- October 1, 2019: Vol. 6, Number 9

Less taxing situations: New products and structures providing investors with the tax optimization strategies

by Mark Bell

Change seems to be the only constant in the world of tax and estate planning. In recent months, those changes have begun to benefit increasingly high-net-worth and large investors. Indeed, it appears as though long-awaited tax relief might at last be at hand. When advisers work with clients, they develop a thorough understanding of their investment objectives and tax circumstances. What follows are a few areas in which advisers have been particularly active of late with their high-net-worth and family office clients. It is always important, of course, that advisers coordinate with the work of clients’ tax and legal advisers to ensure investment strategies are appropriate for each individual client.


Many currents are converging around tax situations for families. One of these currents is new highs in the stock market, which have led to an increased need to find shelter for gains. Another current is the increasing speed of wealth transfer as a result of aging baby boomers eager to take care of their descendants. By far the largest current affecting current thinking around tax and estate planning is the Tax Cuts and Jobs Act of 2017 (TCJA), also known as the Trump Tax Cuts or tax reform. For individuals, most of the changes in the Act expire in 2025/2026. As a result, many families have been hesitant to undo too much of their completed estate planning. Nevertheless, the TCJA represents a minor tsunami in the world of planning and has many repercussions for advisers and families.


The TCJA’s estate tax exemption is the largest change we have seen in some time, as the exemption for married couples has doubled to $22.4 million. We estimate fewer than 2,000 American families per year will be subject to such a tax, or about one-tenth of a percent of deaths, on average. The estate tax, often called the death tax, has long been a target of Republicans due to the burden it placed on small-business owners (who often had the balance sheet but not the cash to pay the tax) and the philosophical inconsistency of taxing the wealth twice (i.e., at generation and transfer). Now that the estate tax is not a concern for the vast majority of even the very wealthy, many of the planning techniques used to avoid or mitigate the tax are not being employed. Less taxing, indeed!

Opportunity zones: An aspect of the tax cut which has garnered considerable interest is the creation of opportunity zones. In short, areas (or zones) deemed disadvantaged have received a special designation that provides favorable tax treatment for any capital gains invested in them. Importantly, this is only available for capital gains. The favorable tax treatment includes a deferment on tax owed, a step up in basis, and forgiveness of tax on the ultimate gain if held for 10 years. Despite strong enthusiasm for this bipartisan piece of legislation, we approach such investments with a cautiously constructive view. It is true that the structure allows for a tax deferment and no tax on the ultimate exit; however, this is an investment inside a tax structure, and even the best tax structure cannot save a bad deal. Opportunity zones often require taking ground-up real estate risk in the form of new developments or the repositioning of old assets. Risky real estate developments in economically challenged neighborhoods are never easy, but there is a concern it could be even more difficult as we enter the late stages of this economic expansion. Caution may be widespread among asset managers who have created funds to pursue these opportunities, as it is estimated that potentially only a tenth of the expected funds for such opportunity zone funds have been raised versus initial expectations. These structures may be a strong opportunity for the traditional 1031 investor as well as for those who have low basis stock with strong gains they would like to diversify into real estate. For instances in which opportunity zone investments make sense, we have tended to recommend that investors seek funds that provide diversified exposure to multiple assets. While June 30, 2019, was the deadline for investors to roll in gains realized in 2018, there will be continued interest in these structures in the coming months and quarters.

Municipals shine: Municipal bonds are another surprising winner from the TCJA. Long viewed as a sleepy corner of fixed income, municipal bonds have become popular as SALT deductions diminish. Many high earners live in coastal states that have high state and local taxes (SALT). As a result of the cap on these deductions, a high earner in California, for example, will experience a nearly 6 percent increase in taxes, making the tax-exempt nature of municipal bonds almost a must. In the category of unintended consequences, few foresaw the impact the tax cut would have on the municipal market: nearly $50 billion in assets have flowed into the sector in the first half of 2019 alone. Following the financial crisis, many municipalities have been hesitant to borrow, leading to a limited supply of bonds. At the same time, demand for these bonds has increased. Some investors concerned about new highs in the stock market have turned to bonds for shelter from taxes and potential future volatility in equities. Nevertheless, municipalities have taken little advantage of this high demand. Recently, a Florida municipality issued a bond with nearly a 1.5 percent interest rate, a potentially historic low for borrowing costs. There is hope that an infrastructure plan will incentivize municipalities to take advantage of low rates and high demand for their debt in an effort to renew some underfunded parts of the national infrastructure. The recent run-up in municipal bonds is a reason for some caution in buying high. As such, the tax shielded interest will likely continue to be too attractive to pass up.

Stretch IRAs snap: Congress giveth, and Congress taketh away. Just as there has been some substantial benefits from recent reform, there is legislation in the works that would take away some traditional tax structures. One such structure is the so-called stretch IRA. The stretch IRA has been a favorite vehicle for wealthy individuals who do not anticipate needing the money in the account and use it as a way to pass assets to their heirs by “stretching” out the withdrawal period. Such vehicles have been in the crosshairs for nearly a decade after the discovery that then-presidential contender Mitt Romney had more than $100 million in his IRA. At the time of this writing, the SECURE Act (which would limit the effectiveness of such stretch IRAs) has stalled in the Senate. Regardless of what happens with the SECURE Act, many observers believe the stretch IRA will soon be eliminated. If that happens, advisers and planners should no longer use IRAs as estate planning tools. For those still affected by estate taxation, one potential silver lining is converting the stretch IRA into a Roth IRA and allowing it to then grow as planned. The owner would owe taxes now (at historically low rates) and then could allow the remainder to grow tax free. In addition, Roth IRAs do not have the required minimum distributions that come with traditional IRAs, and beneficiaries can inherit Roth IRAs tax free.

SLAT time? Those who believe the benefits of the current less-taxing times may be fleeting may wish to use the higher limit on spousal lifetime asset trusts (SLATs) as an estate planning tool. The TCJA created a new “fiscal cliff” in which the current exemption will revert (or sunset) after 2025. While some believe that such a reversion would be politically unpopular and the current limitations will be made permanent, others point to high deficits and the inevitable need for more government revenue as evidence of the future need for more tax revenue. Those unwilling to wait to learn the ultimate outcome of the exemptions are considering the benefits of a SLAT. A SLAT is an irrevocable trust created by one spouse for the benefit of the other (as well as additional family members, such as children and grandchildren). Today it is possible to use nearly twice the prior exemption. An individual can transfer up to $11.4 million into a SLAT, at which point that amount — along with any future potential growth — is free from future transfer taxes. While SLATs can hold any type of asset, many individuals use them for assets with the potential for large appreciation (e.g., stock in a fast-growing company) in order to get the greatest tax benefit and keep probable future estate values below the exemption threshold. Advisers eager to take advantage of this higher exemption are looking to additional strategies, such as intentionally non-grantor (ING) trusts. Like SLATs, the goal for some is to use the higher exemption now with a view that it might expire after 2025.


Each family and client has unique needs and circumstances. What should you do? The classic answer: it depends. In most instances, a wait-and-see approach makes sense, particularly leading up to the 2020 presidential election. For those who have spent the time and money implementing estate and tax planning structures that are no longer needed due to the higher exemption, it likely does not make sense to spend more time and money undoing those structures, since they may be needed again in six short years. Likewise, for those who have been waiting to create these structures, it might make sense to continue waiting until there is a greater sense of which way the winds will blow.

Nevertheless, there are certain circumstances in which it might make sense for wealthy families to leverage some of the tax planning strategies noted above, including when the estate is likely to surpass the higher TCJA threshold even if it becomes permanent; if they live in high SALT states; and if they have capital gains and were planning to make long-term private real estate investments as part of their regular asset allocation. Combining a view of tax strategies and investment strategies has had a meaningful impact on the prosperity of many intergenerational families. The times are indeed changing, but at least for now, they appear to be less taxing.


Mark Bell is head of family office services and private capital at Balentine.

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