The Wealth Cast Ep 02 - Michael McBratnie

With Covid-19 wreaking havoc on all aspects of life around the globe, we are facing financial uncertainty of epic proportions. The pressure of a volatile market leaves us wondering what’s next. In Episode 02 of The Wealth Cast, Trusts and Estates Attorney, Michael McBratnie joins Chas and offers insight into how to find and maximize opportunities during a significant economic downturn.

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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. Today’s guest is Michael McBratnie, Trust and Estates attorney, partner in Taxation, and the Wealth Planning Department co-chair at Fox Rothschild LLP. During the podcast, Mike and I discuss the estate planning opportunities that exist during economic downturns like we’re experiencing with the COVID-19 crisis. I hope you find it helpful.

Mike, thank you so much for joining me today. It’s a great pleasure to have you on the podcast, and I appreciate you being here.

Chas, thanks for having me.

You’re quite welcome. You know, we’ve both been in our respective professions for quite some time now. I think you and I have known each other for more than 25 years. And I’m sure you feel the same—when we’re going through periods of economic difficulty, there are opportunities that present themselves both from an investment perspective, and from a planning perspective. And I thought it’d be helpful today to talk to you a little bit about some of the estate planning opportunities that might exist because of the impact the unfortunate impact of the of the COVID pandemic.

Chas, you’re spot on with that. First, it’s always a good time to review your estate plan, but with (the) COVID-19 outbreak, it may even be a better time to do it. Even though we’re facing, you know, an unprecedented pandemic, we might have more time on our hands to think about and be more reflective of, you know, what our estate plan’s all about. When we’re in a busy day to day normal life, which we hope to return to soon, you know, we lose track of it. But we now have a little more time to be reflective, and as you stated, there are a lot of opportunities.

Is there a hierarchy of decisions that you think people should be going through at this point?

The best place to start would be, kind of dust off their current documents, and you know, maybe schedule a time to talk with their estate planning attorney and just review their current documents—you know, who have they put in charge of their estate, who have they appointed as their agents under their medical or financial powers of attorney? If there’s minor children, you know, who do we name the guardian? Because who we named five or ten years ago may not be the same person. Should we have a will or revocable trust? Checking our beneficiary designations is important.

One thing that’s been overlooked Chas, earlier in this year before COVID breakout, Congress passed the SECURE Act, and that made major changes on a beneficiary’s ability to stretch out retirement benefits. So it would also be a good time to look at that. And then it’s uncertain as to what’s going to happen to the estate tax exemption. We know that it’s going to be cut in half in  2026, but with the political climate the way it is, that might happen sooner, and therefore that’s where the opportunities may come in.

So that’s great. I know in my own personal case, Mike, the stress involved in going through doing estate planning documents during normal times for a lot of people is relatively high. No one really likes to do that—think about what happens when they’re no longer there. But it is absolutely necessary to have these documents in place, if only to make sure that your wishes are executed and taken care of, and that your family’s taken care of. I just went through this process myself and I know that my wife and I feel much more comfortable that all of this is buttoned up and taken care of once again. So all those points that you made, I think are very relevant and helpful and should be helpful to people.

What do you think sort of the three or four biggest planning opportunities might be for people right now beyond just checking the review of their current documents? Where do you think they tension could or should be focused at this point?

You know, 2020 was going to be a good year to plan anyway, and now maybe even more. So the higher exclusion amounts, which are approximately $11.5 million per person, are set to expire on January 1st of 2026. So even though that seems like a long time away, it was going to be a good time to, you know, take a look at that, and decide whether that’s something we need to take advantage of. 

With the 2020 election looming, and all the political partisanship going on, there could be a chance that Congress accelerates that sunset. So we don’t want to be caught flatfooted when we were planning on having till 2026. And it might end up being sooner, especially with all of the aid that the government’s been providing to businesses and individuals—that’s going to have to be paid for somehow, and typically, estate taxes are, you know, at least politically, a good source to collect that money.

And then the other thing she says is low interest rates. I mean, they were low before COVID-19. And now they’re even lower, and low interest rates always provide a good opportunity for planning.

That makes total sense to me. One of the things I had thought about recently, and I think you and I chatted about recently, was Roth IRA conversions being an opportunity, perhaps at this point.

Absolutely. A reason for that is with the dip in the market, we now have an opportunity to convert an IRA—a regular IRA that has an embedded income tax in it—to possibly paying that tax currently, while the value is low, and then thereby having all the appreciation post-COVID-19 grow tax-free.

The other thing that kind of brings that plan to even better light is the Secure Act. You know, we used to be able to leave an IRA to our children, and have them stretch it out over their lifetime, paying taxes that possibly their low rates and their low life expectancies. That has been changed to a ten year time frame, which is now making, you know, a Roth conversion, where they could take it out tax free, even better.

So it’s something that you should definitely talk to your advisors about to see if this is a good opportunity for you. You don’t have—it doesn’t have to be a full Roth conversion of the IRA, it can be a partial, so you could hedge your bets and convert half of your IRA to a Roth IRA.

Yeah, we’ve seen some cases where it seems to be most applicable, is where clients may be in transition between going into retirement, for example—where their incomes are dropping significantly in 2020. And you can use the Roth IRA conversion to fill up the tax buckets, the bracket buckets to whatever level you feel comfortable with. Does that seem to square with your thinking as well?

Yes. I think the factors that the listeners are going to want to think about is, “Has their account gone down in value?” For most of us they have. “Do we expect it to increase in value?” I think most of us hope that it does, and, you know, history tells us that it will. “What’s our income tax rate this year?” You know, perhaps this would be a good year to incur, you know, as you said, fill up those tax buckets in the lower brackets. “What’s your income tax rate going to be when you’re ready to withdraw the funds?” I mean, there’s a good chance that rates are not going to go down. If anything, they’re probably going to go up. And I think probably the most important thing to think about here is, you know, “Will you need your IRA in retirement?” Some of us are fortunate enough that maybe the IRA is just sort of extra, or a safety net that we probably will never need. If that’s the case, and the IRA is going to be inherited by your children, the Roth conversion makes a lot of sense, because it’s essentially giving the kids a gift, because they’re going to get that IRA, they’re going to be able to withdraw tax free and you know, save dollars that way because you paid the tax today.

Absolutely. That makes total sense to me, and in terms of the Roth conversion, I think it needs to be a really careful calculation—you need to make sure you understand what the assumptions are about this year’s income, the future tax rates, right? I think you mentioned that it’s not likely the rates go down from here, it’s likely that they go up. But that is an estimate. It’s likely that the government’s gonna have to raise taxes in the future to pay for all the bailout, and the public assistance, and all the programs that are being put in place today, let alone what was put in place previously. So it may provide the right kind of opportunity for these conversions, and you can calculate how high rates would have to go to make it not worth, or make it valuable to you, to make the switch. So these are financial calculations that can be made, and I think it’s, it’s absolutely sensible to just spend some time thinking about it, if you’re in the right situation to do it.

What about gifts or sales of privately held companies that have decreased in value? Right now, companies are clearly being valued less, because there’s more risk, and there’s more uncertainty about the future. Can business owners take advantage of that to gift interests in their companies?

Absolutely, Chas, and while that was a good planning technique before COVID-19, because of the expiring estate tax exemption, it makes it even more valuable now, because even though a closely held business may still be very profitable, because market conditions are down, and the market is so volatile, the multiples that business valuation experts use are down. So you could be able to even get a larger discount than you might have gotten pre-COVID-19. 

And you don’t have to just give it away. Maybe you sell it, so you’re freezing the value, especially if maybe family members are in that business. You could do a gift, or a sale, or a part-gift or part-sale, and be able to transfer the value of that business for tax purposes at a much, much lower value than its real value.

And the main discounts that are given in these types of transactions are a lack of marketability—because they’re a closely held company—and typically, if you’re giving less than 50%, or 51%, a lack of control discount. So those discounts always exist, but now they’re even more amplified by the lower multiples and the volatile market.

So the basic advice would be if you’re owner of a closely held business, and you were considering transitioning or transferring this to others, at some point, particularly family members, perhaps now is the time to really dust that off and do the hard calculations and see if it makes sense.

Yes, absolutely. And there’s things that a lot of business owners are always reluctant to give up control. And there’s ways to keep that control, but give away value—create voting and non-voting stock and things of that nature. So I know a lot of business owners are reluctant to do that, but there are really thoughtful ways that you can transition the value of the business without necessarily transferring the control.

Gotcha.

So excellent time to think about that, given all the factors that are existing now.

That’s great. That’s great. So what would be next on the list?

I think another very popular technique that it’s sort of been quiet of late, but was very popular back when the estate tax exemptions were lower, is something referred to as a “grantor retained annuity trust” or GRAT. Us estate planning attorneys have lots of acronyms, and you’ll hear them from time to time. But if you’ve ever heard of the term GRAT, what’s really nice about it Chas, is that it’s a blast technique. So a lot of these planning techniques, you know, you do take a little bit of risk that the IRS may review something and not agree with your evaluations or your discounts. But the nice thing about the GRAT is this is something that’s in the Internal Revenue Code. It’s something that the IRS actually allows you to do, so that’s a great thing.

The other nice point about these GRATs is, you can structure them so you’re not making a gift. And let me back up because maybe some of the listeners don’t understand what a GRAT is. Without getting too technical, essentially, it’s a trust that you set up for yourself, and you get money back. So for example, if you had a million dollars, you could put that in a trust for yourself, and the GRAT is structured so that it pays that million dollars back to you over a term that you pick—the term has to be more than a year, but it can be as long as you want it to be. 

And so essentially, when that person gives the million dollars to the trust for themselves, they’re going to get that million dollars back with a rate of return determined by the IRS. And that’s really the case as right now because that rate of return is under 1%, and it’s projected to be somewhere between 0.6 and 0.8% in the month of May (2020).

Yeah, really low.

Yeah, if you had a portfolio that was down, and you put that in a GRAT, and you could be—the appreciation on that portfolio is going to beat that 0.6 to 0.8% each year, you can basically give away the appreciation in your account, you know, tax free, and still retain what you put in, plus the relatively small return the IRS requires. So it’s a nice freeze technique where you’re not using up a gift exemption, and you’re not giving away the store. In other words, you’re just giving away the appreciation.

Yeah, that makes total sense. We’ve used that in a number of cases for clients. It’s worked out really well.

I was just going to give an example. Because you know, in my million dollar example, you need to make sure that the million dollars increases—the larger the portfolio, the more chance that you’re going to get more appreciation to your beneficiaries, without any risk to you. And if for some reason the portfolio goes down, you get all your money back. So you’re always going to get back what you put in, plus the rate of return that the IRS requires. So it’s kind of a no-risk endeavor.

Yes. And it’s really useful in certain cases.

How about other gifting or loans that might be done, that could take advantage of this lower interest rate at this point?

Sure. I’m glad you mentioned that, because inter-family loans are something we’ve used for years in the estate planning world as a way to shift income and value to the next generation and move future appreciation out of your estate. Right now, the interest rates that the IRS requires us to charge on an inter-family loan are under 1% for short-term and midterm loans, and slightly over 1% for a long term loan, which is a loan that would exceed nine years. So a lot of families I know, including myself, are reluctant to just give things away to our children, for fear that you know, they may not appreciate it. But this is a nice way to use your wealth to leverage for your children to build wealth, without actually giving them anything other than the capital they need to invest in an appreciable asset or business or real estate project.

And the return, frankly, the return that we would get from our children is really as good as what we would get from the bank, so we think our children are good investments—these inter-family loans are really nice.

Yep.

Also, Chas, if there was an existing loan that you had made to a family member, now might need the time to refinance that loan. But typically, there needs to be some type of change in the arrangement, where maybe there’s some more principal paid down, or the term is extended, something like that.

You can’t just unilaterally lower the interest rate.

Yeah, it’s certainly not recommended, because the IRS may just look at that as this was purely a tax avoidance scheme.

Mmm hmm.

So you want to make it look good, or do what a bank might do. Typically, if you were refinancing your loan with a bank, you’d either be putting more money down, or taking out for a longer term or something like that. So you want to have those kind of arm’s length changes made to the documents as if there’s an existing family loan.

Yeah, that all makes that all make sense to me, Mike.

Well, this is a really helpful overview of some of the opportunities that may exist in the current environment. We will make a copy of Mike’s notes on his discussion on this discussion available on the podcast. But I would encourage you, and I’m sure Mike would do the same—is to reach out to the folks that help you with your estate documents and your planning opportunities to make sure that you’ve addressed, certainly, the review of documents that Mike mentioned on the beginning of the podcast, and perhaps explore some of these additional planning opportunities.

And Mike, I can’t tell you how much I appreciate you taking the time to share this information with me and the listeners, and I look forward to talking to you again soon on another interesting planning topic. Thank you very, very much.

Oh, my pleasure, Chas. And thanks again for having me, and I look forward to another opportunity.

Thank you, Mike. Stay well.

Alright. You too.

Thank you for joining us today. Please remember to subscribe and join us for our next episode. Thanks again for joining us.

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About Michael

Portrait of Michael McBratnieMichael McBratnie is a Partner in the Taxation & Wealth Planning Department at Fox Rothschild, LLP. Michael’s practice involves a broad range of taxation and wealth planning matters including family business and succession planning, federal estate and gift tax planning, trust and estate law and administration and probate litigation. Michael is a former Chair of the firm’s Taxation & Wealth Planning Department.

Michael advises owners of family and privately held businesses on sophisticated matters and transactions including succession, business planning and asset protection. He helps identify and resolve sensitive intergenerational issues and conflicts that many closely held businesses confront. Michael advises clients on how to form a comprehensive tax and estate planning strategy that focuses on providing for continuity for a multigenerational family business while reducing the income, federal and state tax costs associated with making donative or other transfers during life or death.

Disclosure

Original Release Date: May 13, 2020.

This podcast was originally distributed on May 13, 2020, by Independence Advisors. Independence Advisors officially merged with Modera Wealth Management on December 31, 2020. Please note that the information provided in these recorded conversations may no longer be current or may refer to events that have since passed.

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.