David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Worldwide Tax Daily. This week: Too soon? With the U.S. presidential election on the horizon, popularity of the Tax Cuts and Jobs Act remaining flat, and some of its provisions set to expire in the coming years, we're taking a look at what practitioners should be planning for in this environment of uncertainty. Joining me in the studio is Tax Notes Today reporter Jonathan Curry. Jonathan, welcome back to the podcast.
Jonathan Curry: Hi Dave, glad to be back in the studio.
David Stewart: Now you recently spoke with a practitioner who has been thinking about these questions. Who did you talk to?
Jonathan Curry: I talked to Brad Dillon. He's the director of fiduciary tax and trusts in Brown Brothers Harriman's New York office.
David Stewart: What did he have to say?
Jonathan Curry: We talked about a couple of different topics. We talked about the prospects of policy change and the future 2020 election, as well as what might change even if the election results don't really change a lot politically, we could see that some of the TCJA provisions expire. We have things like the 199A deduction set to expire in 2026. The estate and gift tax exemption is gonna expire absent any action. And so there's a lot of sort of planning considerations around that. How do you mitigate the risk and how much stock should you put in any one particular proposal? We also talked a little bit about the questions about the entity choice when it comes to the 199A deduction. He had some really interesting things to say as far as how much clients are actually taking advantage of that provision. And I don't wanna give it away. You’ll just have to listen for it I guess. But we also ended with the discussion of the Kaestner case. That's the case that was just before the Supreme Court, and he had some interesting insight on what to expect when the Supreme Court rules on that.
David Stewart: Alright, we'll go to that interview now.
Jonathan Curry: Well Brad, thank you so much for being here with us today. The first question I had, of course in the last election, Republicans took a beating. And in the next election, 2020, we could see Democrats cement their control, and they could take full control of the legislative branch, they could take the White House. And there's been no shortage of proposals from Democratic presidential candidates that are wanting to hike taxes in any number of ways. And so, I'm curious, from your experience, which Democratic candidates’ proposals are getting the most attention in your practice?
Brad Dillon: I think that no one's focused on a particular proposal. There's always a sort of Bernie Sanders or Elizabeth Warren who seem to have the sort of stronger proposals out there. But I think that people and clients in particular are focused on just the Democratic field and what the sort of Democratic Zeitgeist is and the Democratic movement right now, which is income and equality. And I think that the focus on that and their focus on how to raise taxes and you'll see, even when you look at the Democratic candidates, and I think there are now 18 and soon to be 19 with Joe Biden, that half of them have actually released proposals, sort of not super detailed but somewhat detailed particularly for this early on in a race, tax proposals. And particularly when you look at the estate tax, for example, those eight or so that have released proposals have all suggested increases in the estate tax rate from what is now 40 percent all the way potentially up to over 70 percent. And then the lowering of the exemption from what is now a very inflated exemption until 2026 of 11.4 million all the way down to three and a half million. And then in the tax proposals otherwise that are sort of set to expire from the Tax Cuts and Jobs Act, I think that people are just focused on the Democratic field and not on a particular candidate, but the sort of nervousness around the, what does this mean for our planning and our tax planning, our estate planning in general? But I haven't heard someone say, oh no, I hope it's not a particular candidate one way or the other. It's just that the prospect of a Democrat taking true control over not only the administration but Congress as well.
Jonathan Curry: You mentioned planning — what are some proactive tax planning steps that clients can take or are considering?
Brad Dillon: One of the interesting things is, even in my line of work or even an accountant's line of work, or in a financial planner’s line of work, I don't think that the prospect of a Democrat coming in is what drives tax planning. I think that even if, my specialty is estate and gift tax planning, and even if you look there, we're always trying to drive people to do planning regardless of who's in the office. And the reason for that is, the number one tool in the toolbox of an estate planner is get assets out of your estate as soon as possible because the future appreciation on those assets happens outside of your estate. So when the tax man comes along at your death and tallies everything up that you own, those appreciated assets that you got out in life are also outside of your estate and are not subject to the estate tax. We're saying that regardless, and we're saying that get assets out now, quickly, soon, that you utilize your exemptions now. In the same way that we would no matter who's in office, no matter if it looked like President Trump was gonna win a second term and the Republicans were gonna maintain control of the Senate and maybe retake control of the House. We're still telling them, your planning is not gonna change. You have these exemptions available to you right now, and they're currently inflated. Maybe sooner, but at most at least until the end of 2025. So use those exemptions now, don't wait. Don't wait till tomorrow or the next day. Do it now because all of that future appreciation will happen outside of your estate and subjected to a lower estate tax and a lower gift tax if you decide to make those gifts later. So we aren't looking at what could potentially happen. Our planning isn't changing regardless of what's happening in the Oval Office.
Jonathan Curry: Now that's interesting that you mentioned urging people to get their assets out of their estate now. And that seems to be advice that I've heard sort of unanimously in the estate planning industry over the past year. I'm kinda curious though, are clients taking this advice, or are they still sort of leery about parting with large sums of assets?
Brad Dillon: That's a great question, and I think it sort of runs the gamut. If our clients have the assets to part with, I think they're doing it. And the reason is that, of course, we've seen these exemptions temporarily raised under the Tax Cuts and Jobs Act. And so our strong advice is always utilize that while you have it. And now that there are regulations that have come out that signify that, there's going to be no clawback. In other words, you use it or lose it. But they're not going to penalize you for using it. So you have this short period of time, this short window where you can give away so much more for just eating up into your exemption and not having to pay a gift tax. So if you have the assets, use it. The really tricky part comes in when you have clients who are sort of on the border of, oh, we don't know how long we're gonna live, we don't know what expenses we might have in the future, and we wanna be able to sustain our lifestyle until we die. But if we part with $22 or $23 million of assets, the collective amount for a married couple to be able to give away, then that's going to really cut into very massively our ability to potentially care for ourselves in the future. We could do it, but it might be a tight squeeze. Those are the real, real planning opportunities that the ones I actually prefer and like because there's a lot more difficulty to it because you have to build in a lot of flexibility in the plan and as sort of a rainy day fund that, the whole idea that you get assets outside of your estate and you can no longer control them and they're not for your benefit. But there are ways to build a lot of flexibility into a plan so that you could potentially get the assets back if you really needed to. You will have wasted your exemption in doing so, but at least it's there. It's not always in the back of your mind that I wish I hadn't given away so much and that way it's there, and you've given it away, and if you know that you don't need to touch it, that's great. You had a really excellent estate plan. However, if you live to be 104, and it turns out that your medical expenses are increasing as you age, and things are happening that are outside of your control, that you need more assets, the pot is there potentially to actually withdraw from. And there are number of ways to build that kind of flexibility into a plan. And I think that's what we're doing. So we're still advising everyone who can afford it to make these gifts while you have it, to temporarily increase the exemption, the time of that, to utilize it. It's a use it or lose it truly. And even though in the 103 years, the estate tax exemptions have never declined, really in the Tax Cuts and Jobs Act, they're very increased to a level that I think that people are finding that there actually could be a first time where that exemption amount decreases or declines.
Jonathan Curry: I'm interested to find out what's more a concern to your clients. Is it the prospect of Democratic tax proposals taking effect, even if there's not specific ones necessarily, like you mentioned just the zeitgeist of the Democratic field being to raise taxes and undo some of the tax cuts? Or is it more just the possibility that we could have a deadlocked Congress for the next couple years? And then a lot of these provisions in the TCJA, like the estate tax exemption that was doubled, that could expire, or the 199A deduction that could expire. I mean, what's the bigger concern?
Brad Dillon: I think the bigger concern among our clients and among advisers that I speak to is the potential expiration of these favorable tax laws that were implemented under the TCJA. There is this prospect of Democrats potentially taking control of the White House and the Senate. But I think people see that as not necessarily a long shot but something they cannot predict. And so there's not much planning to be done around it. Whereas, we have a date that is codified into the law, December 31, 2025, and we know at that point that our income tax rates are going to increase. The estate tax exemptions are going to decline, the GST exemptions are going to go back down to the 5 million adjusted for inflation. That the 199A deduction of 20 percent for the passthrough entities is going to go away. The only sort of real remaining thing that will stand is the new corporate tax rate of 21 percent. So I think that people know that there's this problem out there. And unless we have sort of probably Republican-controlled White House and Senate and House, that those favorable tax laws likely are going to expire and go away. So I think people are trying to take advantage while they can and where they can over the next seven years. Or I guess it's six years now.
Jonathan Curry: Now the section 199A passthrough deduction, that one's received a lot of attention this year. And especially, I've been covering the estate and gift tax beat for a year, so I see it come up in the family business context quite a bit. But like you mentioned, it's also set to expire in a couple of years. Does the uncertainty about the long-term durability of this provision come up in conversations with clients? Or are they just excited to hop on board and figure out any way to take advantage of it?
Brad Dillon: Truly I think people were very excited about this potential additional 20 percent deduction for their family limited partnerships, or their sole proprietorships, or their S corporations. Those sort of passthrough entities that they believe that this deduction became available. But as we started working through the section 199A, which is a monstrous section, it is truly a very meaty section that is just full of twists and turns and limitations and other ways that it's been circumscribed. And it turns out that most people can't afford themselves of this new 20 percent deduction under that section. And it turns out there are so many limitations just for specified service industries. And the list goes on for the kinds of businesses that it simply doesn't apply to. The list goes on for the kinds of wages or incomes in excess of certain amounts that would mean that you are suddenly now out of that section and are not afforded that section any longer. So as we worked through it with many of our clients, and I know other advisers have done the same thing, while initially there was a lot of hubbub about section 199A, it turns out that most of our clients haven't been able to afford themselves of the benefits of it because of all the restrictions and limitations that it also provides. There are a couple of circumstances where people are thrilled that it has worked for them. But mostly those are much smaller businesses. Or those are much smaller kinds of industries that aren't subject to the limitations or restrictions for the specified service industries under that section. And so those people, while they enjoy it, they also know that it's temporary, and that that's going away. We've seen a lot more people more interested in figuring out whether they should restructure their businesses in the form of, rather than a passthrough, but getting up to a C corporation, in fact. Doing some kind of a tax-free exchange so that you can take advantage of the permanent lower deduction there. And particularly fueled a lot of discussion about qualified small business stocks and whether or not that you can transfer the assets to a C corporation instead and take advantage of a qualified small business stock election, not even an election but availability, so that you don't have to pay capital gains up to $10 million, or 10 times your adjusted basis of the corporate stock. So that for us has been sort of where the 199A has gone, which has sort of made people refocus on how their assets should be held in what kind of entity. A lot of people have asked that question. But then as soon as we work through the analysis and show them in fact, it turns out that you won't be able to afford yourself of this benefit under 199A, then the question then becomes, are there other ways that we could restructure this business to take advantage of other sections of the code? And I think that we've particularly seen that arise in the case of QSBS, or qualified small business stock, and actually going the opposite way, where we thought many people might convert to a passthrough entity of some sort. Maybe they remained as a C corp, or in fact, converted to a C corp for the benefits of QSBS, if it supported them under that section.
Jonathan Curry: Now, I'm kind of curious to pivot to a different issue here on sort of the subject of kind of general TCJA-related guidance. Of course, we had this new tax law enacted at the end of 2017, and then we got right into it in 2018. But it took over the course of months and months, and it's still ongoing. We're getting new guidance projects and regulations being released. How big of an issue in your practice was the lack of TCJA guidance when you're waiting eight months to really kind of get any details on this? Was that a big issue? I mean did it put a lot of planning on hold while you waited for proposed regulations?
Brad Dillon: I don't think it did. And I think that the reason is there was a lot of, again, hubbub about both section 199A, about the 20 percent deduction for passthrough entities, but also the hubbub related to qualified Opportunity Zones that also came out in the TCJA, which could afford people the potential advantage of eliminating their capital gains entirely on certain assets and certain kinds of funds. And those two in particular took a long time for regulations to be released from Treasury. And I think even just a couple days ago new regulations were released about qualified Opportunity Zones. I didn't find that those regulations, which dealt with the sort of nitty gritty of how certain assets or how basis was going to be treated, and certain 90-day rules, and very technical limitations that advisers are waiting on. But a client sort of really knew about the, okay, I could potentially get 20 percent deduction for my passthrough entity. Or I can defer gains by investing in a qualified Opportunity Zone fund. They sort of knew the high-level stuff, so they weren't thinking about planning. But the real issue is again, the hubbub about 199A, it turns out to be a little bit more dead in the water than we thought because there's so many restrictions and limitations that we covered before. And similarly for qualified Opportunity Zones, we're finding that people were very excited about it. But then once you find out, well I need to actually invest in a qualified Opportunity Zone, what are those investments? Where are they, how can I take advantage of them? People started realizing, oh, but are those investments good? You still want to have a good investment, a solid investment that you vetted, that you believe will actually appreciate over time. And I think that's where people started hitting a wall. It wasn't in the regulations that were coming out about sort of the technical tax issues that people were looking forward to. It was really, alright we know this is gonna take effect, we feel pretty good about that potential for it, but now once we go to the next step and figure out, for example, with qualified Opportunity Zones, where are we gonna invest? And what does that look like? That's where we're hitting a wall. Because a lot of people don't know what are the good investments in those zones. And they're having a hard time, at least as I’ve found and I know some of advisers have found, of finding truly vetted good qualified investments in those zones that people feel very comfortable with to make investments and to be able to eliminate or defer those capital gains. So really the hubbub hasn't been about the regulations for me and for the clients I've worked with, or for the other advisers I've spoken to, it's been more around this actually isn't as effective as we thought it would be, or it turns out it's more difficult to take advantage of this section than we thought it would be.
Jonathan Curry: I've always kind of been curious, whenever people talk about Opportunity Zones, a lot of times the talk is about corporate investors and that sort of thing. But from your perspective working with a wealth management practice, what's the level of interest with your clients?
Brad Dillon: Interest has been high. The number one question I get from clients or friends, or family, or anyone, from myself, is how do I eliminate my capital gains, or reduce them? And the code is pretty tight around that. There are very few ways, clever ways or sophisticated techniques that you could take advantage of to eliminate or defer your capital gains. Suddenly, though, there was this qualified Opportunity Zone section that came out under the TCJA and then people were hearing about it. Oh, now there's a way. The question, again, that is always on people's minds of how do I reduce my tax liability? And suddenly, there's a popular way out there that has been released and blessed by the IRS, Treasury, and backed by governors who created these zones. And so what can we do? How can we take care of it? That is a very big question I've gotten from many, many, many of my clients. However, again, we run up against, okay, well, let's try to look at where we can invest your funds. What kind of funds are already out there and existing in the marketplace, free to invest in, and what do those funds look like? Where are they investing? What kind of assets? What are the quality of those assets? And it turns out that, again, as I've said, people aren't as comfortable once you get to that point. They're very excited. But then once you start looking into the weeds, particularly on the investment side, they start getting a little bit less comfortable and less excited about that potential. And so I think people are sort of waiting for better funds to sort of pop up and better investments to pop up. I sense that they will in the next few months or even a year, particularly as the latest round of regulations have come out. But so far, I found that most, in fact all, of our clients have declined to move forward once they look at what the investment field is.
Jonathan Curry: Wow, no kidding. I'm gonna pivot to one last new development we've had recently. The Kaestner case was recently heard before the Supreme Court, and I'm kinda curious to hear your thoughts. How big of a shift do you think it would bring to the world of trust tax planning and then any predictions on how the Supreme Court's gonna rule on this?
Brad Dillon: Well, I don't know if you listened to the oral arguments or read any of the transcripts. I did. I was very much interested in this case, and I think a lot of people in the trust and estates community were. And it looks like from the oral arguments that one, justices on different sides are kind of in agreement — not universally, but more so than I thought they would be. You suddenly see Sotomayor and Gorsuch on the same side really drilling the state's position in this case on whether or not they have the right to tax those trusts in other states just because there's a beneficiary located in their state. And really, so there was a due process question that a lot of constitutional lawyers were really looking at. Then when you went to oral arguments, you really saw that justices shied away from a broad sort of due process question and really focused on the mechanics of trusts — the discretionary distribution came up from several justices about whether or not the income was actually owned by the beneficiary in that state, and there was a lot of skepticism there. So one, my hunch, my guess is that it will come out in favor of the taxpayer in these cases that states will not have the right. I don't know if it'll be so broad. But from listening to the justices, it may seem that the states may not have the right to tax trusts in other states just because the beneficiary is located in a state with a taxing authority. It's a highly anticipated case. I think it would maybe not change tax planning so much, because there's not a lot we can do about that. But it would give a lot more comfort to certain kinds of trusts, for example, located in Delaware or South Dakota or Nevada or Alaska where you really try to set up trusts in these jurisdictions for many reasons, but one reason is for income tax planning, and it will give a lot more assurance to those people that have trusts in those jurisdictions that just because there are beneficiaries located in other jurisdictions that have a more aggressive form of taxation, that those trusts would be safe from the undue burden of additional taxation.
Jonathan Curry: Well, Brad, thank you so much for taking the time to chat. This has been really interesting, and I'll check back with you after the Supreme Court rules.
Brad Dillon: Thank you so much for your time. It's been a pleasure.
David Stewart: And now, Coming Attractions. Each week, we preview commentary that will be appearing in the next issue of the Tax Notes magazines. We're joined by executive editor for commentary, Jasper Smith. Jasper, what will you have for us?
Jasper Smith: In Tax Notes, Steve Butler and Ryan Phelps propose expanding the REIT rules in order to attract private investment to U.S. infrastructure, and K.C. Chiang considers the hypothetical distribution method in the proposed section 956 regulations.
In State Tax Notes, Caroline Bruckner and Annette Nellen discuss how gig workers are affected by section 199A as well as state actions to institute new income reporting requirements, while Alysse McLoughlin and Kathleen Quinn discuss relevant case law concerning the imposition of tax on the owner of an entity, as well as two recent trust cases.
And in Tax Notes International, Barry Larking discusses the extensive global input on the OECD's recent consultation document on the digital economy, and Sarah Hinchliffe examines how Australia's retirement savings scheme applies to employers and employees participating in secondment arrangements.
We also want to remind listeners of the June 30 deadline for the student writing competition. For more information, visit taxnotes.com/contest.
David Stewart: You can read all that and a lot more in the May 6th editions of Tax Notes, State Tax Notes, and Tax Notes International.
That's it for this week. You can follow me on Twitter @TaxStew, that's S-T-E-W. If you have any comments or questions or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
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