FALL 2018 PERSPECTIVES THE NEW TAX LAW: TOP QUESTIONS FROM OUR CLIENTS

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1 FALL 2018 PERSPECTIVES THE NEW TAX LAW: TOP QUESTIONS FROM OUR CLIENTS

2 ABBOT DOWNING PERSPECTIVES Fall 2018 In this issue: The New Tax Law: Top Questions From Our Clients 3 Only the Beginning 7 Contributors: Lisa Featherngill, CFP Head of Legacy and Wealth Planning Carol M. Schleif, CFA Deputy Chief Investment Officer, Asset Management 2 Abbot Downing Perspectives Fall 2018

3 The New Tax Law: Top Questions From Our Clients The Tax Cuts and Jobs Act (TCJA) was signed into law at the end of 2017 and has introduced the most significant changes to the federal tax laws since Given that we have had nine months to digest all of the provisions included in TCJA and we ve been talking with our clients through it all, it s an opportune time to discuss some of the most common questions we hear from clients. What follows is not your typical Q&A with simplified answers. Because of the scope of the changes to existing tax law, there aren t easy answers that apply to every individual situation. In addition, while some states scrambled to mesh their own tax requirements with the new federal guidelines, other states are not quite there. The overall impact of the new tax law will depend on the state where you file your taxes. With all of the moving parts, the answers provided here will provoke ideas for strategies you may wish to pursue after careful investigation. That process requires input from your entire team those at Abbot Downing as well as your CPA, estate planning attorney, and others. What should I be doing with 1 the temporarily doubled estate/gift/gst exclusion? The new tax law increased the amount of assets that an individual can pass to others from $5.49 to $11.18 million meaning a couple can now give away $22.36 million without incurring estate, gift, or generation skipping transfer tax. It s important to understand that, as written in current law, this increased exemption expires on January 1, This could result in unintended consequences such as underfunding of bequests for your spouse. The higher exclusion provides an opportunity to transfer wealth to future generations tax-free. Depending on how much wealth you would like to transfer, there are creative ways to shield a very significant amount of assets from estate tax for many years, while still protecting the interests of a spouse. The doubled exclusion is only available for seven years. Under the law as it s written today, if the additional exclusion is not used by the expiration date in seven years, it is lost. It s important to move quickly if this strategy is important to your situation. This is also a great time to clean up existing wealth transfer structures without incurring gift tax. For example, if you sold assets to a trust in exchange for a note, a portion or all of the note may be gifted to the trust during this period. There are many factors to consider related to the temporarily increased exclusion amount. We suggest a thorough review of your estate plan to look at various scenarios in light of the new tax law. Do you think the exclusion 2 will be available through December 31, 2025? The new law states that the exclusion reverts to the pre-2018 level of $5 million (adjusted for inflation) on January 1, That said, there are already proposals in Congress to make changes to the 2017 law. There are three congressional elections and a presidential election before 2026 so there is a chance this could be changed either reduced or made permanent. Many clients are feeling a sense of urgency to use the exclusion to avoid a fire drill if a change appears imminent. To determine what steps might be appropriate for your individual situation, it s important to start by considering the impact of the exclusion on your current estate plan. Your Abbot Downing team can review your estate plan to model the funding of trusts and distributions to heirs. Before the new tax law, most estate plans provided for a family trust to be funded with the decedent s remaining exclusion. Abbot Downing Perspectives Fall

4 What happens when/if the 3 exclusion reverts to the lower level will I be taxed on gifts in excess of any new exclusion amount? Several clients have asked questions about this. The new law contains a provision to avoid an estate tax on the gifts that utilized the temporarily increased exclusion. For example, if a client utilizes $11 million in exclusion through gifts and passes away when the exclusion is only $6 million, the additional $5 million will not be subject to estate tax. Another question is how to calculate the remaining exclusion after For example, if a client utilizes $8 million of the $11 million exclusion, how much will be available after 2025 if the exclusion is $6 million? You could argue it is $3 million ($11 million available on December 31, 2025 less $8 million of gifts made) or you could argue $0 remains (the amount gifted of $8 million exceeds the available exclusion of $6 million). At this point it is all conjecture. When/if a change is made, the IRS will issue regulations to address this issue. Some analysts anticipate headaches with state tax return filings next year because some states do not conform to federal rules and will require additional adjustments in determining state taxable income. There are a few planning strategies to consider to reduce the effect of the state tax limitation. For instance, converting a second residence to a rental property changes the character of the real estate taxes from itemized deduction to business expense, which is not subject to the limitation. However, there are strict rules around personal use of rental property. Before going this route, consider what your goals are related to the property. At the expense of minimizing taxes, you may be limiting family time together or putting restrictions on when family members are able to stay at the property. If you are considering keeping the second home in the family, consider transferring it to a trust. The trust will be subject to the limitation on SALT deductions, but this provides an additional $10,000 of deductibility. This is a temporary provision that is set to expire on January 1, How can I plan around the 4 Will interest on my mortgage new $10,000 limit on state 5 and home equity lines be and local tax deductions? deductible? The new limitation on state and local tax deductions has created confusion for taxpayers, particularly those who live in high income/property tax states. In fact, four states have filed suit against the U.S. government claiming that the limitation is unconstitutional. As it stands now, the limitation is part of tax law, though it is a temporary provision set to expire on January 1, In reality, many high income taxpayers received partial or no tax benefits from the state and local tax (SALT) deduction in the past due to the calculation of alternative minimum tax (AMT). According to the Tax Policy Center, in 2015 taxpayers with adjusted gross income (AGI) between $500,000 and $1 million, over 46% paid AMT. This approaches 60% in some of the higher income tax states like New York, New Jersey, Minnesota, and Maryland. The numbers are less for taxpayers with AGI over $1 million. Interest on home mortgages existing on December 15, 2017, will continue to be deductible to the extent principal does not exceed $1 million. The cap for deducting interest on new home mortgages is $750,000. A mortgage is defined for tax purposes as a loan used to buy, build, or improve a primary home, or one second home. The loan must be secured by the home. The new tax law eliminated the interest deduction for home equity loans through December 31, Note that a portion or all of a home equity loan may qualify as mortgage debt, to the extent the funds were used to buy, build, or improve your primary, or second home. If this is the case, the interest may be deductible, to the extent you do not exceed the principal limitations described above. 4 Abbot Downing Perspectives Fall 2018

5 6 Should I use my IRA for charitable contributions? For taxpayers who are charitably inclined and over age 70½, it will be important to evaluate whether it is more beneficial to donate cash or stock, or make a qualified charitable distribution from an IRA. Donating Cash. Cash contributions are deductible up to 60% of your adjusted gross income under the new rules (until 2026) an increase over the amount allowed in prior years. Donating Stock. The recent gains in the stock markets, particularly in the technology sector, could provide opportunities to donate appreciated stock and take a deduction for the fair market value without recognizing the gains. Gifting of appreciated securities from your non-retirement portfolio has the added benefit of rebalancing your portfolio in a tax-efficient manner. Qualified Charitable Distributions (QCD) from IRAs. A QCD is a direct transfer from a qualified IRA to a charity. This type of contribution does not qualify for the charitable contribution deduction, but it can help to fulfill your requirements for taking a required minimum distribution (RMD). You will not pay tax on a qualified charitable distribution. Some taxpayers may want to consider bunching charitable contributions into alternate years with a view to qualifying for itemization at least some of the time. Bunched gifts to donor advised funds might be another way to accomplish this goal. The cash flow impact on the taxpayer and the charity should also be considered. Again, it is important to work with your advisors to analyze the alternatives and choose the option that best meets your overall goals. 7 What is the Opportunity Zone program and can I benefit? The TCJA established the Qualified Opportunity Zone program to provide a tax incentive for private, long-term investment in economically distressed communities. The hope is new investment in these areas could lead to the creation of jobs and economic development. This provision has been somewhat undiscovered, at least initially, as practitioners and the media focused on the changes affecting a larger number of taxpayers. An investor can defer and potentially reduce taxes by making a long-term reinvestment of their recognized capital gains in economically underdeveloped zones (these zones were identified and applied for by each state s governor). An Opportunity Zone investment provides tax savings in three ways: 1. Deferral of Tax through A taxpayer can defer any taxable gain by rolling that gain into an approved Opportunity Zone Fund within 180 days of recognizing the gain. The tax on the gain is not due until December 31, 2026, or until the interest in the Opportunity Fund is sold or exchanged, whichever occurs first. In addition, the deferred gain can be further reduced, as described in the next point. 2. No Tax on 10% to 15% of Deferred Gains. A taxpayer who defers gains through an Opportunity Zone investment receives a 10% step-up in tax basis after five years and an additional 5% step-up in tax basis after seven years. To take full advantage of the 15% step-up in tax basis, the taxpayer must invest by December 31, When the tax is triggered at the end of 2026, the taxpayer will have held the investment in the Opportunity Zone Fund for seven years, thereby qualifying for the 15% increase in tax basis. 3. No Tax on Appreciation. A taxpayer pays no tax on the appreciation of the investment in the Opportunity Zone fund if held for more than 10 years. Abbot Downing Perspectives Fall

6 8 Should I convert my business to a C-corporation? Many factors go into changing the structure of a business, and your CPA should be included as you explore the options. You will need to consider the permanent tax rate of 21% on corporate earnings and double taxation of distributed earnings. Generally, if earnings are distributed each year, the double tax (21% at the corporate level and 20% at the individual level as dividend income) is more expensive than a flow-through structure like a partnership or LLC. An advantage of the C-corporation is the Qualified Small Business Stock (QSBS) gain exclusion. To take advantage of this exclusion, which means gain on the sale of the stock is tax free, you must meet these requirements: - The corporation must have had less than $50 million in assets at the date the stock was issued and immediately after, - You must have acquired the stock at its original issue, and - 80% or more of the company s assets must be used in a qualified business. Qualifying for this exclusion is complicated and some states have created separate rules, so think through any decision carefully. All businesses corporation or other have the temporary ability to expense 100% of qualified business property without limitation through the year 2022 under the new tax law. This provision was enacted to spur economic growth through capital expenditures How should I fund education for my children and grandchildren? As you probably are aware, there are many options for you to help pay for education for children and grandchildren. In light of the tax law, it makes sense to look at all of the options carefully. For now, here is an update on one popular strategy to consider. The new law made 529 plans more flexible in that up to $10,000 per year may be used for primary or secondary education. The 529 plan is an attractive vehicle for funding education for children and grandchildren because the funds grow tax-free and remain tax-free if used for qualified education expenses. In addition, up to five years of annual exclusion gifts may be funded in a single year. In 2018, the annual exclusion is $15,000. Thus, $75,000 may be contributed to the fund by each relative. Another option to consider is paying education costs directly to the institution. This is done without gift tax consequences and does not use the annual exclusion. Then, annual exclusion gifts can be made by other means directly to the individual or in trust. Talk to your advisors about all of your options before taking action. Do I still need life insurance? This will depend upon the purpose of the life insurance. If the insurance was purchased to provide liquidity for the estate due to illiquid investments, it may still be necessary. The estate tax has been reduced due to the doubling of the exclusion so your estate expenses may be less than originally projected, but remember the exclusion is slated to revert back to the 2017 level in If you don t need the policy or feel it is too expensive, consider your options. If you are over age 70, consider a life settlement it often provides more cash value than you would receive if you cancel the policy. 6 Abbot Downing Perspectives Fall 2018

7 11 Is alimony still deductible? The alimony deduction is scheduled to be eliminated January 1, However, agreements in place prior to that time will be grandfathered, meaning the payments will be deductible to the payer and taxable to the recipient. Please consult your attorney about this issue prior to amending existing arrangements. Only the Beginning As you can see, the new tax law has many implications for estate and tax planning. It is important to gather your team and hash through the nuances as they relate to your family s specific situation in essence putting your goals and plan through a thorough review and updating as necessary to take these new tax provisions into account. 12 Are the fees I pay to Abbot Downing still deductible? The new tax law repealed the deduction of miscellaneous itemized deductions, including investment management fees, through Note that certain fees of trusts may continue to be deductible. Regulations are being issued on this subject. The impact of the repeal may be minimal if you paid AMT in the past. Miscellaneous itemized deductions were not deductible when computing the AMT. Thus, if you paid AMT your deduction was limited even before the tax law changed. Family offices often have unique structures that enable the deduction of investment fees without the limitations of miscellaneous itemized deductions. Earlier this year, a family office won a case against the IRS on this issue. The family office was deemed to be a trade or business and thus the expenses were not itemized deductions. If you want to learn more, contact your Abbot Downing relationship manager. Abbot Downing Perspectives Fall

8 For more information on Abbot Downing, our people, and our services, we invite you to visit our website. Abbot Downing, a Wells Fargo business, provides products and services through Wells Fargo Bank, N.A., and its various affiliates and subsidiaries. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company. Wells Fargo & Company and its affiliates do not provide legal or tax advice. Please consult your legal and tax advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depend on the specific facts of your own situation at the time your taxes are prepared. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Past performance does not indicate future results. The value or income associated with a security or an investment may fluctuate. There is always the potential for loss as well as gain. The information and opinions in this report were prepared by Abbot Downing and other sources within Wells Fargo Bank, N.A. Information and opinions have been obtained or derived from information we consider reliable, but we cannot guarantee their accuracy or completeness. Opinions represent Abbot Downing s opinion as of the date of this report and are for general information purposes only. Abbot Downing does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. Additional information is available upon request Wells Fargo Bank, N.A. All rights reserved. Member FDIC. WCR A Wells Fargo Business