Watch a collaborative discussion featuring three of our senior First Republic Private Wealth Management leaders, who collectively have over 75 years of industry experience.
Our panel will address the current tax landscape and potential changes on the horizon along with the implications for wealth transfer strategies. Panelists will also explore how to navigate the impact that significant wealth transitions can have on recipients.
Read below for a full transcript of the conversation.
Rich Scarpelli - Welcome everyone. And it's a pleasure to be speaking with you today on transitioning your wealth, strategies to consider in 2021. I'm sure it's going to be a very interesting year for many of us. Before we start to introduce ourselves there are a few housekeeping items I'd like to go over. First we will be taking questions and we will definitely save some time at the end to address some of those questions. But we are going to try to answer some of those questions throughout the discussion that we're going to have today. If you would like to ask a question please submit the question through the Q&A function at the bottom of your screen. Thank you, I appreciate it. And now for introductions, I'd like introduce myself, I'm Rich Scarpelli, at a financial planning at First Republic and I'm joined by two great colleagues of mine, Stacy Allred, managing director and head of family engagement and governance. I'm also joined by senior managing director, regional leader for advanced planning at First Republic, Miranda Holmes. Welcome the both of you. There is a lot going on, so many great ideas and thoughts to share with everyone. I think this is going to be the year where my hair goes entirely gray. I'm really not too sure where to start, Miranda, here do you think we should start today?
Miranda Holmes - Rich, let's start with the current tax landscape. So where do things stand right now?
Rich - That's a good question. Why don't I bring up a slide to share with everybody? Let me just share my screen. Okay, so what are we looking at today? Well, let's start with what we're looking at today and what are some of the potential changes, coming down the pipe? So today we have a top income tax bracket of 37% today. We have a current long-term capital gains tax rate, that's top rate of 20%. Now there's also the net investment income tax with 3.8%, the surtax people refer to it as the surtax. So it could be as high as 23.8% close to 24%. Currently the federal state tax exemption is $11.7 million. That's the amount one can transfer either during their life or at death, the state and gift tax rate and the current federal estate tax rate is 40%. So that's where we are today. There are a lot of other taxes, there's corporate taxes, payroll taxes, et cetera which we're really not going to get into. But today we're going to focus on these taxes. What could it look like tomorrow in a Biden administration? So the top bracket could be as high as 39.6 for high-income earners, those income owners with $400,000 or more. Also the long-term capital gains rate for high income earners and that would be defined as having a million dollars of taxable income or more. That long-term capital gains rate could go from 20% to 39.6%. The surtax, we're really not too sure where that 3.8% surtax comes into play and a 39.6% rate environment, is it an additional tax? Are they going to do away with it? So that's on the income tax side. Miranda, why don't you touch upon the estate tax side?
Miranda - Yeah, so Rich, the estate and gift tax side may be changing as well. The current gift and estate tax exemption is 11.7 million per person that you can give throughout your lifetime or when you pass away. And this is set to revert back to 5 million adjusted for inflation at the end of 2025. However, there is talk of reducing the exemption sooner than that, possibly later this year, we could see some tax law changes reducing the exemption to three and a half million per person, or possibly even reducing the lifetime gift exemption to $1 million. That would be a really significant decline. And the current estate tax rate of 40% may also be increased.
Rich - Yeah, so those could be really some significant changes in the tax landscape. So many things going on, but like I said before there's also the business taxes, payroll taxes, thinking to the estate tax side. People also need to be aware that there could be an elimination of what we call the step-up in basis at one's death. So today Miranda heirs may not have to pay much in terms of capital gains tax, if they sell assets soon after they receive them from permanent estate that's because the cost basis has stepped up to full fair market value on data death. So when we look at the exemption going down as well as the state tax rate going up and the potential for the step-up in basis to go away significant tax increases could be in play in the near future.
Miranda - Yeah, up in basis and federal capital gains rates increase significantly. We may have to radically change the way we address low basis assets in an estate. So that's something that we're looking at right now. Also, there's some renewed discussion of a wealth tax. So the ultra millionaire tax act is proposing a 2% annual tax on wealth, over $50 million. That would go up to 3% for wealth over a billion dollars.
Rich - Yeah, I'm going to add Miranda, I'm going to add another item. We really can't forget about the states as well, New York, New Jersey, California. Yeah, who knows what they're going to do, what they're not going to do, it just for an example in New York state, there was a bill introduced to put in place an in inheritance tax. Like, wow, I'm not saying that's likely to happen, but clearly states are looking for additional sources of income, additional sources of revenue, even Hawaii has a bill to increase their capital gains and income tax rates. Washington state has it as well. What about California? Are you seeing anything in California, Miranda?
Miranda - So right now there's no talk of a California state inheritance or a state tax. So that's great. We are seeing a lot of folks individuals and families leaving California or maybe considering leaving California because of concerns about rising income tax rates as well as last year, there was a discussion over the course of the summer about potential California state wealth taxes. There was also a discussion of the top California income tax brackets going up as well. So I think people are thinking about that a lot and with the potential for higher federal long-term capital gains rates for individuals earning over a million dollars that means that wealthier California residents are looking at a significant total tax rates when you add in the California state tax. So I would note, if there's anyone considering changing residency from California to another state it's really important to work closely with the tax or your tax advisor to make sure that you're taking any necessary steps to minimize a potential challenge from the California Franchise Tax Board because we know that there are lots of challenges going on. And then so California tax payers and those in other high income tax states like New York are looking for ways to minimize their overall tax burden. And one of the things we've been seeing more of is California residents establishing trusts in other States. So First Republic has a trust company in Delaware and a trust company in Wyoming. And we have clients who are establishing non-grantor trust in those days for the benefit of kids, grandkids and other heirs who may live outside the state of California non-grantor trusts are trusts that pay their own taxes. So a trust that situs and a non-income tax state or a low-income tax state like Wyoming or Delaware can potentially reduce or even eliminate state income taxes. Now on that subject, some people in the past have established trusts known as names or dings or wings. So you might've heard of Delaware or Wyoming incomplete gift non-grantor trust. This is where the grantor is a beneficiary of the trust, the grantor is the one who sets up the trust. They're also a beneficiary of the trust but they give up control over the assets. It's important to note that the California Franchise Tax Board recently proposed legislation to treat those non-grantor trust as grantor trust for California tax purposes with an assumed enactment after June 30th of this year. So if that legislation were to pass that would mean the California taxes may be owed by the grantor, the creator of the trust on those wing and ding assets. I think that's really something important to think about.
Rich - Thanks Miranda, I'd like to comment a little bit about 2020, 2020 was really busy, like we haven't seen before and 2021's probably going to be no different. But a lot of clients and folks that we talked to, they were concerned about the window closing for making gifts and transfers. We're worried about that exemption shifting sooner. And now that those clients have made the transactions, what sort of the ramifications, what's the after-effects, now that they're catching their breath, what are they thinking about now now that they've completed those transfers?
Miranda - So, last year we saw a lot of transfers happening. It was really busy. We're still seeing a significant amount a wealth transfers being contemplated and completed. So I was working with a couple last year, they wanted to minimize the family's estate taxes. So we started to talk about setting up dynasty trust in Wyoming or Delaware. They have an older daughter who's age 30. She just had her first child, so now there's a new grandchild in the family. Their son is age 27, he's a scientist. He just founded a nonprofit organization to work on climate change. He's not necessarily making a whole lot of income but his parents are very proud of what he's working on and wanted to support his efforts by providing him a regular income stream from the new trust. So in conjunction with transferring their gift tax exemptions to the Delaware Dynasty Trust I suggested that they have a family meeting with their adult children to talk about what the children's goals and needs are, going forward. What is it that their son for example might need from the trust? And so my clients loved the idea. They weren't sure where to start. So they weren't sure how to frame and structure their family meetings. They weren't sure how much to share or not to share. So Stacy, how might clients go about entering into these kinds of conversations?
Stacy Allred - Miranda, it's an important question because we know firsthand that initializing these wealth conversation is a moment that matters, has an outsized impact on how well family members will integrate wealth into their lives. We also know from the research that the number one reason that wealth transitions fell is because lack of trust and communication within the family. So it's well worth the effort to put some extra care into constructing this dialogue. I want to invite you into the bowling alley. Think about, you've got the ball in your hand and as you mentally and physically prepare to make your move you're aware of the gutters on both sides. What you stand against. Let's say that gutter on the one hand is under-communicating. We're sharing information too late, now this is the most common style that we see, why that family members are worried about the, knowing about the wealth will undermine motivation and they're not sure where to start, so they don't say anything. On the other gutter, less common is sharing too much, leading to overwhelm. Now that we've defined the gutters, let's look at that middle of the lane. And while you want a strike, ideally you still get points just by being in the lane. So there's a wide amount as you determine what it looks like in your family to share the right amount of information at the right time. And often times it's helpful to start by, if you're having a hard time defining what that right amount of information is, start by defining the gutters. What's too little, what's too much and then let's move into the lane. So how do we work with families to define what that lane looks like? We have a four step process. Now, most people start, this is a trap with the what, and we say, there's a step before that which is really important. It's kind of the Simon Sinek, start with the why and providing the context, what's the purpose of our wealth, our values, our operating and principles. Once that's defined, you can start to get into the what, what can I, as a beneficiary expect, what can I not expect? And also what is essential of me it's this last step that turns it in from a one-way street of receiving to a two-way street. One family had the slogan that along with the privilege of wealth from responsibilities and here's what those responsibilities are. Now remember, this is a series of thoughtful conversations over time when you're using the four-step framework in the beginning conversations, it's very high level. Over time, you're getting into more detail and you're disclosing numbers as appropriate. So what did this look like in one family? Here's an example of the why and one family, their purpose, the essence of it was flourishing. They wanted the wealth to be fuel for family members becoming the best versions of themselves.
They were very focused on a productive path. They wanted the family to remain connected, they didn't want money to undermine those family relationships. And of course they wanted to have positive impact in the community. So if you think about the way they structured the wealth and the way they communicated this structure it aligned to support this purpose. And there were five key pillars in supporting these purpose ranging from family connection to the productivity, health and wellness, financial security and making the world a better place. So for a family, with kids in their 20s they really started to talk about what that looked like. So for family connection it was all about family vacations and travel. They funded a family meeting for meaningful productivity, in our family you can graduate debt-free, kindergarten through PhD will be paid for with the serious participation of the family member, leading towards an objective, we'll pay for a life coach, will pay for seed capital of starting a business with a valid business plan vetted by an outside family member. I want to share just one other piece of this communication strategy. In this family it was really important that the family members fund their own, the bulk of their own lifestyle. Now, the family had set themselves up for success by saying, we're paying your education. We're helping you with a first time home. We're buying you a car, but we're not going to take away the necessity to work, really important in the 20s to have that productivity. And so that's what it looked like in one family and each family's unique and different but you start to get a sense of these money conversations are not a big reveal. It's a series again, a thoughtful over time.
Rich - So Stacy, in determining how much to share what should families consider?
Stacy - We would invite our listeners as you're creating your own wealth communication plan if you haven't already done so, to consider the following, the first one is what information is already publicly available. So if you Google yourself, what's out there. And then consider what is the narrative that you want to steer versus leaving it up to the web. Next ask yourself what are the pros and cons of communicating about money versus the pros and cons about not communicating about money? This important question gets us out of our emotional brain and into our thinking brain and can help us take that next step. Look at the emotional readiness of your beneficiaries not just age, the relevance, how will wealth impact them over the next couple of years? And then lastly, take a look at any upcoming milestones where assets would need to be disclosed such as entering into a prenuptial agreement. Ideally, you want to get ahead of any upcoming milestones.
Rich - Stacy, just occurred to me when, I'm going to jump in here and ask you a question stick with you, when we think about families and communication between family members and generations, multiple generations, I think it's really also important to understand the family composition as well. I was reading something recently from a Pew Research Center where it had some interesting statistics on family composition. It was talking about how in 1960 there's really one dominant family forum. And at that time, 73% of all children were living in a family with married parents in their first marriage. Today it's my understanding for this research that it's less than a half around 46%. So there are a large number of these, what I would say is non-traditional families, blended families, if you will. And what are these families do differently, if anything at all, or is the same game plan when communicating between generations and just family members at the same generation.
Stacy - Great question, Rich and key differences really depends on the timing of the blending, the relationship and the source of wealth. I'm sure your team sees all the time that sometimes the amounts that family members are receiving with gifts and inheritance can be different. So keep that in mind as you're constructing your communication plan, for some blended families they might meet together to discuss philanthropy. And then if the inheritance amounts are different, they'll get an or when you get good detail of more than numbers, more of the reveal conversations, you might do those separately. Next and this is true for all families. It can be helpful to take extra care in considering the well-researched top needs in relationships as you construct the dialogues. And those four top needs are the needs to understood, appreciated, respected and lastly, the need to protest and be trusted. So Rich, it's important for families all, again all families not to fall into the trap of the most common style of parent that parents youth when they talk to their kids about money, the so-called Hellene conversation. Instead, the much more effective approach is a learning conversation where you arrive prepared to share what's on your mind and also curious and open to listening and learning what's on the mind of all family members.
Rich - Yeah, Stacy, I'm a big believer in documenting, putting things on paper. How important is it to document the shared values concept that you're talking about?
Stacy - I'd like to share a quick story here in service to helping our listeners see around the corners. Years back I met with a couple and they were part of a blended family and starting with blank flip charts and markers through a facilitated dialogue we spent the day co-creating bulleted value statements, values in general and values around the earning, saving, spending, and sharing of money. Years later, the patriarch passed and I was called back in to meet with the matriarch and her trusted advisors in supportive of making some, her making some big financial decisions. She shared how overwhelming it was, now in her new role as a widow, suddenly be the key financial decision maker. We started the meeting by going back to this work we had done years prior of these bulleted value statements, two pages worth that collectively formed the framework for financial estate and lifestyle decision-making, mom started to enter the room as you could feel the voice and the wisdom of the patriarch. Collectively and then as we spent the day together to work through these decisions, including decisions that impacted her husband's children from a first marriage, she did an amazing job of honoring their shared values in making these decisions. And all too often, we hear these stories about estate planning, where one of the wealth creators is gone and what rolling out, they said, oh, they would roll over in their grave. This was the opposite of that. And it's hard to put into words, the difference that the values framework made for effective decision-making at are really critical time. It was one of the most gratifying experiences in my career. And I hope this story inspires our listeners who haven't already done so to create a written set of value statements. Rich, I'm going to turn it back over to you. Speaking of blended families what are some strategies that a blended family might consider?
Rich - Well, thanks Stacy. So back to me, so when I'm thinking about strategies that blended families should consider, blended families, aren't unique but neither are some of the strategies and the strategy that I think I'd like to talk about most is something that's often overlooked it's incorporating life insurance into the overall plan. And there are a number of advantages that life insurance can have. And let me just go over several key areas. First life insurance can provide an estate liquid with liquidity, liquidity needed to fund some costs, it could be the estate taxes, if you will. So that's the first thing and that's really an easy solution to implement. Number two, it's really easy to implement a solution where life insurance can act as a great tax deferral vehicle. Number one, proceeds our income tax rate. And then if structured properly the life insurance proceeds won't be subject to estate tax as well. And then lastly, if folks are entertaining a policy where there's a buildup of cash value, built up over the underlying investments and they plan to take out those assets for various reasons the growth on that may also not be subject to income taxes when it's taken out, if again if structured properly. So a great, the second point is it's a great tax deferral, tax management wrapper. Thirdly, it could also serve as a great alternative asset class and investment option where it would have an impact in terms of a portfolio performance, as well as volatility. And then lastly, I guess, lastly, to get to your question Stacy is when did family specifically it could play a major role in equalizing one's estate with a couple of other advantages. Number one, it allows families to equalize the states without transferring significant assets, year marking specific assets that really may have an emotional component to them and really may cause conflict within a family. And then also it avoids splitting really hard to split assets. Sometimes it's a major headache, it's a major problem. And the second advantage which I alluded to before in my first point was just ease of implementation. And sometimes this is often overlooked, incorporating life insurance in an overall plan but it can be fairly easy to implement and mitigate family conflict, if you will. There are lots of strategies out there. That's just one solution that could be applied. Miranda, is there anything that you're talking to your clients about?
Miranda - Yeah, so last week I was speaking with a client about diversifying some of his concentrated stock position. And this particular client has hundreds of thousands of shares with varying basis, tax basis, some high basis, some lower basis. And he's in need of some liquidity this year. So under normal circumstances I would generally advise a client to sell the higher basis shares that are subject to long-term capital gains in order to minimize and defer taxes to the greatest extent possible, which also helps a client retain low basis shares to use for charitable donations. But this year with the possibility of a significant income tax increase in the federal long-term capital gains rates, we discussed something a little differently. So we talked about first determining how many shares should be retained for charitable purposes and set aside the lowest basis shares for that. Then taking a look at the next lowest basis shares and this year selling those, excuse me, next lowest basis shares to take maximum advantage of the current 20% long-term capital gains rate. so we can leave the higher basis shares to sell in future years when the tax rate may have doubled potentially. Now it's really important to consider the advantages and disadvantages of doing that. But we're thinking about this in a whole different way than we typically would have in the past. Also clients who have qualified small business stock or QSBS may want to consider ways to multiply their QSBS exemptions by transferring portions of that stock, to non-grantor trusts for the benefit of children or other family members. And for those people who are still thinking about whether or not to use their 11.7 million gift tax exemption for wealth transfers outside their estates especially those who may be concerned that transferring for a married couple $23.4 million that might be just too much for some people. Or they only want to give to 11.7 million instead of 23.4, it may be valuable to consider establishing and funding a spousal lifetime access trust or SLAT in which one spouse establishes his or her trust.
And in addition to the children and other descendants also names the other spouse as a beneficiary, so that distributions could be made in the future to the beneficiary spouse if needed. So I would encourage people to act on this sooner, rather than later, there is some possibility that any new tax legislation later this year has the potential to take effect as of the date that the legislation is introduced. That means if new legislation was introduced, for example on June 30th, it could take effect as of June 30th, even if not actually signed into law until later. Also it's a good idea ff you're creating a brand new trust to consider including a substitution power in the trust to give you flexibility, to swap out different assets of equal value in and out of the trust in the future. So it's a really valuable piece of language to have included in the trust. There is a slight chance, also I mentioned the effective date of new tax legislation. There's a slight chance that we could see new tax legislation made retroactive to January 1st of this year, I would say it's unlikely, but it is possible. So we have some clients who decided to transfer a large amount of illiquid assets to dynasty trust last month. And the estate attorney was concerned about the possibility for retroactive tax law changes including reductions to the estate tax exemption. So what was done is they use a defined value clause with the gift to ensure that if the exemptions are reduced retroactively, the gift tax would be reduced. The gift would be reduced and the clients would avoid a very large and unexpected gift tax due. So if you are considering large gifts, talk to your estate attorney about the possible risk of any retroactive tax law changes and whether you should be taking action to mitigate those risks. So those are some of the ideas. Stacy, so much work goes into first creating the wealth and establishing structures and making the gifts. What actions can families take to bolster the wealth having a positive impact on the lives of the family members.
Stacy - When you look at the leading research in our space, it's by Dr. Dennis Jaffe and he spent years studying over 100 families who had sustained the wealth into the third generation and beyond, so around a 100 years. This is all documented in his wonderful 400 page book "Borrowed from Your Grandchildren." We partnered with Dennis recently to publish essentially an executive summary of this research, eight insights from long lasting global enterprising families. And you can see the link in the chat, you can find it on our website, ask your advisor. But one of the core themes of this research of what actually works is that these families really take seriously this idea of developing a learning family. So I want to bring you, you've been to the bowling alley, now we're at the escalator and this escalator is going down but there's a plot twist you are facing up and you're just trying to stay in the same spot. But with this escalator going down, you have to keep moving and learning and growing just to stay current. Well, this is like our current environment that we're all in with the increased complexity and the speed of change just to stay current, in the same spot we need to keep learning and growing. And so an MIT professor, Peter Senge came up with the idea of the learning organization. We borrow that idea and bring it to the family. So a learning family is a family that has a shared purpose and they continually increase their capacity to create what they truly want to create. In fact, the early adopter family offices have a new position called the CLO or the Chief Learning Officer. This is how important it is. So as we thought about, in our experience what are the core competencies needed to effectively integrate wealth in partnership with our friends at Money Meaning and Choices Institute we developed ten core competencies, now five are external, what you know, your financial skills, wealth and life planning, stewardship, and governance, et cetera.
And the other five are your internal or your vertical development, who you are, your wisdom, your EQ, that learning and growth mindset, responsibility and accountability, et cetera. And so it's interesting because when family, that when parents come to us, and they are requesting help to educate their children, they're in for a surprise because our model goes from age five to 100, including those last vibrant chapters of life. Because a learning family is a lifelong learning family. And so our 10 by 10 model looks at the 10 life stages. And then looked at the nuance of how these 10 core competencies look at each of these 10 life stages.
Rich - Thanks, Stacy really appreciate it. And we're at the past the bottom of the hour, I'd like to open it up to questions soon but I really think it's important to touch upon another strategy that I think everybody should be aware of. It's called a grantor retained annuity trust. So let me just bring it up. Share my screen. Next slide of grantor retained annuity trust. Now why do I want to bring this up? I want to bring it up for a couple of reasons. Number one, it may come under scrutiny. Okay, there's been talk over the last 15, 20 years that Congress may pass laws that would make it less effective and that's no different this year. Secondly, it's a to try and choose strategy that we've been talking to our clients for a very long period of time. And it's really effective in low interest rate environments. And even though we've seen an uptake in interest rates, they're still low. And so this is really a very viable strategy. And the idea behind a grantor retained annuity trust, in essence, you're trying to remove further appreciation from your estate. You want to freeze your balance sheet for estate tax valuation purposes. And what this strategy also does, it allows you to use your estate tax exemption that 11.7 million that Miranda was referring to for other strategies such as the spousal lifetime access trust that Miranda went through. So why don't we just run through a quick example and then we'll open it up for questions. So people have a sense of how it works. So you being the individual, you would gift assets to a grantor retained annuity trust the acronym, GRAT. This GRAT would pay an annuity stream back to you. And here in this example, it's over three years. When you initially established the GRAT the grantor retained annuity trust, it's irrevocable once you establish it, but you determine the number of years at that point in time. And why is that important in determining the number of years?
Because if one should happen to pass away during that term then those assets are brought back into your estate. So you would really need to outlive the term. So you may not want it 10, 15, 20, or 100 years but you may not want it to, something in between where you can capture the appreciation in an asset and you intend to give assets that are going to appreciate significantly over a period of time. So if we look at the numbers behind it, in that example, if one gifts $5 million of assets into a grantor retained annuity trust and that $5 million is sitting in there and let's assume it's a 10% growth rate on that, the first year annuity payment, again based upon current interest rates, because you're doing a present value calc of the annuity stream. That first year payment is almost 1.7 million but the assets continue to grow at 10%, that leaves 3.8 million. You make another payment of 1.7 that leaves 2.5 at the end of the year two. And your third and final payment of 1.7 leaves you with about 1.1. So the total annuity payments back to you is a little over $5 million. You put 5 million in, you got 5 million back plus a little interest. So the IRS looks at that as not having to make a gift because you've given something, but you've taken it back. So, it doesn't need into your estate tax exemption. What's left at the end the 1.09 or the 1.1 can go to your beneficiaries or into trust for your beneficiaries estate and gift tax free. And again, like I said you can use that exemption for other purposes. So before we turn to some questions just items to consider given the potential tax law changes, capital gains, if you plan to recognize significant long-term capital gains in the near future and have control over the timing you may want to consider accelerating those gains now to take advantage of the lower rate, well, but there are so many things that can come into play whether or not you're charitably inclined that will factor in because you can give away those assets that have an embedded capital gain whether you're not, you have a gifting program to other family members potentially in a lower bracket, what bracket you're in could impact how those gains are taxed. There's a lot of other factors to consider.
As we talked about consider strategies that utilize your gift tax exemption in a way that provides flexibility. Something that we didn't mention here is making loans to family members at really low rates and then those family members investing those proceeds in higher earning assets, and then paying you back with such a low interest rate, it's just principal and a minimal interest rate that's spread there could also pass on to your heirs estate and gift tax rate and gives you a lot of flexibility. And then also the last thing to consider that could come under some scrutiny is this concept of family limited partnerships and LLCs. There are many of our clients that will give minority interests in these entities to family members. And when you do that, you can take what you call evaluation discount where the underlying assets, for example maybe worth a million, but for wealth transfer purposes and valuation purposes, they may be worth 750,000. So that discount can be anywhere from 20% to 30% depending on the underlying assets and what they're made up of. So for that state tax valuate or gift tax valuation purposes, it could be 20 or 30% lower. That gift tax value allows you to pass on more but that could also come under scrutiny over the next 12 months or so. So why don't I stop sharing. Miranda, well, I saw a question come up and I know you brought this up before qualified small business stock, our audience may not know what that is. Could you share a little bit about what that is? I saw a question come up, like, what is this?
Miranda - Yes, absolutely Rich. So qualified small business stock, or QSBS is a stock in a C corporation that meets certain IRS rules that's really intended to encourage investment in certain small businesses and provided that you hold your QSB stock for at least five years, some or all of the capital gains can be excluded from federal capital gains tax up to the greater of $10 million or 10 times your cost basis. So there are a bunch of requirements for qualifying for QSBS treatment. Those include acquiring the stock directly from the company when its gross total assets are and have consistently been below $50 million. Exclusions are also per taxpayer. So there are ways to your QSBS exclusion using gifting and other strategies.
Rich - Thanks Miranda, there's something coming in a topic we didn't cover, opportunities zones. Should I consider opportunities zones to help manage capital gains tax? So why don't I just touch upon opportunity zones, opportunities zone was a recent enactment over the last couple of years, where if an individual has recognized a significant capital gain or a capital gain they can take the proceeds and reinvest it and they have 180 days to do so, they can reinvest it in qualifying assets, opportunity zone funds, if you will. Reinvest it in qualified assets that reinvest in certain low income, low economic zones throughout the country that had been designated by the treasury. We won't get into how that was done, but that was done. And in doing so and making that contribution of those gains that you've recognized, you're actually rolling it forward and they're not going to be taxed now. And that's going to continue to be invested in that opportunity zone fund these opportunities zone assets, these business assets, et cetera. And the tax triggering event will come in 2026 where that gain is going to be recognized in that year. However, if you do hold the asset for 10 years, beyond that, any appreciation beyond your initial investment because it would be all the capital gain could potentially be income tax-free as well. So, that's really in essence high-level how it works. Is it a good way to manage your capital gains tax? Sure, I would say never let the tax tail wag the dog. So if it's a good investment option for you based upon your risk profile and your portfolio, then yes, absolutely it's definitely an opportunity to manage the capital gains tax, but again don't let the tax tail wag the dog, make a good investment choice first and then figure out how to manage your taxes. Another, let me take a look. Another question, how best can I use the annual gift amount? I believe it is still $15,000. Stacy, do you think you can take that?
Stacy - Sure, so not only are annual exclusions good template standpoint, I want to take this, I love the question more along the themes that I was focusing on which is the communication and the skill building. So making an annual exclusion gives a great opportunity to practice those communication skills. So if you guys remember our four step framework what's the purpose of that gift? What can I expect? What can I not expect? And what's essential of me. So, and then we also can use that annual exclusion gift provides a really nice feedback loop to say why was my family member interacting with money. We all make a lot of, we make mistakes with money, this is a simpler, more safe to fell place to make mistakes with money. So, very quickly, let me give an example. One family had been making annual exclusion gifts for years and the communication was pretty light but it was very directive. Dad made the gifts and he said, put the, this needs to be invested completely. And so every family member and their spouses, the adult kids and their spouses very diligently invested the money every year, every cent. And then one year dad said, wait a minute, no, one's really getting to enjoy, or the annual exclusion gifts. And so the rules changed. So we had a family meeting and explained that this year the annual exclusion gifts were different. Your job this year was to decide in the framework of save, spend, invest and share, not share because that was done through the family philanthropy but so save, spend and invest what to do with it. But with an encouragement to do something that really more on the spin side, that made a difference in their lives and to come back and report back with that next family meeting. And so they started to get more experienced. So the purpose of the annual exclusion gift can change over time. And we really like providing some structure with that in avoiding that trap of giving a check saying cash this by the end of the year it's a real teaching opportunity for all. And one last thing would be there's a great book called "Cycle of the Gift." And, it would be a nice gift book to read as you're making an annual exclusion gift to have more context of what does it mean to be an effective giver and what does it mean to be an effective receiver?
Rich - Thanks, Stacy, why don't we take one more question and then we'll wrap it up. We're approaching the top of the hour. This is going to be a big deal. What should anything additional to consider as to whether or not to recognize gains this year versus out in the future? So I think it's best to think about it in terms of framework and Miranda, feel free to comment as well. Now, the way I think about it, I'm thinking about frameworks. So one framework is, you know you're going to sell next year and you're pretty positive that capital gain rates are going to go higher and you really want to manage it and minimize it. And if you know, you're definitely going to sell, then yeah, sure it makes a lot of sense to recognize it this year. You got really have to have a good crystal ball in two respects. Number one, that the sale was going to happen in a higher tax rate environment and the tax rates are going to go up. And that's the crystal if you have that crystal ball, yes, it makes a lot of sense. Another framework to think about is all the other components that I was talking about before, just in terms of am I giving away to charity, am I giving away assets to kids? What sort of other things are going on in my life and my tax life that may impact any analysis that's being done. And then thirdly, you can also look at it from the perspective of, so what's my breakeven point. So if I were to sell today and it's in a lower income tax rate environment and this is like the third framework, if I was to sell today in a lower tax rate environment versus two years, three years or four years in a higher tax rate environment what sort of return would I need on that asset in order to cover the increased tax payment. And that can give you a really good framework. And really what's going to hinge on that and what's going to really impact that analysis is the relationship of your cost basis to the fair market value. So it's going to vary depending on the asset and the makeup of that asset in terms of cost basis and fair market value. So that's how I would think of it. Miranda, I don't know if you have anything else to add if not, we'll just wrap it up. I have some closing points that I just wanted to make but anything to add Miranda.
Miranda - Well said Rich.
Rich - Oh, thank you. I appreciate the compliment. All right, so let's close. Let's wrap it up. Thank you, Miranda. Thank you, Stacy. Thank you all for joining us. Some three key takeaways, knowledge is power, stay informed about the potential tax law changes, know about them. Number two, explore some strategies that we've mentioned on this call, exploring with your advisors, really important to talk to them. And then number three, don't forget about the impact these strategies have on your family members, the emotional aspect, it could be critical to a successful plan. So take care, enjoy the rest of your day or evening depending on what coast you're on. And look forward to speaking to you again in the future. Bye.
