Rosalind Sutch of Drucker & Scaccetti joins Chas for episode 29 of The Wealth Cast, and she shares her insight into potential changes in tax law for 2021, as well as various tax-reducing strategies that will likely apply regardless of those changes. She discusses the utility of Donor-Advised Funds for charitable giving (including an example illustration) the importance of coordinating discussions between tax and investment advisors, and much more.

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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. On this podcast, we bring you the information that you need to know in order to be a good steward of your wealth, reach your goals, and improve society.

Today’s episode is all about taxes with Rosalind Sutch of Drucker & Scaccetti. Rosalind is a graduate of LaSalle University and Villanova University’s Master’s in taxation program. Rosalind and I are going to discuss the potential impact of tax law changes that are afoot and how you should consider preparing for year-end tax planning with your accountant. I hope you enjoy the show.

Hi Roz, and welcome to The Wealth Cast. 

Chas—thanks for having me.

You’re very welcome. So today, we’re going to talk about taxes—everybody’s favorite subject—I know it’s yours! And, you know, maybe review the proposed changes in the tax law that may be coming down the pike. There may not be much to do, sort of in anticipation of those changes, because they’re either just proposed at this point—but I thought it might also be helpful to talk about what we should be doing in any given tax year as we approach year-end: strategies, tactics, just bookkeeping, best practices, etc., for both clients and advisors.

Okay!

So why don’t we start out with the proposed changes for 2021?

So the Biden plan has been released, and it was released before really the election, and refined over time, and then we got the Green Book that came out a couple months ago. And that kind of gave us a little bit more insight into what to expect should this legislation go through. And of course, legislation takes time to—and gets curated, if you will—as everyone takes a little snippet of what they want. And so it’s hard to plan for legislation that’s been proposed yet. We don’t even have a proposed bill, we just have theories, and then the Green Book that kind of describes what to expect, as far as for budgetary purposes.

So the one change that everybody is most focused on is the increase in tax rates. So the proposal would increase the 37% top rate to the 39.6% bracket which existed prior to TCJA, which was the Tax Cut and Jobs Act. So I think that the jump in the top rate, obviously, is it’s just under 3%—while it can be meaningful, especially for high income taxpayer, what’s more on people’s mind is the jump in a long term capital gains rate that is proposed.

So that would apply to long term capital gains and qualified dividends that right now have preferential rates. Those rates right now are 20%, plus a 3.8%, kicker, if you will, on the net investment income tax. And the proposal is that those rates would stop being preferential, and they would go to the ordinary income rates. So for our top earning taxpayers, those in the top bracket, that would mean if the top bracket jumps to 39.6%, they’d go from what is 20% to 39.6% on those capital gains and qualified dividends—which is a substantial tax increase.

 That’s supposed to be for taxpayers with adjusted gross income over $1 million, and right now, the way that it read in the Green Book is that that will be retroactive to the date of the announcement and 2021, meaning we don’t know for sure, but that could mean the budget transmittal date, which was May 28, 2021, or the date the American Families Plan was released, which was April 28, 2021.

Unfortunately, what that does is take away our ability to plan for it. So if we thought this was going to be effective 1/1/22, we might take some steps to recognize gains that would, you know, if we thought we were going to recognize them in ‘22, we’d want to expedite the recognition or realization of those gains. A lot of folks that are looking at mergers and acquisitions, possibly selling their businesses—it might be too late now to try and, you know, make that sale occur before year-end. But then again, we don’t know what’s really going to happen. It might wind up being effective, 1/1/22. That’s kind of like the best case scenario. So there’s—it’s not that there’s not planning it’s it’s more like, what do you think might happen?

Right.

And rolling the dice a little bit.

Yeah, that makes sense. One thing that seems to me, and you can correct me if I’m wrong, is that the one strategy may become more valuable—and that is loss harvesting. If rates go significantly higher than those carry forward losses, and losses that you might realize this year, became that much more valuable, is that not correct?

Well, depends. So it seems in theory, that that would be correct. But there could be something that says—in the new law that hasn’t been written—that says that carry forward losses are still only going to avail you to a 20% benefit, you know. We can assume that it’ll offset gains, and at the higher rate, but we just don’t know. But in theory, yes, I do think that, you know, harvesting losses, which is a year-end strategy, or really a year-round strategy, you know, while you’re rebalancing a portfolio, will still be valuable. And on a definitely on a going-forward basis, I shouldn’t say definitely, because, again, it’s not written, but it would seem on a going-forward basis, it certainly would benefit us at the higher rate. And hopefully, the carry forward. I do have some clients with some substantial capital loss carry forwards, things that occurred in the 2008 collapse of the market. So you know, there still might be—that might be very valuable, that might suddenly become a very valuable tax asset that wasn’t as valuable before.

Is there anything else sort of, in theory, that may become really something investors should focus on from a tax standpoint?

Well, I can just say that there’s things that we could dream about, right? So the $3,000 limit for capital losses, to be deductible against ordinary income, it made sense, right? Because when capital gains had a preferential treatment, then you know, you want to put some kind of stopgap on the losses. Well now, if capital gains no longer have this preferential treatment, why couldn’t we take those losses, all of them? You know, I don’t know that that’s gonna change, and it’s nowhere in the proposals, but just like, you know, I like to think about taxes a lot. 

Right! Understood.

But it was, you know, in theory, it seems like you should—there should no longer be a limit on, you know, capital losses that we’re allowed to take. It’s hard, because we just don’t know, we don’t know what could come.

There’s also some interesting things in proposed changes, such as the elimination of 1031 Exchanges, and that was—there was no date specific, like, effective date for that. So I would say that taxpayers that are considering a 1031 Exchange, I would definitely try and get that done before year end.

So why don’t we explain in layman’s terms, what a 1031 exchange is.

A 1031 exchange allows you basically to defer the gain that you might recognize upon the sale of real property. So if you have a rental property that you’ve been carrying for quite some time, and you want to sell it, but you want to buy a new rental property to replace it—maybe the market where you’re renting isn’t doing so great, and you want to get into a better market—then you can basically defer that gain. You know, there’s a lot of rules, so this is overly simplifying it, but you can defer that gain and basically roll the gain and embed it into the new property so that you wouldn’t recognize the gain or realize the gain, until you sell the replacement property.

Gotcha.

Let’s talk just for a moment about the potential corporate tax rate changes, right? There’s proposed, or thoughts about increasing that, from what 21 to 28%?

Correct.

Is that still on the table?

Well, everything’s on the table right now. 

Yeah!

They’re also proposing a minimum 15% tax on corporate book income for large companies. But no one knows really what that means. 

Right! Including me, to be honest.

So it’ll be interesting to see how this all shakes out. There’s a reason corporate global and tangible income tax, from 10.5 to 21%, basically doing away with the guilty tax rates—don’t want to get in the weeds here with kind of more complex tax things. But, you know, there’s a lot of increase in tax rates that are proposed.

And just to go back real quick to the long-term capital gains rate discussion: when we talked about the net investment income tax, which is a surtax of 3.8%, we’re told that that’s still going to be in place with regard to capital gains and qualified dividends. So not only would the rate go from 20% to 39.6%, but that 3.8% tax would still apply. So now capital gains would actually not only—it wouldn’t have a preferential rate, it would actually have a higher rate than your normal earned income, which is interesting. But the proposal does expand that 3.8% surtax to households making more than $400,000. Right now the limit is $250[,000] before that kicks in.

So if the capital gains tax rate goes as high as you just indicated, it may make charitable contributions in kind, and securities, much more valuable. Has there been any talk about changing charitable deductions or anything like that?

Not that I recall there—no changes there. But certainly we have a lot of tools in our toolbox for charitable giving. There’s a couple examples I’d want to discuss. But first, maybe let’s talk about the nuts and bolts of what a Donor-Advised Fund is, because I think that’s such a powerful tool. And it’s a really popular tax saving strategy that we use to maximize philanthropic impact and tax savings.

So Donor-Advised Funds, also known as DAFs—they allow philanthropic taxpayers to give strategically. Basically, you contribute appreciated securities—though you can contribute cash, it just would take away the significant tax benefit of a Donor-Advised Fund. And if you donate appreciated securities, this avoids paying tax on the capital gains, which obviously becomes more valuable if their tax rate goes up on capital gains. And so the appreciation of the securities that you would normally realize and pay tax on, would go away, but you’d still get the deduction for the fair market value of what you’re donating.

So if you have a stock that was worth $50, but you only paid 25 for it, you put it into a Donor-Advised Fund, you get a $50 deduction, and that $25 gain disappears, and you never have to pay any tax on that gain.

And what, Roz, are the limitations on Donor-Advised Funds in terms of amounts that you can contribute?

I’m not aware of any specific limitations for Donor-Advised Funds. I think they’d be fund specific. And you know, most major investment houses have their own Donor-Advised Funds. You know, anyone that’s interested in using Donor-Advised Funds should research the ones that are available to them. Their investment advisor probably will have one that they prefer that they use most often, or most have vetted and are most familiar with. But you know, they have different fees, different minimums, so that all should be researched before a decision is made on which Donor-Advised Fund to donate to.

But there are limits on charitable giving.

Yes.

So those limits are based on Adjusted Gross Income. And currently, it’s 60% of Adjusted Gross Income. So you may be able to make a large donation to a Donor-Advised Fund, but not get the whole deduction in the year of the donation. But you could also spread it out over time; you don’t have to fund a donor advised fund in one year, you can keep funding it every year, or over multiple years, if that’s what you prefer, if you want to be opportunistic, you know.

A lot of advisors are reviewing client portfolios—I’m sure you do that regularly with your clients—and when you’re doing rebalancing, especially after the market is has been strong, that’s a great opportunity to use those gains that you’re trying to rebalance out of, to contribute those funds to a donor advised fund, and then basically avoid the tax on those gains, while you know, funding the philanthropic giving of the client.

So for clarity, for the listeners, the limitation is not on the contribution of the Donor-Advised Fund, it’s just on the advantage you can take or what you can take advantage of in terms of charitable contributions in any given year.

Yeah, the same that it would be on if you were making cash contributions. That limit is there, regardless of how you donate to charity, whether it be through securities, a Donor-Advised Fund, directly through cash, any way you donate, there’s a limit.

So the nature of the Donor-Advised Fund sort of requires you to think ahead if you’re going to make a large contribution as to what your subsequent year’s tax planning might look like. And it’s another reason to get together with your accountant and think about, what are the next several years look like if we’re going to make a large Donor-Advised fund contribution?

Yeah, but I would say Chas, it doesn’t have to be a big donation, too .I’ve seen as low as 10,000, maybe even 5,000 for certain funds. And if I just kind of go over a simplified example of someone that could benefit from a Donor-Advised Fund who maybe wouldn’t ever think of using one because maybe they don’t think they are—they’re in that, you know, that stratosphere of wealth.

Okay, great.

So if you take someone who normally has $10,000 in state and local tax deduction, which is the maximum you can deduct currently under the law, and maybe $12,000 of mortgage interest, okay? So that’s $22,000 of itemized deductions. We’ll assume this is a married couple, so the standard deduction is $25,100 in 2021.

So if they were to make charitable contributions up to $3,100, right, so that would be the 10, the 12, and the 3,100 would equal 25,100, which is the same exact as a standard deduction. That would mean they actually got no tax benefit for the charitable contributions that they made—that $3,100 of charitable contributions—great that they helped whichever charity they decided to give to, but no tax deduction for that $3,100.

So now, let’s say that same taxpayer decides, “I still want to give economically $3,100 a year, but instead of doing it $3,100 each year, every five years, I’ll give $15,500”—which is simply $3,100 times five.

Okay.

So in that instance, they would receive a tax deduction for $12,400 of charity, because in that one year, they’ll far exceed the standard deduction of $25,100. But economically, they haven’t changed anything. And this is called bunching. So they’re bunching their charitable contributions to one year as a means to take advantage of the tax deduction.

So in this example, say it’s a 25% tax rate couple, they would receive a tax deduction of $3,100. They basically funded one year—I didn’t make the math funny on purpose—but they funded one year of the five years of giving, with a tax deduction that they wouldn’t have received otherwise, if they gave that amount every single year.

Now, they could do that by simply just giving $15,500 one year, or they could put it in a Donor-Advised Fund, which would allow them to still dole it out each year, because a lot of people say “I can’t not give the charity for four years, that would just break my heart. I love these charities, you know, whatever they may be, they depend on my donation each year.” So a Donor-Advised Fund would allow someone who maybe, like I said, doesn’t think of themselves as a really high net worth individual or ultra high net worth individual. They think that Donor-Advised Funds are only for those folks—they’re not. They can be used in very simple ways, like the example that we just went over. And I’m going to send it to you. So you can put in the show notes, the example.

Awesome.

Because really, in that situation, it’s just amazing how you can take something economically the same across the board. But the tax savings, I mean, you can—literally, one free year of charitable giving. Or maybe they decide to give that other $3,100 to charity too, I don’t know. Depends on how charitable they are, I guess.

Right, yeah, of course, of course. So that’s helpful to understand. Does it, from the large donor’s perspective, can you use that, or share an example, or just a theoretical example of someone selling a business or someone having a wealth event in a given year, how they might use a Donor-Advised Fund in a similar fashion?

Well, it’d be a little bit different, in that you’d be bunching but not to take advantage of the standard deduction rate, or the standard deduction amount. In that instance, what you’d be doing is bunching so that you could take advantage of the fact that your tax rate is higher in that year.

So in a year that you have a mergers and acquisitions event, a liquidating event where you received a lot of proceeds, then you’re going to be in a higher tax rate. Assumably, you’d be in the highest tax rate that year. And maybe in other years prior and your normal everyday life up before the sale, you were in a lower bracket. So now what you can do—and you expect to be in a lower bracket after the year of the transaction—now, if you fund a Donor-Advised Fund in that year, where you have the higher income and the higher tax bracket, you get a deduction at that higher rate. So it becomes a more valuable deduction, and then you can use those funds that you put in the Donor-Advised Fund to fund your charity over multiple years, and you just make the grants most Donor-Advised funds that make it very user friendly to be able to make those grants to any 501(c)(3), normal public charity.

That makes total sense to me. So it’s just another reason why having a conversation towards year-end about tax planning issues with your accountant is a good idea: Donor Advised-Funds being one of them. I imagine in theory, in short order, relatively short order, we’ll have some clarity on the implementation or what’s actually going to happen with the tax law. In a normal year, what do you think the best practice is for a client and their accountant / advisor from a tax planning standpoint? What should that look like?

I think regular conversations at least semi-annually, maybe quarterly, to just check in and see what’s going on. You know, maybe they’re thinking about doing some house renovations, and they could put in, instead of doing one type of window, they could put in an energy efficient window that would garner them an energy credit. But even sometimes the simplest things—if you think of an executive who’s in the higher income earning threshold, but not the, sounds funny, but not the “super” threshold, we’ll say. They’re under a million, but say between $400-900,000 W-2 income. And say $200,000 of that is a bonus. Well, that bonus is going to be withheld at 22%, meaning their federal tax withholding is going to be 22% on that bonus, because that’s the mandatory withholding rate currently—and that’s only if you make under a million dollars. If you make over a million dollars, it’s the top rate, which would be 37%. 

But this presents a problem for someone who’s making, say, over $600,000 because their top tax rate is—they’re in the 37% tax bracket. But they’ve now had a $200,000 bonus that was withheld at 22%. So if you run the numbers, they’re about $30,000 underpaid for withholding, which you know, assumably they got a $200,000 bonus. They have the cash available to pay it. But if they didn’t provision for it, they weren’t discussing with their tax accountant, and they didn’t know they may have already spent it. Or maybe they already gave it to their investment advisor to invest it, and didn’t tell them to reserve the cash.

So by having those conversations early, it will allow them to kind of take a team approach. So say they wanted to invest those dollars, they can advise their investment advisor, or their investment advisor can talk to their tax advisor offline, and they can prepare, and be opportunistic about how they invest the dollars.

Similarly, if they have a big event that maybe creates income, but not necessarily cash—which can happen—then their investment advisor may need to liquidate some holdings in order to fund the tax bill. Well, I’m not an investment advisor, but I assume you’d prefer to be told way in advance so you can be opportunistic and look for things that you’d like to sell, instead of being told the week before the bill is due, “I need this much cash within a week.” And now you can’t be opportunistic, you just, I mean, you can do your best with what you’re working with. But you can’t really be thoughtful and opportunistic about which securities you liquidate to fund those tax dollars.

So, you know, having those conversations throughout the year are really important. And we run tax projections for our clients regularly to make sure they understand what their tax cashflow needs are. Because sometimes they’re just like, people don’t think about it. Some people think about it all the time. I have the spectrum of clients: some clients, it’s all they think about is their taxes. Some clients, they say, “That’s what I pay you for, to worry about my taxes, Roz.” But it’s really it’s a group effort, we need to be somewhere in the middle where we’re both thinking about it.

Yeah, it’s, you know, as in any other disciplined, open communication and clear communication among interested parties and advisors is really invaluable. And I think, you know, to your point about cashflow needs for a portfolio, the more notice you have, the better, because you can raise cash in rebalancing transactions, you can coordinate it with other cashflow needs that they may or may not have.

When you talk about tax projections, you know, as you get closer to your end, is there sort of a threshold, sort of a checklist or an alarm that goes off that says “We should do a projection for that person?” What, in other words, what sort of events or circumstances really encourage or would encourage you to advise let’s do a projection for this client? Is it transaction based? Is it an unusual outcome and something you weren’t expecting? What do you think?

Maybe all the above? When there is—when we know there’s a transaction, a large transaction, usually the sale of a business, we certainly will do tax projections, again. And that’s so that we can advise our client and their investment advisors how to provision for the cash that we’re going to need to pay the tax bill when it’s due—whether it be for estimates or when the tax bill is due in April. The quarterly payments is another reason why we do the projections. Sometimes we do it just to figure out what’s the minimum we have to pay in each quarter. Because maybe I have a client whose income is his investment base, like almost all their income investments. And because of that their income is different every year. The market did really good last year, maybe sans a few couple weeks there.

At the end of the day it did well, but it was touch and go there for a while!

You know, last year, a client who maybe was paying on a Safe Harbor based on 2019, which is just a way you can pay estimates, based on the prior year, they may have been underpaid because the market did so well and their investments returned so much, that they had taxable income that required larger payments. So doing projections there would have been helpful.

So I would say clients that have income that is almost strictly investment-based, we do projections for them pretty regularly: quarterly, semi-annually, sometimes. You know, right  before year-end. Just depends on the complexity of the client, how much their business changes. Closely-held businesses that have a lot of volatility in what they make—someone who, you know, sells products and maybe the market dropped out from under them last year in 2020. You know, we want to make sure that we’re paying in the right amount—not too much, too, right? Because we may have sent them a Safe Harbor estimate. But then they call me and they say, “I know we decided these estimates, but wow, we’re having a bad year,” you know, COVID aside like that can just happen. I’m sure any industry can have a bump in the road. So it’s really just client specific, but definitely a transaction year is when we’re doing projections.

I find that the executives benefit from it, like in the example that we just went over with under-withholding for bonuses. They often are unsettled by a large tax bill—that’s not fair, though. Because it really is person-specific. I have some clients who say “I don’t want to pay estimates. I don’t want to give the IRS $1 before I have to. I’m willing to pay the underpayment of estimated tax penalty,” which really isn’t a penalty, it’s an interest payment. Right now it’s 3%. So some people think “I can do better in the market”—a little risky, but that is the thought process for some folks.

And then you have some folks that say, “I don’t want to pay one more dollar than I have to. So tell me the exact amount I have to pay to avoid any penalty.” And then there’s some people that are in the middle, like, “I want to pay some because I don’t want to have a big balance due, but I don’t want to pay it all.” Now, it just, it’s really up to each client’s personality. Sometimes I keep notes in their file so I know.

Of course!

So I know which way they want to go!

Well, like any service profession, it’s knowing your client and their needs, and being able to customize the advice to that client is critical, right? I mean, it’s the whole ballgame.

I had one client once tell me, “3% is the penalty. Wow, that’s a great, that’s wonderful capital. You know, I can’t get that from a bank at 3%. So I’d rather fund my business with that, and then pay later.”

Yep.

Again, risky.

Right.

Risk tolerance. Just, you know, I’m sure you know, better than anyone in your profession is very person specific.

It is.

It’s similar in tax.

It is.

Well, this has been really helpful, Roz. We’re going to provide some of the examples that you offered in the show notes. So if the listener wants to go and read not only the transcript of this interview and discussion, but also see some of the examples, or an example or two, that Roz has provided, they’ll be there and you can easily find them in the show notes.

So thank you so much, Roz. I hope we have the opportunity to revisit this discussion or continue this discussion, once we have some actual clarity on the tax law. And perhaps there’s something that we can guide our clients to focus on as a result, to take advantage of opportunities. But I just wanted to say thank you, and I look forward to the next chat we have.

Great. Thanks so much, Chas.

You’re very welcome.

Thanks so much for joining Roz and I today as we discussed taxes—both the potential impact of tax law changes and how you might consider planning for taxes as we approach year-end. There’s additional information on today’s podcast on the website. Please visit the site and feel free to take advantage of those resources. Thanks again for listening, and I’ll look forward to next time.

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About Rosalind

Portrait of Rosalind Sutch

Rosalind W. Sutch, CPA, MT, is a shareholder at Drucker & Scaccetti in Philadelphia.

Roz began working for D&S as an undergraduate intern and quickly advanced in her career.  In January 2009, Roz became, at that time, the youngest shareholder ever at D&S. She provides business, tax and financial consulting services to the LGBT community, professional athletes, artists and entertainers, large corporations and partnerships, high-net-worth individuals, entrepreneurs and closely held businesses. Roz often works with successful young business professionals in varying industries.  Roz is active in firm management as a member of the D&S Executive Committee.

Roz is well known as the Greater Philadelphia-area expert on tax and financial planning issues for unmarried couples and the LGBT community.  She has appeared and been published  in media as a subject matter expert. She finds great pride in being a visible ally, advocate and resource to the LGBT community and is an outspoken supporter of all civil rights.

Roz is a maxima cum laude honors graduate of LaSalle University, with a Bachelor of Science degree in accounting and management information systems. She also holds a Master of Taxation degree from the Villanova Law School Graduate Tax Program. She is a member of the American Institute of Certified Public Accountants, the National Society of Accountants and the Pennsylvania Institute of Certified Public Accountants.

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.