Tax and Financial Planning Considerations: Plan Today for Tomorrow

First Republic Private Wealth Management
October 28, 2020

Watch Richard Scarpelli, Head of Financial Planning at First Republic Private Wealth Management, present on timely tax and financial planning strategies that we believe all clients should consider in today’s environment.

Read below for a full transcript of the conversation.

Richard Scarpelli - Good afternoon, everybody. Thank you for joining me. My name is Rich Scarpelli, head of financial planning at First Republic. And today we're going to be talking to you all about a number of different things. Most of it, tax-wise. But before we get started, I will be taking questions at the end. I am going to try to answer questions as we go along. And how you submit questions is through the questions and answer, the Q and A function at the bottom of your screen. So please submit them. We have a good number of folks with us today. Again, I'll try to answer as many as many as I can, as I go along today. Like I said, a lot of our discussion, as I bring up my screen, I'm going to share a presentation, is going to be tax centered, tax focused. I love talking about taxes. I'm a CPA myself. In fact, I even married a tax accountant. That tells you how much I love taxes. So let's just put this in presentation mode. Okay. Be talking about tax and financial planning considerations. So there are going to be some objectives that we want to accomplish today. What are some of these objectives? We want to number one, summarize some of the potential tax changes that could be coming down the pipe, given the election and all of the spending that's been going on, in the spending that's going to continue into the future as we all may be aware of. I'd like to provide a high level overview of some tax management techniques by making you aware of some specific income tax strategies. Generally speaking, we're going to stay away from estate tax strategies, and we're going to focus on income tax strategies. I'd also like to show you the impact.

So I have some nice, pretty graphs and charts to show you, so you can see the impact visually. And then cover some topics that you may not generally be aware of, but may only be relevant to some of you. But for those that these are applicable to, it's going to be extremely important that you are at least aware of these things. There are many accountants, tax accountants, and tax advisors that aren't even aware of them, or they're just not top of mind, but something that you should all be aware of. And then we're going to round out just by covering some core estate planning documents, and that'll be short and brief, but it's really important to cover that as well. So why don't we get started? Big question I get today is, tax me today or tax me tomorrow in light of what can potentially come down the pipe. So it's important for us to really understand where we are today. So from a tax perspective, we have a top income tax bracket of 37%. We have a top long-term capital gains tax rate of 20%. However, many people quote that at 23.8%. And that's because of the 3.8% net investment income tax associated with it. So the capital gains tax can be as high as 23.8% for certain taxpayers. On the estate tax side, again, which isn't the focus of today, but everybody should be aware of, the federal estate tax exemption, the amount that you can give, estate and gift tax free during your life and/or at death is about $11.6 million. That has increased substantially over the years. And then the federal estate tax rate is 40%. Now taxes today, we have payroll taxes. I know there's talks about changes in the payroll tax, and the corporate tax going from 21% to 28%. But again, we're not going to focus on those today. So what could things look like tomorrow? We could very well have a top bracket of 39.6% for those earning $400,000 or more of income. We could also very well have a long-term capital gains tax, a top bracket, or a top rate of 39.6% as well, for those making a million dollars of income or more. On the federal estate exemption side, that is set to drop to $5 million at the end of 2025, going into 2026 under current law.

Adjusted for inflation, which puts it around $6 million. But there is talk of that being even lower, three and a half million, and gift tax wise, being even lower than that, at a million. And the federal estate tax, the tax rate, who knows where it's going to be. I've seen it as high as 55% as low as 35%. There's talk that it will be 45%. I'd say that's less important than the exemption. The exemption's going to have much more impact than where that lies. Does it stay at 11.6 or almost 12 million? Or does it go all the way down to three and a half or $1 million? That's a little bit about the tax landscape, and why is it so important? It's really so important to know where you are and where you're going in order to guide you with the appropriate strategies, and in order to make an assessment as to what's right for you. And just a general theme, you know, in the tax world, it's always general because there are always exceptions in the, in the tax code, just about for anything, but a major theme is, you don't necessarily want to pay the IRS sooner than you have to. It's generally best to defer your tax payments as long as possible. However, there are exceptions to that. But again, the general rule is, you want to defer as long as possible. Why pay any bill sooner than you have to, whether it's your rent, your lease, credit cards. You generally want to hold onto that capital and have that capital working for you in a very fruitful way before making payment. You want to pay your fair share, but you don't want to pay sooner than you necessarily have to. But we're going to talk about some of those exceptions that come into play, because they could be important, and they could work out for many of you. So let's look at the timing of impact. The impact of deferring tax payment out as long as we can. So here's a scenario where we look at a million dollars of, of wealth as our starting point. And what does that million dollars of wealth grow to on a pre-tax basis, and on a post-tax? So the bottom line is post-tax wealth growing to $3.1 million in this example, almost 3.2. And that's a scenario where we're taxing that wealth as we go along. Long-term capital gains, short term capital gains. A top federal bracket of 37%. California state income tax, we're assuming California for our purposes here of 13.3. All right, that's a significant tax.

So there are portions of that wealth that are generating taxable income and are going to be taxed along the way, and you have to pay out of that wealth. Versus, what if that wealth was not taxed, except at the end? So it can grow on a pre-tax basis, pre-tax wealth compounding to almost $6 million. And at the end of that, you would need a 46% reduction in that wealth in order to equate to the post tax wealth scenario. So as you can see, it's generally best to defer. And I will say this, that post-tax wealth, if, I made a certain set of assumptions here, 37%, right, capital gains rate of 20%. But if those rates go higher, that disparity is going to be even greater. And that reduction would be even greater in order to equate pre-tax wealth with post-tax wealth. That's just the power of deferral. However, I did say there were going to be exceptions, which I'm really excited to talk to you all about. So what can we do from an income tax perspective? Three things, I break it down to three things: defer, accelerate, and mitigate. Let's talk about deferral first, since we started there. So the easiest ways you can start to defer wealth is by contributing to retirement plans. And I just want to go over a little bit about the retirement plan contribution limits. So for 2020, you can contribute to a traditional IRA $6,000. Now that could be deductible or nondeductible, which we'll get into, or you contribute to a Roth IRA, $6,000. The Roth IRA contributions are subject to income limitations. So if you make a certain amount of income, you're not going to be able to contribute to a Roth IRA. And with a traditional IRA, you can contribute, and most of the time, individuals could receive a deduction on their tax return. So you're really contributing pre-tax wealth to a traditional IRA. Now that's a big difference between a Roth IRA and a traditional IRA. With a traditional IRA, you're generally contributing pre-tax dollars, and it's going to grow on a tax deferred basis. And when it's finally distributed, that's when the tax event occurs. And typically those distributions take place in retirement.

So you're not paying tax up front on your contribution, you're getting a deduction, it's going to grow tax deferred, and your hit with the taxes on distribution. The Roth IRA is just the opposite, where I'm contributing after tax dollars. So I don't get any deduction for the Roth IRA contribution. Taxes have already been paid on those dollars. And it's going to grow in a tax-free manner. And at the end, when it's distributed, that's distributed, tax-free unlike the traditional IRA. And I also want to mention for those 50 and older, there's a catch-up contribution where you can contribute more than 6,000, you can contribute to 7,000. So easy way to defer wealth, defer taxes, I'm sorry, on your wealth. 401k contribution limits. Let's review this, because there's something in this that people generally miss, and I want to point out. So the contribution limits for 401k plan, 19,500 for 2020. Again, that is to a pre-tax 401k, or a Roth 401k. And that pre-tax 401k, and that Roth 401k work the same way as I was describing the IRA and the Roth IRA. Okay, it's just in a 401k. Catch-up contributions for those 50 and older, $6,500. Whoever, I want to note this. What is this $57,000 figure? So if I contribute to 19,500, how do I get up to 57,000? And I'm going to run through an example as to how you can get to contribute up to $57,000 into a 401k. That's much more than the 19,500. So let's run through this example. Alex, in this example is under 50. So not going to deal with the catch-up contributions in this case. Has a base salary of $225,000. He wants to maximize his contributions to the 401k plan. His employer also has a match, a generous match up to $9,000. And we're going to assume Alex maxes out on that match. So he's contributing 9% of his pay to pre-tax 401k, not to the Roth. Here, this example, it's going to be to the pre-tax 401k. It could be to either, or. And then he's also going to make an additional contribution of 13% to an after tax account. So what does that mean? 19,500? That's your regular contribution. Plus the $9,000 that the employer matches, plus the $28,500 of an after tax contribution gets you to the 27,000. So once you've hit that 19,500, depending on whether or not your employer matches, you have a big Delta, a lot of room to contribute additional dollars after tax contributions.

So those dollars going in are already going to be taxed. They're going to grow in a tax deferred manner. And when those dollars are distributed, you're not going to be taxed on the 28,500 that you put in because you already paid tax on it, but you'll be taxed on the earnings that come out of that. And just a little known secret as well, all right, there are some 401k plans that have a Roth 401k option, and the ability to convert that after tax contribution that 28,500, to a Roth 401k. Just think about what I said, I was describing the traditional IRA and the Roth IRA and same applies to a traditional 401k and a Roth 401k. If you're able to convert that after tax contribution to a Roth 401k, all the earnings on that, when distributed, will not be subject to tax, because it's a Roth 401k. Extremely powerful. So that's on the deferral. Two other deferral mechanisms I think are very important to mention. And there are many times they don't get a lot of attention, but these are great tax wrappers, life insurance and annuities, where you can contribute assets, okay to these contracts. And depending on the type of the contract, and we'll go into that in a second, but those assets can grow in a tax deferred and/or tax-free manner. So it's like this tax shield, just as with an IRA and the 401k. So generally speaking with life insurance, we tend to think of it as protecting your family and your income. So God forbid, the income earner passed away, that income needs to be replaced. Or even you may want to consider insurance for the non-income earner, because that income earner may have to adjust his or her lifestyle to accommodate the needs of the family at that time. So generally we think about it as protecting your family and your income, but you can also think about it as an additional retirement savings vehicle as well. There are certain types of insurance policies, and I'm not talking about term when I talk about taxes and tax deferral. Term insurance is set for, it's the cheapest form of life insurance, usually buy it for 10, 15, to 20 year period, pay as you go, it's a level of pay, and then you're done. But what I'm talking about is permanent type of policies, like a guaranteed universal life policy or some sort of guaranteed universal life with the ability to invest those dollars in stocks and bonds, or a whole life policy that pays dividends that accumulates cash value, that you can use those funds at a later date.

Brief note, there are many folks that assume, during this time of COVID, that you can't get coverage. You can get coverage, speak to your life insurance professionals, we have life insurance professionals here at First Republic. So I'd urge you if you were considering it, don't feel like you can't get it. You can get coverage. Carriers are accommodating the current environment. So with annuities, annuities is another tax deferral wrapper. And we generally think about annuities as filling the income gap in retirement. So you're approaching retirement, you're in retirement, you're counting on social security. Maybe you have some other form of income like pension income. Maybe you have a part time job so there's W-2 income, earned income coming in, but it's not enough income to meet your annual living expenses. And it keeps you up at night having to think about tapping into your portfolio that's exposed to market fluctuations. Maybe it's a stock and bond portfolio, and we've seen some volatility over the last year, right? We all have. And sometimes it makes us a little uneasy. And so there are folks that go to annuities, really, to sleep well at night, you don't get peace of mind where they have that guaranteed income stream. You put dollars in, if it's in the appropriate contract, you can guarantee that income gap during retirement. So between your social security pension income, and any other earned income, plus your annuities, or, you covered your expenses. A lot of folks take that strategy. And again, like I said, it's an income tax deferral wrapper, and there are ways where you can receive distributions in a tax-free manner. Everything I just said is really just part of my other notes. Increased retirement savings, minimize the impact of taxes, potentially receive tax-free withdrawals from annuities and insurance. Okay. Let's move on to accelerate. This is where it gets interesting. So okay, Rich, you just told me to for as long as possible, and here you're going to start to talk to me about accelerate. Yeah, accelerate income. Before we jump into some strategies, big question I get.

I get it almost every other day, do I recognize capital gains now? So there may be folks out there that are going to potentially be subject to a higher rate if the tax law changes, okay, and if it does go to 39.6. Right now it's 23.8, adding the net investment income tax. Well, doesn't it make sense to pay the 23.8% now as opposed to the almost 40% later? And you're absolutely right. All right. If I sell a capital gain assets subject to long-term capital gain rates today, and in this example, its $200,000 of long-term capital gain that I'm recognizing at a rate of 23.8%, I'm almost paying $50,000 in taxes. If I was to hold off and wait next year, and if the law does change to 39.6, I'm almost going to pay $80,000. It's almost a double, it's almost $32,000 tax increase. It seems like a slam dunk, sell it. Hold your horses. There are a number of additional factors that need to be considered. So in my mind, it's a long cause for pause, having practiced myself as a CPA, all right. And here are some other factors to consider, and it's a laundry list. All right, number one: like I said, different tax payment over a long period of time is generally advantageous if you have the ability to do so. So I'm telling you if you were a 100% sure that you were going to sell next year, or even in 2022, you knew absolutely you were going to sell, then sell now. And you knew for sure that it was going to be subject to a higher capital gain rate in 2021 or 2022, then it makes all the sense in the world sell now. You sell now, you recognize the gain, pay the lower rate, take your investment, and re-up. And you could re-up in the same investment if you will, if you liked it. So you could take that strategy, or utilize those funds in a more efficient manner. Question mark about the election. Are the Democrats going to take control of the Senate? Will Biden's plan come to fruition? Even if Trump were elected, we have a lot of spending going on. Tons of spending, and there's more to come. It has to be addressed, right? All of this spending has to be addressed regardless of who's elected. So generally speaking, I'm a believer that tax rates are generally going to go up. More than likely, they're going to go up across the board. Consideration: you have to consider your capital losses as well. So you could have significant capital loss carry overs that offset gains. You could also have unrealized losses that you're planning on using. Well you may want to think about using those unrealized losses next year, because they could be more valuable, offsetting capital gains subject to a potentially higher rate. What income tax bracket are you in, both now and in the future when you sell? You could be in a lower bracket that causes you to be in a lower capital gain rate. You may not be subject to the 39.6.

You've got to consider that as well. Here's one that people often forget. What's your charitable intent? If you make charitable contributions every year, and you make cash contributions, you could also consider donating stock to the charity. Because a donation of stock that has a large embedded capital gain, guess what the charity takes it, they're able to sell it. It's a tax exempt organization. So the charity doesn't pay any income tax on that sale. And then they can use the full proceeds towards their charitable intent and endeavors. So consider long-term capital gain property as a charitable donation. Does basis step-up at death come into play? So for all those that don't know, when one passes away, all the assets in one's estate get a stepped-up in basis. So if the heirs and beneficiaries were to sell right away, there would not be an income tax due, a capital gain tax due on those assets, okay. There's much planning that has gone on around this, around taking advantage and getting that step-up in basis at death. Although that's going to be under attack as well. That may very well go away under some various tax proposals. Do I gift my shares to family members? Maybe you have a gifting program in place. And when family members receive that property that has an embedded capital gain, maybe they're in a lower tax bracket. So maybe you don't have to worry about the 39.6% bracket. And then you have to take a look at a hedging strategies, deferral strategies, where are you where you hedge, you diversify your portfolio in a very tax-efficient manner where you're not paying capital gains tax upfront. There are strategies that are called exchange funds, where you contribute that single stock that has a large gain into this diversified pool of assets. And you achieve diversification without having to pay that capital gains tax upfront. Or CRTs, that means, sorry for the acronym. It's a Charitable Remainder Trust. That's a tax exempt entity where you contribute capital gain property, you sell it off, it's a tax exempt entity, so it doesn't recognize capital gains tax immediately, but it pays an income stream back to you over time, and you recognize that income over time, not upfront on the sale. So lots to consider, it is a laundry list. That's why it's not a slam dunk to say hey listen, sell today, and pay the 23.8%. Okay. I've been talking, some of you may have heard me talk before, I talk a lot about this.

This is an income acceleration and deferral strategy at the same time. Yes, it's a little bit of both. I talked earlier about a traditional IRA and a Roth IRA, or a traditional 401k Roth 401k, but here I'm going to focus on the IRA, where one in this strategy is taking a distribution from your traditional IRA. And what did they say, what happens when you take a distribution? It's an income tax hit. So I'm going to pay the income tax on it now, but I'm going to turn around, and I'm going to contribute that amount to a Roth IRA. So we can get the tax-free, tax-deferred, just like an IRA, but on distributions, those distributions will be tax-free. You know, why do you want to do it now? Because you want to take advantage of that tax-free growth and distributions from the Roth IRA, and it's really the distributions, that's the difference between a Roth IRA, and a traditional IRA. And why would you want to do this now? Three main factors driving this. And we're going to go through an example in a second. But three main factors. Number one, your current tax rate may be lower now compared to future tax rates. So if you're contemplating this, if maybe your tax advisers were talking to you about it, and you're contemplating it, if you wait two or three years to do it, you may be in a higher tax rate. Your tax bill just got larger, all right. Number two, 2020 maybe a low income tax year for you. You know, there were a lot of people that have reduced working hours. Their taxable income is lower. We have a lot of business owners out there that have reduced business income, maybe even net operating loss that offsets all their taxable income, or most of it. And so the income taxes you would pay on that conversion, it would be minimal to none, depending on your situation, right? More than likely minimum. If this is a low taxable income year for you. And then thirdly, which I think makes a lot of sense, it's just the account value may be lower today than tomorrow. You know, two years down the road or three years down the road. Again, if you were contemplating it, that tax bill will just grow as these assets continue to grow. And so it will be harder and harder to pull that trigger, to pay that tax man upfront. I know it would be for me, but it definitely can be advantageous.

And so let's run through an example. So Richard, not related to me, he's 49 years old, lives in California. I just happen to live in Jersey, so it's definitely not me, and is in the highest federal income tax bracket. He has a traditional IRA that has $500,000 in it. And oh, and he also has an investment account of 250,000. That investment account is important, because that's the account where we're going to pay the income tax on the conversion. When I take that distribution out of the IRA, how am I going to pay the taxes coming from that investment account? It shouldn't come up from the 500,000, because if it did come from the 500,000, that means less goes into the Roth IRA, you have less working for you. So it's really important that you have the funds in another account to pay for the tax. So Richard is considering converting a traditional IRA to a Roth IRA, and we assume a certain growth rate on the accounts of 5% in both accounts, and in the taxable investment account, we need some turnover every year. So 20% of that growth is taxed each year as capital gains. Okay, here's where the graphs come into play. So our starting point, if we see our starting point for the traditional IRA, it's $750,000, halfway in between 500,000 and a million dollars on the graph. Right, that's the taxable account of $250,000, plus the IRA. The starting point for the Roth is lower, because we have the 500,000 IRA that will go into, is distributed, taxed, goes into the Roth, and I pay the tax out of the 250,000. So just about that entire 250,000 is used to pay the tax on the 500,000 conversion. So my starting point is close to $500,000. We're plodding along, we're going over time, and is growing on a tax-deferred basis. What happens here? Little blip. A little blip in the radar, okay. There's a dip because that's where in the traditional IRA, one is required to take out required minimum distributions.

And when those distributions have to be taken out by operational law, when they come out of the traditional IRA, they're taxed. So you see they tax it, and you see it go down. In order to compare apples to apples, we do the same thing with the Roth IRA. We take it out, and we put it in the, in the taxable account, all right, but there is no tax due when it's taken out of the Roth IRA. Then it continues to grow over time from that point, and you can see that they're starting to get closer. So there's a crossover point, all right. So the Roth IRA is catching up. So the longer, what does this graph tell you? It tells you the longer your time horizon, the Roth IRA is going to make up for that, eventually going to make up for that initial tax payment. But I also think it's important to look at it, the traditional IRA on a graph on an after tax basis. So every year, if I was to take funds out of the traditional IRA, just deplete the whole account because I needed it, what would I be left with after tax? So let's look at the after tax values. You can see the lines have flipped. So in year one, my starting point's the same. I take it out of the traditional IRA, I do the Roth conversion, which is the Roth IRA line. My starting point's the same, I'm paying the tax. So every year I look at it as if I liquidated everything. And you can see the disparity, the tax free, tax-deferred compounding, and the tax-free distributions from the Roth continue to outpace the traditional IRA. I think it's so important for me to mention, when does it not make sense? Because there are certain assumptions that are going in here, okay. And you really have to be able to sometimes predict the future a little bit. And sometimes it's really hard. You really have to know, when do you plan on taking distributions out, as well as know, what tax bracket will I potentially be in when those distributions come out? So way out into the future. This may be the only form of income, aside from social security income. So you may be in a very low bracket. I don't know what the tax brackets are going to look like in 2053, but you may be in a 12% bracket, right? That's going to impact this analysis. So the conversion is not a slam dunk, you really have to look at your own personal situation. It's really hard to make a generalization, but the one generalization I can make is that the power of tax deferral, tax-free compounding, and tax-free distributions is tremendous, and it should not go overlooked.

Especially if you're on the younger side, and you have a long time horizon. Okay. Here's where we get into switching gears. We're going to get into two elections that may save you some taxes, but which aren't going to be for everybody. They're very very specific around those employees, or those individuals, that have equity compensation, or equity awards: shares of stock, stock options, in their employer, in a business. And there are two elections that these individuals have at their disposal that some people are not necessarily aware of. And these elections are called an 83 election, and an 83. An 83 election, 83 is the section of the code, Internal Revenue Code Section 83, or what practitioners call an 83 election. This election you can make for restricted stock and stock options if you have the ability to exercise early before the stock options vest. And all this election says is, you're raising your hand, I don't know if he could see my hand, you're raising your hand and you say, IRS, I want, even though I'm not vested, and the tax event did not occur, I want you to tax me now on it. Because it's only worth a dollar now, and I'd rather give you 40 cents on that dollar today because I know when that tax event eventually occurs, it's going to be worth $10. And I'm better off paying you 40 cents on the dollar today instead of 40 cents on the dollar when it's $10 in the future. Okay, and instead of 40 cents on the dollar when it's $10, I'll pay 20 cents on the dollar, which is the capital gain rate, or 23.8%. Now, then, I'm assuming the capital gains rate in that scenario stays the same. But I'm just describing the election to you. And there are many folks that kind of raise their hand. But there is risk. You pay the tax, you can't get it back. So if the stock goes down in value, somebody goes bankrupt, Guess what?

The government's not going to give your money back. You paid the tax. So you run that risk. With an 83 election, this is available for those that have received restricted stock units in particular, in privately held businesses. So if you have RSUs and publicly traded companies, it's not going to be applicable to you. It's also not going to be applicable to CEOs, CFOs, very, very senior management at these companies. It's really for the broad employee base, where they've vested in restricted stock units. There's a taxable event, but they're raising their hand and saying, I want to defer payment for five years. Because there are many times these individuals don't have the liquidity to pay for the income tax. So the government's saying, we need to give these folks a break and let 'em defer the income tax payment out for up to five years, potentially. So two elections to be aware of, very important. Not too many people know about it, and we talk to our clients a lot about these elections. Okay, moving on to mitigate. I want to stress the importance of deductions, and the concept of bunching deductions. And I'll do that by way of just an example. I'll talk about the charitable deduction, it’s a very common deduction. And I'm going to talk about the standard deduction. So right now, the standard deduction for married couples, it's really high, it's $24,000. So there are many of you on this call that may just not itemize, you just take advantage of the standard deduction. But you do make charitable gifts on a regular basis, but you don't get the benefits of those gifts. So the concept here is that, or the strategy is, bunch those charitable deductions in a particular year that could potentially put you over the threshold. So maybe I'm at $23,000 of itemized deductions this year. You know what, instead of making that $2,000 charitable donation, because I'm not going to get the benefit of it this year, I'll make it next year. I'll combine it with my 2021 donation, and I'll just take the standard deduction this year. And so next year, maybe my itemized deductions are $25,000.

So I'll get some sort of benefit from that charitable deduction. You know, and it works vice versa, where you may want to accelerate your deductions into this year, as opposed to pushing them out into the following year. So that's what I wanted to say about just managing, mitigating the tax liability, and managing it from year to year. Managing your itemized deductions. Work with your tax accountant, very important. Two other tax management strategies that I'm going to briefly cover, net unrealized appreciation, not too many folks are aware of this, but there's many publicly traded companies that have a 401k plan where one of the fund options, the investment options, is making an investment in their employer stock. Okay, and there are employees that have contributed over a long period of time, and that stock has grown over the last 20, 25, 30 years. And there's a large gain in that, in that position. And the idea here is when you're ready to make a distribution, these employees can take a lump sum distribution, and actually request the employer stock distributed to them. And when they receive the employer stock, there's preferential tax treatment where you're only taxed on your basis, which could be very low, and all the capital gains will be long-term capital gains when you actually sell the stock. So this is a strategy again, that not many are aware of. If you do have a 401k plan, you do invest in employer securities, you have the ability to do this, a special tax treatment. Generally speaking, when the basis is below 30% of the fair market value of the account, that's when you want to start taking a look at this, that's really when it's advantageous. And then for employers, there's a concept of an employee stock ownership plan, which is another retirement plan. So I'm an employer, I'm a business owner. I'm looking to sell my business. Under code section 1042, not to get technical on anybody, but section 1042, I can sell that business to a retirement plan where my employees are beneficiaries. And as long as I invest the sale proceeds in an inappropriate manner, we're not going to get into that, but there's a lot of rules around it. I don't have to pay capital gains tax immediately, I can defer it out for a period of time. Employee stock ownership plan. Haven't seen too many of those over the last 20 years or so, 'cause it's really something very specific.

It's got to fit the profile, and year of fact pattern. Very briefly, I'm going to touch upon estate documents. I'm looking at the time, and then we'll cover some questions. I can see a bunch of questions. So I really very briefly want to stress the importance of wills. A will is where you, you know, write down your wishes, your distribution of assets, and how they are going to go to your family members, your heirs. You know, and why do you want a will? You want to name guardians in there if you have minor kids. You want to name a personal representative, an executor, an executrix. They really make sure the documents followed and executed against. You also outlined specific bequests in the will. I want my baseball card collection to go to Nicholas. I want my, you know, wine collection to go to Bob. You know, whatever it may be. And the will can also establish trusts at your passing. So if I'm leaving assets to family members, maybe I don't want them to receive it outright. Maybe I want them to receive it in trust. And there are certain benefits of leaving assets in trust. Asset protection is one. Some of the issues with just having a will. Well, if you don't have a will, state law will dictate how your assets are going to pass. And you don't want state law dictating that. I can't imagine, maybe you do, maybe not. But state law varies from state to state. Number two, the assets that pass through a will pass through probate, court system, which can be costly and take time. There's also some privacy concerns. It's a public record, that process. So there are some downsides to just having a will. How do we fix that? You may be asking how you fix that. You fix that with a combination of a will, where the will just basically names your guardians if you have minor kids, some specific requests you may have, and it says take my assets and put it into my revocable trust to the extent that they're not already titled in your revocable trust. And that revocable trust will transfer your assets to your heirs. And you'd want to do this, you avoid probate. What's important about avoiding probate here is, the assets need to be titled in a revocable trust. So when you set up a will and a revocable trust, you have to make sure that you actually take another step and retitle your assets that would otherwise pass through probate and just your will, and are put inside your revocable trust. And this is going to reduce cost and increase privacy, for those that are concerned about privacy. So it's a combination. We usually call the will a pour-over will to a revocable trust.

Ancillary documents: durable power of attorney, very important. You're authorizing somebody to handle certain matters when you just can't. You're in a hospital, you're incapacitated. You don't have the wherewithal to make decisions, you need somebody to make decisions, continue a gifting program, a charitable program, paying the bills. You need somebody to have that durable power of attorney. Healthcare directives, living will, healthcare proxy. These are all different documents with some overlap, but in essence, it's communicating a couple of things, your end of life wishes, and it's also giving somebody else the ability to make healthcare decisions on your behalf when you can't. So who's going to talk to the doctor, who's going to make those decisions. Very important documents to have, especially nowadays. So key takeaways from today. Looking at the time, we have some questions coming in. Generally, defer recognition of taxable income as long as you can, except where it makes sense. Maximize contributions to retirement plans, one of the easiest ways to defer taxation of wealth. Consider life insurance and annuities as another mechanism. Consider a conversion to a Roth IRA from a traditional IRA. Take advantage of special tax elections and a tax treatment. I mentioned a net unrealized appreciation, 83 election, 83 election, ESOPs, employee stock ownership plans. And just a reminder, establish your will and revocable trust. And put in place those ancillary documents. So questions, I'm going to step out and stop sharing my screen so everybody can see me. Let's go, oh, we have a lot of, a lot of questions here. Okay, is the, let me run through some of these. Is the federal tax exemption per person, or per household? Great question. It is a per person exemption. So that 11, approximately 11.6, if you're married and have a spouse, you have around $23 million, the state tax exemption. So that's quite a bit. And again, that's, could potentially go down to three and a half per individual. You also, as a reminder, have an annual exclusion gift that you can make, gift tax free.

That's $15,000 from each individual, and that resets every year, where the estate tax exemption, the federal estate tax exemption, does not reset every year, that's a lifetime exemption. Is the $400,000 cutoff for single filers or joint married? I don't think that's really clear yet in Biden's tax proposal. Imagine it would be for joint, but it's not really clear. That's a TBD, to be determined. The other question, what charitable deductions can I get this year? I believe there were some changes in the law. There were changes in the law, the CARES Act. There's a couple of things in the CARES Act. If you're making, if you're taking advantage of the standard deduction this year and you're making a charitable contribution, before the standard deduction, you're allowed to deduct up to $300 in charitable contributions. That's what we call an above the line, an adjustment, an above the line deduction, if you will. Also, for those making cash contributions to qualified charities, typically contributions to charities are limited based upon a percentage of adjusted gross income. And that limit is, goes all the way up to a 100% of adjusted gross income this year. So the CARES Act did have a couple of things there. Are there limitations on IRA contributions if we are participating in a 401k plan? There are going to be limitations, not necessarily on the contribution amount, but on the deductibility amount. So you would be able to make a nondeductible contribution, and we've seen a lot of folks make that contribution. Another question, will there be changes in the payroll tax? So I guess somebody's referring there to, in Biden's proposal, the payroll tax for those making $400,000 and more, that 12.2, 12.4% payroll tax, half the employer half employee, will also be imposed on income of $400,000 and over, so that's in the plan. Well, here's an interesting one. Are cryptocurrency gains taxed? Yes, they are. They are taxed. In fact, it's my understanding that the IRS in their forms has a little question at the beginning. Do you own any cryptocurrency? So be sure to fill that out accordingly and appropriately.

They're definitely tracking that out. So can you contribute to the $6,000 to a traditional or Roth IRA even if you do the max 57,000? You can in certain instances, so you can be able to do that. You can do that. Again, your contribution to the traditional IRA will be a nondeductible contribution. Well with the Roth IRA, there's an income limitation when you're contributing to a Roth IRA. I think it's just over $100,000, maybe $125,000 of income. So there could be some folks that aren't able to contribute to a Roth IRA, but you could make a nondeductible contribution to a traditional IRA. That's not going to prevent you from doing that. What account is the after tax contribution in this example going to? So in the after tax contribution in the 401k, it goes into, you almost view it as a regular 401k, and it's going to grow in the same manner. You're just keeping track of your basis, because when you take distributions, you don't want to be taxed on that. And that example, I think, was up to $28,500 that could be contributed on an after tax basis. When you take that 28,500, you don't want to be taxed on that, but it's going to work the same way. All the earnings on that are going to work the same way as a traditional 401k where you're going to be taxed on it. Are you able to touch on the backdoor Roth IRA for higher income earners? Yes, well I was just touching upon that before. So what folks do, some individuals do, is they'll make a nondeductible contribution to a traditional IRA. Because they're there through the income limits, they cannot contribute to a Roth IRA. So they can contribute to a traditional IRA, but it's nondeductible. So you have basis, what I would call basis, in that traditional IRA. And then they'll turn around and they'll convert that traditional IRA to a Roth IRA. And so since you have basis, that distribution, there's no tax due, because you're already taxed on those dollars.

That's how the IRS looks at that. And now it's in the Roth IRA and it'll accumulate. That is the backdoor Roth IRA conversion for higher income earners. However, you definitely need to be aware: if you have other traditional IRAs that do not have basis after tax dollars, a pro rata portion of that conversion will be taxable. So the IRS says you got to lump all your IRAs. You may have three or four different IRA accounts, okay, and they may not all have basis in them, or after tax dollars contributed. You have to look at that, and you have to ratably, on a pro rata basis, pick up some income. Again, just to trap for the wary. Now in the 401k, when you do conversions from traditional 401k to Roth 401k, that pro-rata approach is not applicable inside of a 401k. What is the difference between after tax contribution and a Roth? The contribution itself, there really is no difference. So you have basis in it, in your contribution. I'm still getting lots of questions in here. Well, here's a good one. I'm still getting questions in. Sorry, it's scrolling up on me the moment folks enter, submit a question. Is there a tax benefit in contributing to a grandchild's 529 plan? You know, there is a benefit from the IRA. Any distribution from the IRA is going to be taxable. You know, the only distribution that may not be is a qualified charitable distribution, where you're making the contribution but you're not going to get a charitable deduction for that anyway, and you're not going to pick it up in income. But you know, you want to defer as long as you can. I will say there are just benefits to contributing to a 529 plan, because it is a tax deferred mechanism where the distributions from a 529 plan are not going to be taxed.

You just have to find the right 529 plan that's right for you. There are certain states that will give you a tax deduction, or a tax adjustment, the benefit. I believe New York's one of them. So depending on the state you live in, you want to definitely explore your own state's 529 plan, but you don't have to invest in your own state's 529 plan. But it is another mechanism, aside from an insurance and annuity contracts, and IRAs and 401ks to contribute dollars and to have those assets grow in a tax deferred and potentially tax-free manner. I will say this, for those individuals that are using their annual exclusion gift, I talked about the gift tax exclusion of $15,000. That does use up your annual annual exclusion gift. So I'm just going to take a couple more questions, and then we're going to call it. Um, okay. Taxable, let me see. Most of these are IRA. Let's see here. Well, here's one, sticking on gifting. Like, how should I start gifting today? I would start thinking about the annual exclusion gift, and I would really take a step back, just look at your own personal cash flow. If you're worried about that estate tax exemption coming down, or want to use your utilize your annual exclusion gift, your $15,000, or you want to gift capital gain property to somebody in a lower income tax bracket, right? To take advantage of their lower income tax bracket and give them something, you really want to make sure that you have the wherewithal to do that. There are so many times where I've seen you know, individuals maybe give too much away, and they have to bring it. We're doing reverse planning, trying to get it back, because they gave away something that they really needed. Final question here, is there a limit to income for the Roth conversion this year? When you do a conversion from an IRA to a Roth IRA, there is no income limit. So you can make a hundred million dollars, and you can still convert your traditional IRA to a Roth IRA. There's only an income limit on contributing to a Roth IRA. So, with that, I'm looking at time, got a lot of questions. I really want to thank everybody for joining me. They had great participation. It's always a pleasure speaking to everybody. Enjoy the rest of the week, I know I definitely will. Take care, be well.

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