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Shaky Markets Create Tax Opportunities for Estate Planners

Posted on Mar. 11, 2020

Amid the financial turmoil resulting from coronavirus concerns, estate planners have many tools and techniques they can use to help their clients capitalize on the chaos.

“There is nothing better than a really brutal market to remind all of us that we can’t have all our eggs in one basket,” Robert S. Keebler of Keebler & Associates LLP observed. “This is Old Testament logic — we know that, but we need to sometimes bring discipline, and we need to sometimes remind clients of the need for that discipline.”

On the income tax planning side, conversions to a Roth IRA “kind of speak for themselves” with the market in a slump, Keebler said during a March 10 Leimberg Information Services Inc. webinar. “The real goal here is to thread the needle at the depressed price. There’s no magic here,” he said.

The taxable income of a traditional IRA in a Roth conversion is determined based on the value of the assets on the date of conversion, so making the conversion now, when the market is down, effectively reduces the price of the conversion, Keebler said.

Taxpayers should also consider harvesting losses, Keebler said. If clients suddenly find themselves with losses in their portfolio, “the smart move is to harvest losses . . . but then quickly stay in the market,” while being careful to avoid wash sale rules, he said.

Keebler explained that the basic strategy is to sell assets at a loss and then use that loss to offset capital gains on other assets, which reduces or eliminates current capital gain. Once the asset is repurchased, the taxpayer has lower basis in that asset, increasing the amount of gain that is recognized when the asset is later sold. The total gain recognized is the same, but “the loss harvesting itself creates a timing benefit. That is going to create tremendous deferral,” he said.

Estate and Gift Tax Planning

The market slump and low-interest-rate environment have combined to make this an ideal time to implement estate and gift tax planning strategies, according to Keebler.

A down market is an opportunity for clients to make outright gifts, because assets that are undervalued make for tax-efficient gifts, Keebler said. The amount of gift tax exemption used or gift tax assessed is based on the fair market value of the asset on the date of the gift, so there will be lower overall transfer cost and no further appreciation of the asset within the estate, he said.

Now would also be a good time for taxpayers to make late allocations of generation-skipping transfer tax exemption. If estate planners have clients with trusts that don't have an inclusion ratio of zero, but still have GSTT exemption at their disposal, those clients may want to consider fixing those GSTT trusts now that it’s more cost effective to do so, Keebler said.

“Right now, the trust just got beat up valuewise, and we might still have a little bit of [GSTT] exemption left. We can go back and do a late allocation of [GSTT] exemption,” Keebler said. “That’s incredibly powerful.”

Similarly, if a taxpayer has used all their GSTT exemption and they have taxable GSTT trusts, they might consider making taxable distributions out of the trust while the value of those distributions is less in order to minimize exposure to the GSTT. “If you’re going to have [GSTT] anyway, you should just bite the bullet and incur it right now by distributing stock out,” Keebler advised.

Interest(ing) Ideas

The low-interest-rate environment is also one that is highly favorable to many estate tax planning techniques.

“Big picture: Interest rates are incredibly low,” and interest rates in April are going to be lower than those in March, Keebler said. “We’re certainly going to see a real window of opportunity in April of 2020” to lock in the benefit of those low rates, he added.

The low interest rates make grantor-retained annuity trusts (GRATs) — in which assets are placed in a trust for a period of time and then any appreciation on the asset beyond the monthly section 7520 rate goes to the beneficiary of the trust tax free — especially appealing.

“GRATs at this rate have almost no risk,” Keebler said.

An even more basic option is for the grantor of a grantor trust to exercise a power of substitution, which allows grantors to swap assets in a trust for assets of equal value, according to Keebler. “This market volatility presents opportunities to use this power,” he said.

This would allow a grantor to swap assets that are primed for growth into the trust in exchange for assets with lower potential or lower basis, Keebler explained.

“If I knew I was gonna die tomorrow, and I had in a grantor trust a million dollars’ worth of stock with a basis of $100,000, and I could swap into that a million dollars’ worth of cash or a million dollars’ worth of basis for another property and take back my low-basis stock and get a step up [in basis] on that, that is exactly what I would do,” Keebler said.

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