Income Tax Strategies to Move Your Clients Forward

The 2019 estate tax exemption is $11.4 million per person, up from $11.2 million per person in 2018. According to the Tax Policy Center, only 4,000 estate tax returns were filed this year, with only 1,900 of those returns owing tax. Some industry experts estimate that less than one percent of all estates are taxable. Put another way, over 99 percent of all estates are exempt from estate tax. With the likelihood of clients having a taxable estate being relatively low right now (this is subject to change, of course), it only makes sense that clients focus on income tax planning. As a trusted advisor, you hold a crucial role in ensuring that our clients receive the best comprehensive strategy.

Basics of Income Tax
What is the income tax?
Income tax is a tax paid on an individual or entity’s income that meets certain requirements.

Taxable income can be broken into two types. Earned income includes financial gains such as wages, tips, a salary, or bonuses. It also includes other monetary gains unrelated to a job, such as gifts, lottery winnings, alimony (if your divorce agreement was executed before 2019), etc. Unearned income, by contrast, includes income from interest, rent, dividends, or other sources.

How much is taxed?
We have a progressive federal tax system. This means that people earning less each year than a certain federally set limit pay less tax, and people earning six figures or more annually pay a higher tax rate.

What are the current rates?
The 2019 rates for single filers start as low as 10% for the lowest income tax bracket (up to $9,525).

• Those earning $9,526 to $38,700 can expect to pay 12%.

• For people in the $38,701 to $82,500 income bracket, the rate is 22%.

• Those reporting income of $82,501 to $157,500 will pay 24%.

• In the $157,501 to $200,000 bracket, the tax is 32%.

• In the range of $200,001 to $500,000 earnings, taxpayers will be charged 35%.

• For the highest income bracket, $500,001 and up, the current tax rate is 37%.

Setting Goals
As the professional your client has trusted with their financial future, your goal is simple: to help them pay the least amount of income tax possible, or even to avoid it entirely. This goal can be extrapolated to help your clients pass assets to intended beneficiaries in the most tax-advantageous manner.

During your routine client meetings, you have probably covered the basics of estate planning, such as wills, trusts, and gifting using the annual exclusion amount ($15,000 for 2019). However, these measures have no immediate negative income tax impact. For those clients with income tax concerns, we need to move beyond the basics and into more advanced planning techniques, a few of which are discussed below.

Basis Planning
If a client has low basis assets (i.e. assets that have significantly appreciated since their original purchase or acquisition date), planning for the ultimate cost basis of such assets at the client’s death is an important and often overlooked tax-saving strategy. In fact, gifting assets during a client’s lifetime can result in a loss of the stepped-up basis that would have otherwise occurred at their death. Married couples living in community property states benefit from a double step-up in basis upon the first death, resulting in lower tax liability for the surviving spouse.

Charitable Remainder Trust
If your client is charitably inclined, another option is charitable planned giving. By using a Charitable Remainder Trust (CRT), the grantor retains or names non-charitable beneficiaries to receive an annual income stream (as either an annuity or unitrust amount), and at the end of the term (which can be a single life, joint lives, or multiple lives), the remainder goes to the designated charity. When the grantor funds the CRT, he will be allowed to take a charitable deduction on his income tax return (with certain limits). There will also be no capital gains due when the appreciated property is transferred to the trust or when the trust sells the asset in order to have the liquidity to make the annual payments to the beneficiary. Funding a CRT with highly appreciated assets is, therefore, a great planning strategy.

When annual distributions are made from the trust, the current beneficiary will be subject to income tax.

Charitable Lead Trusts
The Charitable Lead Trust (CLT) can be a valuable option as well. A CLT is funded with income-producing assets that have been ultimately earmarked for heirs. Upon the funding of the trust, the grantor may be entitled to an immediate income tax deduction for the charitable contribution. The amount of the deduction will be based on amount ultimately given to the charity and the interest rates at the time. With this type of trust, the charity is the current beneficiary and gets a stream of annual payments (as either an annuity or a unitrust) for a set period of time. At termination of the CLT, the trust assets pass to the heirs, free of any transfer tax on appreciation realized after the date the trust was created, but only as long as the rate of return on the assets exceeds the Applicable Federal Rate (AFR) that was in effect when the CLT was first established.

The taxable gift to the heirs is calculated in the year the CLT is created if the stream of payments is an annuity. If the CLT is a unitrust, it’s calculated at the termination of the CLT.

A CLT is not exempt from income tax, because the ultimate beneficiary of the trust is not a charity. However, this can be a very beneficial strategy for a client who has a substantial amount of income in one year. All taxable income earned by the trust in future years will then be taxed to the grantor, saving your client money.

Don’t Hesitate to Reach Out
With estate tax exposure being a concern for so few clients, income tax needs to be our next priority. Familiarizing yourself with the above strategies will help you advise your clients and assist in creating the most comprehensive and tax-efficient estate plans for your clients. Never hesitate to reach out and collaborate with us on powerful advanced planning techniques that can really make a difference for your clients.