.

There was no life insurance planning, and he was an attorney.

Jim Puplava:

Jim, that's the other thing, too. We're using these life insurance trusts, and especially this is so important. Chris, I think you would agree, for families that own a business that's worth a lot of. And, uh, I have one client that has most of his wealth is in business and real estate. Neither of them are liquid.

Chris Hennessey:

No, absolutely. I have three categories, family business, real estate, and the third one, large IRA account. Now, yeah, the kids can take the money out of the IRA to pay the state tax, but guess what? That's double taxed, right? That's tax coming out as income, so you don't want to do that.

So all those three cases, if there's insurability, you think about life insurance. And, you know, Jim, with survivorship, or sometimes called second to die life insurance, even if one spouse of the two has a medical issue, you could probably still get the insurance. The life insurance.

Jim Puplava:

That's the great thing about it, because it provides, you know, this is what I think it was Jackie Kennedy that used generation skipping. And then I believe, Chris, she had a life insurance trust that they used for the estate taxes.

Chris Hennessey:

Yeah, she had that, and she had a charitable lead trust as part of her estate, and I think it went to a foundation, that part. But she did really very effective planning. Yeah, I know.

Jim Puplava:

And this was somebody that was worth about 200 million. The point that I think we're trying to make, Chris, for our listeners here, is you need to start doing some planning. If you have a large estate, if you have a large IRA, if you have a business, get together with your advisor and take the steps. Now, if you are retired and you do have a multimillion dollar IRa, talk to your advisor now so you don't get caught in a permanent higher tax rate down the road.

Chris Hennessey:

Absolutely. Very important. You've got this window now to do some significant planning both on the estate and gift tax side and also on the income tax side. Take advantage of it.

Jim Puplava:

All right. Well, listen, Chris, as always, it's a pleasure speaking with you. And I think if there's some good news we can give some people, so many lower income and middle class people are going to get hit by higher taxes in 2026. They're probably going to have to do some kind of compromise or otherwise you're going to have a lot of ticked off voters.

Chris Hennessey:

That's certainly my belief, Jim, and thank you for having me today.

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