Managing Director Wintrust Wealth Management
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What You Need to Properly Advise Your Tax Clients Now

Tax and financial advisors must engage clients over tax payment relief and planning opportunities in a down market.

Mar 26th 2020
Managing Director Wintrust Wealth Management
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In the wake of the COVID-19 pandemic and its impact on individuals, businesses, and the markets, the Treasury Department and IRS have taken major coordinated action that tax and financial advisors need to act on.

Treasury Secretary Steven Mnuchin announced that individuals and corporations can delay and/or defer their tax filings and payments interest- and penalty-free until July 15, 2020 (See IRS Notice 2020-18). During the deferral, the IRS will not charge interest or penalties and is also allowing the deferral of first-quarter 2020 estimated tax payments, essentially providing taxpayers an interest-free loan and, hopefully, increased liquidity.

To say these are uncertain times is an understatement, but economic and market volatility like this provides astute tax and financial advisors with a number of unique opportunities to serve their clients. With stocks entering a bear market, now may be a good time to consider the following tax-focused strategies:

Liquidate tax-inefficient mutual funds. Mutual funds often distribute large capital gains to shareholders even during down years, which creates a tax consequence—even for investors who have chosen not to sell holdings with capital gains.

Taking advantage of the market pullback to sell mutual funds can help investors reduce taxes on capital gains and distributions while affording them the opportunity to switch into other tax-efficient ETFs or securities. Making these moves provides a longer-term benefit of eliminating capital gain distributions and resetting the tax basis.

Harvest stock losses. Today’s depressed markets provide the opportunity to sell losing investments, creating tax losses to offset future gains on reinvested capital. That said, investors need to be aware of wash sale rules, which prevent the purchasing of “substantially identical stock or securities” within 30 days before or after the sale of the loss position.

Convert a traditional, rollover, or SEP-IRA to a Roth IRA. The general Roth conversion rule is to convert and pay tax today if you expect your top marginal tax rate in retirement to be higher than it is currently. Stock market declines provide an opportunity to convert while valuations are well off their all-time highs, reducing the conversion’s tax cost.

It should be noted that investors pay tax based on the value of their assets on the conversion date regardless of future price changes. While this allows investors to benefit from large future price increases, they should understand that Roth conversions cannot be undone.

Front-load 529 plan contributions. Current gift tax rules allow individuals to fund five years of 529 contributions without using the lifetime gift exemption. Each spouse can contribute up to $75,000 per child into a 529 plan today. If you’re bullish on the market and have a long-term horizon, today’s depressed values could provide a unique opportunity to maximize 529 plan contributions now and capitalize on future upside.

Gift while portfolio values are low. Taxpayers have a unique window of opportunity between now and Jan. 1, 2026 for gifting. Prior to Jan. 1, 2018, the law provided for a lifetime exclusion from taxable gifts of $5 million per individual or $10 million per married couple, which is indexed for inflation after 2011. However, from 2018 through 2025, taxpayers can double those gifts tax-free, or $11.18 million for 2018, $11.4 million in 2019, and $11.58 million for 2020 as indexed for inflation.

On Jan. 1, 2026, this exclusion benefit sunsets and goes back to pre-2018 levels. Thus, we have a five-year window to essentially double tax-free gifts. On top of this gifting opportunity, as investment portfolios fall, investors can take advantage of this by gifting shares at the current depressed values.

If these investments recover in the future, the benefit will have been passed to the gift recipient. What’s more, the IRS has stated in a 2018 ruling that there will be no claw-back of the temporary gift exemption benefit.

Invest with a health savings account (HSA). HSAs are turbo-charged savings vehicles and a great investment in a down market. Much more than just a simple savings tool for medical emergencies, an HSA can double as a long-term care insurance policy.

Those with high-deductible health insurance plans can contribute up to $3,550 for individuals and up to $7,100 for families in 2020. Those over age 55 can contribute an additional $1,000 per year.

HSAs can be much better savings vehicles for retirement than IRAs, as they provide a triple tax benefit:

1. you can contribute to them by setting aside pre-tax earnings

2. the money can be invested and grows tax-free

3. if used for medical expenses, you can withdraw this money tax-free before retirement, which you can’t do with a 401(k) or IRA. A spouse also can continue to use the funds without any income tax liability for medical-related expenses, continuing the long-term care insurance character of the account.

Finally, in IRS Notice 2020-15, in response to the COVID-19 pandemic, the IRS said that health plans that otherwise qualify as high-deductible health plans can pay for coronavirus-related testing and treatment without jeopardizing their HSA tax-deductible contribution status.

Refinance mortgages. For those that can itemize their tax deductions, mortgage interest remains one of the last tax deductions currently available. Homeowners can deduct interest expenses on up to $750,000 of mortgage debt and can claim the deduction for both a primary and secondary home, up to the cap.

Low interest rates on 30-year loans provide taxpayers the opportunity to buy a new home or refinance an existing home mortgage and lock in a historically low interest rate. Capitalizing on low interest rates offer the benefit of tax-deductible interest and lower monthly mortgage payments, thus increasing liquidity during these challenging times.

Finally, the IRS has also created a coronavirus website specifically regarding COVID-19’s impact on taxpayers. The site links to various online resources and has information about the IRS’ Free File program, tax refunds, payment plans, and assistance for low-income, elderly, and disabled taxpayers.

Despite the uncertainty of this time, there are certainly opportunities for tax and financial advisors to engage with their clients and position them for a stronger financial future.

The original article appeared in the Illinois CPA Society online magazine Insight

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Julian Block
By Julian Block
Mar 27th 2020 17:06

Well-written article. Advice that is immediately helpful.

Thanks (1)