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Navigating Potential Tax Law Changes

March 06, 2024

The following article is based on our recent Lifetime Planning podcast, Strategic Financial Planning Ahead of Coming Tax Law Changes, with Financial Sense Wealth Management’s Jim Puplava and tax planning expert Chris Hennessey, Professor Emeritus of Law at Babson College.

The Countdown to the Sunset of the Trump Tax Laws

The Tax Cuts and Jobs Act (TCJA), implemented during Trump's presidency, is set to expire in 2026, introducing potential fluctuations in exemptions, estate planning, and tax rates for millions of Americans. The time to plan for this is now rather than rushing at the last minute to make changes to wills, estates, trusts, and other areas likely to be affected. Here, we explore the possible upcoming alterations to tax laws and discuss the proactive planning steps that can be taken in advance with tax expert Chris Hennessey, a regular guest on our Financial Sense Newshour podcast.

Preparing for Upcoming Federal Tax Adjustments

As the Trump tax cuts approach their sunset, a married couple today enjoys a higher income threshold before reaching certain tax brackets in comparison to the pre-TCJA tax regime. If the laws revert to earlier tax rates, individuals across various income levels, particularly the middle class and upper income earners, may experience an increase in their tax liabilities, explained Hennessey. Advanced planning is encouraged, with individuals considering actions such as Roth conversions to optimize their tax positions ahead of any potential increases. The awareness of these potential changes is not merely reserved for the "wealthy" but is also pertinent for the average American with retirement accounts or plans for wealth transfer.

Strategic Financial Moves in Anticipation of 2026

The years leading up to the expiration of the Tax Cuts and Jobs Act offer a window for significant financial maneuvers. For starters, Chris Hennessey and Jim Puplava discussed accelerating income into the present, assuming lower tax rates, while deferring deductions until the potential higher tax rates of 2026 kick in. As well, charitable giving and conversions to Roth IRAs could be particularly advantageous during this period. The goal is to align with current advantageous tax conditions before alterations end these benefits. Moreover, proposed changes like the removal of the SALT deduction cap would shift the strategy needed to maximize the full deductibility of state and local taxes.

The Critical Role of QBI Deduction for Business Owners

The Qualified Business Income (QBI) deduction, which has been a significant tax relief for many business owners, is at risk of disappearing with the sunset of the TCJA. This 20% deduction on profits, commonly known as the QBI deduction, offers tangible benefits to a range of businesses, from sole proprietorships to S corporations. Without this deduction, business owners will face higher taxable income levels, necessitating a review and possible restructuring of their business tax strategy, Hennessey also said.

Understanding the potential elimination of the QBI deduction is crucial for business owners as they plan for the future. As revenue fluctuates and expenses increase, the additional tax burden could affect cash flow and operational decisions. Business owners are advised to work closely with tax professionals to explore strategies that can help maintain financial efficiency without the QBI deduction, such as altering the entity structure or adjusting profit distributions.

Adapting to the Reemergence of the Alternative Minimum Tax (AMT)

With tax changes on the horizon, the specter of the Alternative Minimum Tax (AMT) looms large for many individuals and families, particularly those in states like California or New York. The AMT was designed to ensure that high earners pay a minimum amount of tax but had been effectively neutralized by the TCJA. Its anticipated revival will impact millions more taxpayers when the TCJA provisions sunset.

In preparation, clients should reassess their exposure to AMT, especially if they hold significant investments or have large deductions that are disallowed for AMT purposes, Hennessey said. Understanding which deductions trigger the AMT, such as state and local tax deductions, is vital. Taxpayers may need to stagger income recognition or deductions across several years to avoid triggering the AMT.

Utilizing Roth Conversions and Irrevocable Trusts for Retirement and Estate Planning

With the potential increase in taxes, Roth conversions may also be a strategic consideration for individuals, particularly retirees, explained Jim Puplava, President of Financial Sense Wealth Management. As one moves money from a traditional IRA to a Roth IRA, the conversion yields tax-free income in retirement years, a benefit that could outweigh the upfront tax liability given the prospective rise in tax rates, he said.

In the realm of estate planning, an area we focused on our show last week (see Anticipating the Sunset of Trump Tax Cuts in Estate Planning), the transfer of assets to irrevocable trusts serves as a preemptive measure to shield wealth from future tax increases, Puplava and Hennessey explained. For high-net-worth individuals, utilizing the currently generous lifetime gift tax exemption to fund an irrevocable trust can permanently remove assets from an estate before any pullback on the exemption amounts, Hennessey said.

Life Insurance as a Safeguard Against Estate Tax Liabilities

Another way to prepare for the future is through life insurance planning, which provides liquidity to address estate taxes without impacting business operations or forcing the sale of assets. Life insurance trusts offer a solution for business owners and individuals who have the majority of their wealth tied up in illiquid assets like business entities or real estate. Hennessey explained how premiums funded today can provide significant tax-free benefits to heirs later and alleviate the burden of estate taxes.

Survivorship life insurance, also known as second-to-die insurance, is especially useful for providing liquidity in cases where insurability is an issue for one spouse. Understanding insurance options and creating life insurance trusts can be critical in ensuring a smooth and tax-efficient transfer of wealth to the next generation.

Addressing Retirement Savings and the Importance of Qualified Charitable Distributions (QCDs)

Puplava and Hennessey also discussed how Qualified Charitable Distributions (QCDs) remain a tax-efficient strategy for taxpayers aged 70½ or older who are required to take required minimum distributions (RMDs) from their retirement accounts. Directing these RMDs to qualified charities can reduce taxable income and simultaneously allow the taxpayer to accomplish philanthropic goals. In light of tax changes, evaluating the use of QCDs becomes even more valuable for those looking to minimize their overall tax liability in retirement.

Strategies for High-Net-Worth Individuals and Business Owners

High-net-worth individuals and business owners face unique challenges in navigating the possible fiscal changes ahead. Aside from utilizing trusts and optimizing gift and estate tax exemption, they should concentrate on maximizing their IRA strategies. Given the risk of a higher permanent tax rate in the future, it is essential to deliberate on whether converting traditional IRAs to Roth IRAs is beneficial. While Roth conversions can come with an upfront tax cost, the long-term advantages of tax-free growth and withdrawals could outweigh the initial payment, particularly if tax rates are anticipated to increase.

Additionally, understanding the valuation of one's business in this uncertain tax environment is critical. Business owners should ensure their companies are properly appraised to not only inform strategic decision-making but also to prepare for any potential wealth tax implementations. Efficiently managing the possible changes in capital gains tax rates and taking steps to ensure the value of businesses are in line with current benchmarks could save on future tax liabilities.

In conclusion, the uncertainties in the tax environment underscore the need for robust and flexible estate and tax planning. Collaboration with a financial advisor or tax professional is key to navigating many of these changes. With proper expertise, an advisor can offer insights into the timing of income, investments, and estate strategies that are tailored to personal circumstances and responsive to legislative developments.

To speak with any of our advisors or wealth managers about how we can assist you, feel free to Contact Us online or give us a call at (888) 486-3939.

Advisory services offered through Financial Sense® Advisors, Inc., a registered investment adviser. Securities offered through Financial Sense® Securities, Inc., Member FINRA/SIPC. DBA Financial Sense® Wealth Management. This material has been provided for informational purposes only. Financial Sense does not provide tax or legal advice and this is not intended as such. Clients or prospects should consult with their own tax and or legal advisors to determine the potential benefits, burdens and other consequences of engaging in a particular strategy.