Preparing for the Prospect of Tax Changes

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Since the last general election on Nov. 8, Republican leaders in Congress and new President Donald Trump left no doubt that reforming the tax code would be a priority.

There are many unknowns about what, if any, new tax legislation may become law and when it will take effect.Tax Calculator_000015831323XSmall

Beware of following the advice of anyone who’s already telling you which changes to make in anticipation of a new law… but there are some issues you should think about and actions to consider taking when details are known.

In general, a new tax law is likely to have lower tax rates for both individuals and businesses, but fewer deductions and other tax breaks.

If a law is enacted early in the year, it likely will take effect during 2017. This year would be a blended one in which the new tax rates are effective as of the date of enactment and current tax rates apply until then. If it takes longer to enact the law, it probably won’t be effective until 2018. Congress is likely to focus on business tax reform first and individual tax reform later.

However, there are some tax breaks and strategies that could be eliminated in a new law. It is worth mentioning to allow time to think about and to plan for them.

#1: The Stretch IRA

Both the Obama administration and key Republicans have proposed eliminating the Stretch IRA in recent years.

They propose requiring that all of the inherited traditional IRAs be fully distributed within five years, after the original owner’s death. This change also likely would apply to Roth IRAs.

We’ve warned about the death of the Stretch IRA in the past. If your traditional IRA is intended primarily for your children or grandchildren, consider alternatives to the Stretch IRA now. The earlier you start planning, the more options you will have.

#2: Roth RMDs (Required Minimum Distributions)

It is possible that some of the advantages of a Roth IRA will be reduced. The most likely change is to require RMDs for Roth owners. (They’re now required only for beneficiaries who inherit Roth IRAs.)

401k_000004493704XSmallThe distributions would still be tax free. You’d lose the tax-free compounding of income and gains on money you are forced to distribute. It also would reduce the tax-free nest egg you could leave to heirs.

The only action to consider now is to delay planned conversions of traditional IRAs to Roth IRAs until we know more.

You might want to delay conversions anyway until we know if lower tax rates will take effect in 2017 or 2018. An alternative is to go ahead with planned conversions but be prepared to reverse them if a new tax law is enacted.

#3: Estate Tax Strategies

There are several moving parts that taxpayers (who might be subject to the federal estate tax) should consider.

The Obama administration last year drafted proposed regulations that would limit many of the strategies used to reduce estate and gift taxes by decreasing the value of property that could be passed through family limited partnerships and other means.

The new administration and Congress might rescind or repeal those regulations. There is also a good possibility that the estate tax will be eliminated for all estates.

Consider putting on hold for the first half of the year any irrevocable actions that would be taken purely to reduce estate and gift taxes. We’ll reassess the prospects for new legislation at that time.taxes

There are some exceptions, such as grantor retained annuity trusts (GRATs). These are likely to be grandfathered if the estate tax isn’t repealed and the new regulations or other restrictions go into effect.

If the estate tax is repealed, the only effect would be a loss of the attorney’s fees for setting up the GRAT, but that would be insurance to protect you in case the estate tax isn’t repealed.

Talk with your estate planner about which actions to consider postponing and which to implement.

#4: Transition-year Strategies

If the planned tax reform is enacted, there are ways to increase the tax savings.

Consider ways to move deductions into 2017 that would have been incurred in 2018, so they’ll be deducted at the higher tax rate. Also, consider delaying income and capital gains until 2018 to the extent you can, so they would be taxed at lower rates.

You also may want to liquidate in 2017 any business or investment assets that have paper losses. Deduct those losses in 2017 when they’re more valuable because of higher tax rates, if you have gains for them to offset.

Finally, I urge you to click this link to my Retirement Watch investment newsletter and gain immediate access to this month’s issue, plus a full archive of back issues and special reports. You will learn how to:

  • Avoid the 7 Deadly Estate Planning Mistakes
  • Transfer Family Real Estate
  • Maximize the Power of the “Stretch IRA”
  • Manage Second Homes and Vacation Homes
  • Beat the “Downsizing Surprises”

Until next time,

Robert Carlson

Robert Carlson is editor of the monthly newsletter, Retirement Watch. In it, he provides independent, objective research covering all the financial issues of retirement and retirement planning. Carlson also is Chairman of the Board of Trustees of the Fairfax County Employees’ Retirement System and the founder of  Carlson Wealth Advisors, L.L.C.