Planning In the Dark

Bob Keebler outlines a plan of action for a tax reform package whose provisions are as yet unknown.

By now, you know the basic outlines of the Republican tax reform proposal: fewer brackets maxing out at 35%, no AMT, a higher standard deduction, fewer itemized deductions, elimination of the estate tax and lower tax rates on corporations and pass-through entities.  In a presentation at the NAPFA Fall conference, tax expert Bob Keebler of Keebler & Associates in Green Bay, WI told the audience to be prepared.  “Something will happen with tax reform, because it has to,” he said.  “Because the Republicans will have a political disaster if it doesn’t.”

But then he warned that the devil is in the details.  “In that four-page document they laid out the dessert part of the proposals, the good part,” he said.  “They left out the brussels sprouts and the spinach that is going to come out of the Congressional committees.”

So how do you plan for a new tax bill whose provisions you don’t yet know, which might be signed into law as soon as December?  Keebler broke down his recommendations for planning in the dark into four basic parts.

Lower top rate

If next year’s highest tax rate falls from 39.6% to 35%, the ordinary income advice is pretty simple: you want to accelerate deductions into this year and push income into the future.  Except…  Keebler noted that the zero percent capital gains rate for lowest-income taxpayers will likely disappear and be replaced with a 6% rate.  “So if you have a married couple, retired, they are still in that 0% bracket, harvest gains this year, enough to at least fill up that bracket,” he said.

The tax proposal also envisions a doubling of the standard deduction to $24,000, and the elimination of deductions other than mortgage interest and charitable contributions.  That means that fewer of your clients will itemize their deductions, which diminishes the tax incentives to give to charity.  “If most of your retired clients aren’t going to be able to take advantage of itemizing,” Keebler told the group, “that means their charitable gifts will effectively be worthless from a tax deduction standpoint.”

What to do?  Keebler recommended that you help clients set up a donor-advised fund and fund it with a minimum contribution.  “In December, when this stuff passes,” he said, “you’ll be able to go to them and say, hey Bob, your charitable gifts aren’t going to give you any benefit in the future, because of this $24,000 deduction, so I think we should put $100,000 into a donor-advised fund, take the deduction this year and use that to make your gifts for the next 10 years.

Meanwhile, if clients die this year, you can help the executor decide what year-end to choose when managing the estate.  “If somebody dies in November of 2017, they could pick a year-end of October 31, 2018,” said Keebler.  “And from the day they died through October 31, 2018, the income that is picked up by the estate is going to be taxed at today’s rates.

“But,” he continued, “if they cut that year off on December 31, 2017, then for the entire 2018 year they’re in the new rate.”  For many clients, the difference between the top 2017 rate of 39.6% and the proposed new rate of 35% is only 4.6%, and changing the year-end date may not be a high priority.  But what if one of the assets is a small business?  “If the business rate goes, as planned, to 25%, 39.6% minus 25% is now a difference of 14.6%,” said Keebler.  “That could come to a lot of money.”

Elimination of the AMT

Keebler said that this is very good news for people who want to reduce the complexity of their tax preparation.  But it might not be quite as good for certain clients who have been compensated with incentive stock options.

“Under today’s rules, when you exercise ISOs, that throws you into the AMT,” Keebler reminded the audience, “but then when you sell the stock later, you get a credit for the AMT you paid.  But,” he asked, “what if you exercised in 2016, and you sell in 2018 when that credit no longer exists?  You would incur capital gains but you would have no credit.”

That means that if and when a tax bill passes in December, it might be advantageous to go to clients in that situation and say: I need you to sell that stock now, because you need to preserve that credit.

IRA changes

One thing that was NOT in the outline on proposed tax reform was a proposal that has been floating around the Senate for a long time, minimizing the stretchout period of inherited IRAs—which, of course, accelerates the recogniton of income and, therefore, the tax bill, whether the heirs need the money or not.  The most recent version of the bill, said Keebler, required those who inherit IRAs to take the money out over a maximum of five years, with a de minimus amount of  $450,000.  “If I died with $900,000, $450,000 would come out over my children’s life expectancy and $450,000 would have to come out over five years,” Keebler explained.

How do you plan for that?  “Let’s say the surviving wife doesn’t need the money,” Keebler proposed.  “So your client would leave $450,000 of the IRA to children—who would get to stretch it out over their lifetimes—and the remainder to the wife.  When the wife dies, the first $450,000 that would go to the children would come out over their life expectancy.”

Another alternative is, starting around age 60, you recommend that your client do annual Roth conversions up to their next-highest tax bracket.  “You can tweak the number every year,” Keebler said, “and then the money would come out at whatever schedule the heirs decide to set—tax-free.”

If you happen to live in a state with a high income tax rate, you might recommend that clients do the Roth conversion in December of 2017, while they can still deduct their state income taxes.  “If you guess wrong, you can always recharacterize,” Keebler told the group.  “So don’t be afraid of doing conversions in December if you believe they may be the right thing to do.”

Finally, consider naming a charitable trust as the IRA beneficiary.  “I die, my first $450,000 goes to my children, the next $450,000 goes to my wife, and everything else goes into a charitable remainder trust that my children get to take the money out over their life expectancy,” Keebler explained.   “If my wife needs the money to live on, then I leave $450,000 to our children, or to a trust for our children and my wife, we’ll stretch that out, my wife will roll everything else over, and at her death, we’ll leave the money to a CRT that pays income to the children.”

Estate tax repeal

Keebler said that if the estate tax goes away, the generation-skipping tax could also vanish.  That means that wealthy clients who die during this 10-year window would be able to transfer millions (or, in the case of the Koch Brothers, billions) into a GST-exempt trust.

Keebler advised the audience not to abandon estate planning just because the estate tax is temporarily removed from the scene.  “Remember,” he said, “if the estate tax goes away, portability will also go away.” 

To illustrate, he invoked hypothetical clients, Fred and Ethel, who are both 85 and are each worth $5 million.  “The current estate plan has been to use portability,” Keebler explained.  “Fred would die, Ethel would get his portability, and then when she died there would be no estate tax obligation.”

But consider what happens if portability goes away, and Fred dies next year and Ethel dies 11 years from now when the estate tax suddenly returns.  “When Ethel dies, she is not going to have a $10 million exemption; only her own $5 million exemption,” said Keebler.

The solution?  “You’re going to want to fund a bypass trust during this 10-year period of time,” Keebler told the group.  “And meanwhile, Fred and Ethel will still be doing annual exclusion and unified credit gifts.

Wealthier clients may consider a 9-year Grantor-Retained Annuity Trust (GRAT).  “If I set up the trust and there’s no estate tax or gift tax, I run no risk of an IRS audit,” said Keebler.  “If I die before the 9 years, the GRAT is included in my estate and I possibly get a step-up in basis.  If I live beyond the 9 years, I have shifted all that growth downstream—and when the GRAT expires, I can have the assets go in trust for my grandchildren, skipping right over a generation.”


The tax outline also proposes a 20% maximum tax rate for C corporations and a maximum 25% rate for pass-through entities like S corporations and LLCs.  Keebler noted wording in the document which said that there would be (unspecified) provisions that would prevent small business owners from converting their personal income to LLC income, but he seemed to think that there would be planning opportunities in the brussels sprouts and broccoli that the tax writers would not have considered.

Bigger picture, tax “simplification” might open up a lot of new opportunities and therefore create a lot of work for alert advisors over the next month.  “I recommend that you make a list of clients who you want to talk with about these things,” said Keebler, “so that when the bill passes, you and your clients will be able to react quickly.  If you develop an action plan,” he continued, “then if this passes in December, you won’t be scrambling.”