Waiting For Tax Changes: What Can Wealth Advisors Do?

Tom Burroughes, Group Editor, 11 October 2021


We talk to advisors at BNY Mellon Wealth Management in the US about what clients can and should do to manage tax hikes that eventually come out of the Washington DC legislative machine. 

(An earlier version of this article appeared in Family Wealth Report, sister news service. The developments in the US tax system will, to some extent, be studied globally and have a degree of impact outside the US.)

Anyone spending time examining the toolkit of wealth management rapidly learns that there is a profusion of mind-bending acronyms and terms in the US arena: SLATs, SALT deductions, 1031 exchanges; step-up-in-basis and private placement life insurance, to name but a few. 

Understanding that there are many challenges and tools in the box is a big part of the wealth advisor’s role. As of the time of writing, Washington DC lawmakers are still trying to hash out a deal on proposed tax hikes on high net worth individuals. As far as this news service can judge from conversations, capital gains, income and estate taxes are heading north, if not by as sharp an amount as the Biden administration originally aimed for. 

In this environment, advisors need to work out how to prepare clients for what may happen and build flexibility into their plans.

“Lawyers try to make estate plans as flexible as possible to handle changes,” Jere Doyle, estate planning strategist at BNY Mellon Wealth Management, told this news service recently. 

Potential changes to rules about various structures and tax rates cause a lot of anxiety for CPAs and accountants because they don’t want to be sued for malpractice over their advice, he said. 

This publication and Doyle talked about various issues around tax mitigation, such as the gift exemption ($11.7 million). There is a chance that it could be cut sharply, he said: “We have been telling people to use the exemption or lose it.”

Doyle noted that a House of Representatives proposal is to put the CGT rate up to 25 per cent. He said that “a lot of people think that a rate of 25 to 28 per cent is reasonable.”

“The issue is when does the CGT rate become effective? It could be anybody’s guess,” Doyle continued.

This news service has talked to a number of wealth advisors about what tax hikes might affect high net worth and ultra-HNW individuals. In the aftermath of the COVID-19 pandemic, and with the election of a Democrat president - with a Democrat majority in the House and a close position in the Senate - advisors predict that some tax hikes will come. 

One structure that continues to come up in conversations with wealth managers (see an example here) is SLATS, aka Spousal Limited Access Trusts. SLATs are irrevocable trusts that one spouse establishes for the benefit of the other spouse.

To give an example of how they work, Doyle described how a husband transfers assets to an irrevocable trust with his wife and children as discretionary beneficiaries. The gift to the trust is an irrevocable gift and will use part or all of his $11.7 million gift tax exemption. The gift to the trust means that the assets are out of the husband’s estate for federal estate tax purposes, Doyle said 

Any appreciation in the assets in the SLAT is also out of the husband’s estate. Since the wife has not transferred anything to the trust, the assets are not included in her estate. However, the husband and wife were reluctant to make an irrevocable transfer to the trust without having a safety net if they need the money later. Since the wife is a discretionary beneficiary, the trustee could later make a discretionary distribution to the wife. 

The problem from the husband’s point of view is that if his wife dies or they get divorced, he has no access to the money. Some attorneys will include a “floating spouse” provision in the trust to cover a potential divorce or death, he said. The “floating spouse” clause means that the spouse is whoever the husband is married to at the time the distribution is made i.e., the spouse who is entitled to a distribution could be a spouse the husband marries later in the event of the divorce or death of the person he was married to at the time the SLAT was executed, he said.

Waiting for detail
Another consideration is that when a piece of legislation is enacted it can still take years for the specific regulations, as understood by the IRS and other bodies, to be actually issued, and understood.

There are various structures to assist transfer of assets, such as Employee Stock Ownership Plans (ESOPs) for transferring business assets to employees. The drawback of ESOPs is that they are highly complicated, Doyle said.

This news service and Doyle briefly discussed Qualified Opportunity Zones – enacted by the Trump administration – which came in with bi-partisan political backing. These zones are designed to steer capital to areas struggling with poverty and lack of opportunity, in return for investors getting tax reliefs.

There are “traps for the unwary” with these zones, Doyle said. “The traps are at the sponsor level. There are a number of tests that have to be met by the group setting up the QOZ fund so investors have to be careful that the fund meets those tests. A number of tests deal with percentages of business conducted within the QOZ and how much working capital (cash) the fund can hold. The regulations are long and difficult reading,” he said. “The investors should do their due diligence of the fund sponsors to make sure they meet and continue to meet the requirements set out in the statute and in the regulations.”

A useful way to handle inter-gen wealth transfer is the use of lending, and taking advantage of very low interest rates, he said. People can, for example, borrow against concentrated groups of securities such as stocks, borrow against them, and raise the necessary liquidity without losing control of the assets or incurring capital gains tax on the sale. 

Intra-generation loans are a way of transferring wealth without losing assets control. Another option is to use private placement life insurance and other insurance-based tools to protect, structure and transfer wealth, he said. Using PPLI is a way of investing within an insurance product without incurring capital gains tax on the sale of securities within the insurance if rates on gains go up substantially, he added.

Getting around
Doyle’s colleague, Joan Crain, who is global wealth strategist, said she has noticed that a lot of US individuals appear interested in offshore locations. “Given their proximity to the US mainland and their legal foundation in British law, the Cayman Islands and the British Virgin Islands have historically been popular with US clients,” she said.

More recently, there has been a growing interest in the various trust states within the US, she said, such as Delaware, South Dakota, New Hampshire, Alaska and Nevada. 

Clients are raising questions about citizenship/residency-by-investment schemes, aka “golden visas”, Crain said. 

In many cases, US citizens looking at overseas destinations such as Portugal mistakenly think that they can get away from the US worldwide system of tax. Renouncing citizenship is time-consuming and costly.

“We alert clients to these issues and strongly advise them to seek experienced counsel before proceeding,” Crain added. 

Register for WealthBriefing today

Gain access to regular and exclusive research on the global wealth management sector along with the opportunity to attend industry events such as exclusive invites to Breakfast Briefings and Summits in the major wealth management centres and industry leading awards programmes