Wealth Cast Episode 32 - Pat Runyen

On episode 32 of The Wealth Cast, Chas is joined by Pat Runyen of Modera Wealth Management for a discussion on the potential changes to tax law that have been introduced by the House Ways and Means Committee. These changes may impact estate planning, capital gains rates, and more.

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Update:  Please note that this podcast was recorded on October 8, 2021 and as such, some of the content and resources may have changed, as matters are quite fluid. Developments are under way with regard to a number of new tax law proposals as part of the Build Back Better Act, with final legislation expected to be passed by Congress soon.
The summary below has been created by a professional transcription vendor upon review of the recorded presentation. Please excuse any typos as well as portions noted to be inaudible.

Hello, and welcome to The Wealth Cast. I’m your host, Charles Boinske. On this podcast, we bring in the information that you need to know in order to be a good steward of your wealth, reach your goals, and improve society. You may have noticed recently, a lot of stories in the news about proposed tax law changes between now and year end. And while the legislation has not been passed, we think it’s important to familiarize yourself with the changes. And for that reason I’ve invited my partner Pat Runyen onto this episode to discuss those proposed changes, and give you some guidance about how you may want to think about the changes and some guidance about next steps. I hope you enjoy the show. Thanks for joining us.

Pat, welcome back to The Wealth Cast. I’m so pleased to have you here to talk about your favorite subject: taxes and all the associated calculations. So thanks for joining me.

Absolutely. Happy to be here, Chas.

So as I said in the intro, there’s a lot of changes potentially afoot. I know the legislation’s been proposed and not approved, but I think it would be helpful for the listeners to go through the basic changes that are being contemplated with the idea that, sort of, forearmed is forewarned. We might want to, as investors and business owners, consult with our tax attorneys to make sure that we’re taking full advantage of the change or avoiding missing an opportunity allowed by the change or caused by the change.

Yeah, there’s been a lot of talk recently about tax law changes, and we finally had some indication of what they may look like. The House Ways and Means Committee came out in September with a detailed proposal, and there’s a lot there. So we really summarize it down to two particular areas that people need to think about: individual income tax, and estate planning. 

So to summarize for the general person some of the key items that came up: On the individual tax side, the first one is that, as of the introduction of the bill on September 13th, the high level long-term capital gains rate will move from 20% to 25%. Now, that’s not law, but if this were to be passed, the thought is that it would be as of the introduction of the bill, which is September 13th.

The second, and this would begin as of 1/1/2022, is the highest current marginal tax rate is 37%, and that would go to 39.6%. And that would be for anybody over $400,000 if they file their taxes as a single individual, and $450,000 if they file as a married joint filer.

And then everyone else is unchanged below those brackets. Is that correct?

Correct. So far, that’s what we’re looking at.

So, and I did read that if you were contractually obligated or contracted to make a transaction prior to September 13, but haven’t completed that transaction until after September 13, that prior tax rate still applies, at least in the proposed legislation.

That’s right.

Yeah. If you contracted to sell your business before that date, you’re still going to be treated at the old tax rates, correct?

That’s my understanding. But as you know, the devil will be in the details of when this actually becomes law.

Yes, understood. So the punchline is for high earners, there’s likely to be a significant change in their tax rates, and for everyone post September 13th, there’s likely to be an increase in capital gains rates.

That’s right. And it’s on the high end of the capital gains rate. So this is, capital gains at the start, we’ve been zero, 15, and 20. They’re talking about bringing the 20% up to 25% for high income earners.

So has there been any talk about changing how tax loss carryforwards are used? Have they lost any of their importance?

No, not at this point. There’s nothing mentioned on how individuals can carry forward capital losses. They may actually become more valuable if you’re subject to the 20% long-term capital gain rate. So I would look at them as potentially being even more valuable than they were previously.

Yeah, so it’s even more important towards year-end, or it may become more important towards year-end, after September 13th, for transactions after September 13th, to look for loss harvesting possibilities to offset those higher rates.

Absolutely. And we’re in an environment right now where markets have been up for the last 18 months or so, and a lot of people have embedded gains. There may be opportunities toward the end of this year to consider proactively taking gains in the event that that could be advantageous to your situation, whether it be on the income side or capital gains side.

Okay, great. While we’re talking about tax rates, before we get to the state planning question, let’s talk a little bit about the changes that may occur in Roth IRA or backdoor Roths, etc.

Yeah, this is heartbreaking to me for a tax nerd. But one of our favorite techniques is using what’s called a backdoor Roth IRA. And this was a way to work around the fact that if you made too much money, you aren’t allowed to make a contribution directly to a Roth IRA. It’s been a loophole that everybody knows exists, and the IRS has kind of blessed, but they’re looking to eliminate that loophole, starting at the beginning of next year.

So Pat, let’s explain for those that don’t know what the backdoor Roth allows you to do, or what the strategy is—let’s talk just for a couple minutes about that. Because there may be the opportunity to do that. It seems like there’s maybe a window of time that you may be able to do that still.

Yes. So the way this worked was there is something called a non-deductible IRA contribution. It doesn’t matter how much you make or what your income is. Anybody can contribute after tax dollars to a traditional IRA, and that establishes tax basis in those accounts. And then only the earnings upon withdrawal would be taxable. So in that sense, what you could do is make an after tax contribution, and immediately convert that to a Roth IRA, and it was a way around those income limits. What they’re suggesting is they’re going to get rid of the after tax contributions to traditional IRAs, essentially closing the door on that loophole.

And for review purposes, the chief benefit of the Roth IRA is what?

The chief benefit long-term is that earnings on those contributed dollars are tax-free upon withdrawal, assuming that it’s been in there long enough, and you’re of the right age. So what that allows you to do is put after tax dollars into an account, knowing that all of the earnings will be received tax-free sometime down the road.

Gotcha. Gotcha. And then how about Roth conversions early in retirement, which is a strategy that we’ve used on occasion for clients as their income drops, taking advantage of the lower tax brackets to fill those buckets up, so to speak—pay the tax and convert to Roth. Can we talk about that a little bit?

So this was one of the more surprising parts of the bill. Roth conversions, as you just explained, is taking money out of a pre-tax retirement account and moving it into a Roth. That’s a taxable event at the time of the transaction, and you would think that would be something politicians love, because it means current tax dollars. But one of the things that they’re trying to skirt is making sure that high income taxpayers are not taking advantage of maybe temporary low rates to push money into a particular year. So they have proposed to eliminate Roth conversions in ten years, as of December 31, 2031, for anybody making over, say, $400,000 if you’re single, or $450,000 if you’re a joint filer.

Now, the techniques that we’ve historically used and recommended people consider, would be if you’re in a low tax bracket, maybe in the first few years of retirement, that’s a good opportunity to maybe voluntarily pay some tax and fill up the low brackets while your income is low for the right to now have Roth dollars grow tax-free. So that appears that that will still be the case, but some of the folks that are in higher tax brackets, that will probably go away in some form or fashion in this proposal.

Yes, we just have to sharpen our pencils when those opportunities appear. Iit’s not likely to be as broadly available as it was before, but it still may be available.

Absolutely. Yeah.

And turning the page back for a second to the increase in tax rates: It sounds like the tax bracket changes are going to go into effect, or would go into effect January 1st. So that may mean it makes sense for people to accelerate earnings into this year. Is that right?

That’s right, Chas. So this relates strictly to ordinary income in this proposal—so if you are in the highest tax bracket right now, which is 37%, and you’re well into that high tax bracket—much of your income will then be charged an extra 3%, roughly, starting next year. So what people may want to do is push income into this year and make sure that they get to save, you know, two and a half percent or three percent, roughly on those dollars. So I think you’re gonna see a lot of people try to push income into this year if they have some control over it.

Sounds good. Shall we move on to estate planning and the changes that are proposed there as well from an estate tax standpoint?

Absolutely. There’s some interesting proposals there, that some of which have been expected, and others of which we thought were going to happen and aren’t. So let me walk through those two items.

The first of which is, we all right now under federal law have about eleven and a half million dollars that we can exclude from our estate, when we pass away, which means as long as you have an individual estate below eleven and a half, or if you’re married below $23 million, you don’t owe any federal estate tax. So that’s a unified credit that goes for both your estate and gift tax. That is on the docket to be chopped in half, and that would start January 1st of 2022. So there are some proactive things you may want to consider from a trust planning standpoint, from a gifting standpoint, to maybe take advantage and utilize some of that exclusion, while it’s still exists.

So that’s a question for your estate attorney and your financial advisor, first to make sure you have sufficiency of assets so that you can give away those assets potentially to another party, and also to make sure that it’s likely that this is actually an effective strategy for you. If your estate’s not likely to be above those thresholds, for whatever reason, it’s not a huge issue, correct?

Yeah, I would say rule of thumb, if you have an estate of say, ten million and above, you absolutely want to have a conversation with your estate attorney. Unless you have extenuating circumstances where if you’re well below that, this probably doesn’t have a big impact on you in the short run.

Understood. Anything else estate tax- or estate planning-wise, that’s sort of on the radar, that’s unusual that we should make sure people are aware of?

Yeah, two things. One is grantor trusts. There may be some changes to how that interacts with a taxable estate of somebody that passes away. So I would say if you have any trust planning done, it’s absolutely worth a phone call to your attorney, and just make sure you understand how this may impact you.

And the other big one that’s always on the horizon that actually wasn’t mentioned in this proposal was what’s called the step up of basis at death. So this is the idea that if you have an appreciated asset in your estate, that appreciation goes away in the event you die with that asset. So think of an independently owned or self-owned company, or a highly appreciated stock that you own. If you were to sell that today, you would owe capital gains on what the increase in the asset was. If you pass away with it, that asset gets stepped up to whatever the fair market value was at your death, and really wipes away that capital gain.

So that’s a huge planning opportunity for folks that have appreciated assets to let that pass through their estate. A lot of people thought that was going to come into play and be proposed to change. But so far that has not been mentioned, which was a pretty surprising thing.

Yeah, that’s a really important item, right? Because the ability to avoid the capital gains tax on that gain that would otherwise be taxed on sale is an enormous planning tool.

Yeah. And it will affect how you draw down your assets, quite frankly. You know, how you spend your assets down while you’re alive, and what you want to strategically pass through on your estate at death. So we’ll be keeping an eye on it—it’s all subject to change. But that was a little bit more encouraging, because a lot of people thought that was going to go away.

Yes. Okay, good. Thank you. Anything else estate-wise, before we move on?

Not at this point, I would just encourage everybody to be proactive and get in touch with your estate attorney or your advisor, just to see how these changes may impact you.

Gotcha. On a little bit more esoteric, or sort of, not as applicable to as many people, is the idea that in a corporation, there are some changes afoot in terms of S Corp converting to a partnership. Want to talk about that just for a moment?

Yes. So there’s a proposal in this document that essentially outlines the advantages that used to exist for an S Corp, may be more limited. Therefore, they’re allowing folks to consider changing in a tax-free way, going from an S Corp to an LLC or a partnership. So I would encourage you to talk to your tax advisor if this is something that impacts you and you’re an S Corp, this could be kind of a very short period of time where you may be able to do that without significant tax consequences.

And that primarily or exclusively applies to S Corps formed before May of 1996, is that correct?

That’s right. That’s what they mentioned in the bill.

Okay. So if you have a relatively newly formed S Corp, this is not likely to be applicable.

Not likely, yeah.

Pat, that’s a great summary of the income tax changes, the estate planning changes, some minor but could be important changes to the S Corp status for business owners. Anything else at this point that we should cover?

No, it’ll just be interesting to see what actually goes through as law, as we approach the end of the year. So something’s going to happen. We just don’t know exactly what.

Yeah, that’s the nature of these sorts of changes, right? It’s always, you’re unclear right up to the finish line. What we’ll do in the notes of this show—Pat and his colleagues at Modera are going to provide a summary of the tax law changes that we’ll put in the show notes.

If you have questions about the tax law changes and how they might impact your situation, we would encourage you to contact your estate planning attorney, but also feel free to reach out to us if you have questions. We’re happy to put you in touch with the right people to get the right answer. But with that, Pat, thanks so much for joining me today. And I’m sure there’s gonna be more on this subject. But I appreciate you joining me to lend some clarity in these issues.

Thank you, Chas.

I hope you enjoyed that conversation about the new and proposed tax law changes that are circulating now through Congress. Pat and I have provided some additional resources in the notes of this podcast. Please feel free to take advantage of those resources. And of course, please feel free to contact us directly. If you have any questions regarding how the proposed tax law changes may impact your financial situation. Thanks again for joining us, and have a great day.

House Ways and Means Committee Proposed Changes

Modera’s Summary of the Proposed Changes

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About Pat

As a Wealth Manager, Pat Runyen works closely with clients to implement wealth management solutions. He leverages his technical financial planning and consulting experience to assist clients with investment counseling, retirement planning, estate planning, wealth enhancement, asset protection, tax planning, and other personally significant financial decisions. Pat joined Modera with the Independence Advisors team in January 2021.  Prior to Independence, he worked in both the Assurance and Tax Practices at PricewaterhouseCoopers LLP in their Philadelphia and Denver offices. While in the PwC Tax practice, Pat provided financial planning guidance to executives and employees of multiple Fortune 500 companies. Pat’s experience also includes working at a fee-only wealth management firm in the Philadelphia area.

Pat is a Certified Public Accountant, holds the Personal Financial Specialist designation, and is a Certified Financial Planner. He earned a B.S. in Finance from St. Joseph’s University and an M.B.A. with an Accounting concentration from La Salle University. In his free time, Pat enjoys spending time with his family in Ocean City, NJ, visiting national parks, following all Philadelphia sports teams, exercising and fly fishing. He lives in West Chester, Pennsylvania with his wife Ann and their two sons Archie and Henry.

Disclosure

Modera is an SEC registered investment adviser which does not imply any level of skill or training. For additional information see our Form ADV available at www.adviserinfo.sec.gov which contains a full description of our business, operations and service offerings including fees. Statements made in the podcast are not to be construed as personalized investment or financial planning advice, may not be suitable for everyone and should not be considered a solicitation to engage in any particular investment or planning strategy. Statements made are subject to change without notice.