The old real estate mantra also applies to investing, because where you place your assets influences your tax liability and your returns. Strategically place tax-inefficient assets, such as taxable bonds, REITs and some alternative strategies in tax deferred accounts. Let investments that are likely to grow over time reside in taxable accounts.
Federal Reserve interest rate policy generally has a delayed effect or no effect on statutory interest rates on loans for planned gifts under section 7520 of the Internal Revenue Code. To the extent that gifts and transfers can earn returns in excess of the applicable federal rate, this means the excess returns can be passed on to beneficiaries free of transfer taxes.
It's important to keep an eye on what's happening on Capitol Hill. Legislative changes can be complex, and could have a significant impact on your taxes. For example, a bill passed by Congress in 2001 gradually reduced the estate tax until it disappeared entirely in 2010. But the bill included a sunset clause that meant that estate tax would return in 2011 at 55% (with a $1 million exclusion). However, in 2010, the Economic Growth and Tax Relief Reconciliation Act was passed, resetting the rate to 35% for the next two years. Today, the highest rate is 40%.
Grantor trusts have traditionally offered a compelling way to transfer wealth to heirs and beneficiaries. But this is changing. To capitalize on the powerful tax advantages of these trusts, establish one while opportunities exist. Proposed changes to the tax treatment of grantor-retained annuity trusts could reduce or eliminate this benefit.
Converting a traditional IRA into a Roth is often accompanied by a large and immediate tax liability. However, paying taxes now excuses you from paying in the future and shields you from tax increases. Furthermore, with a Roth IRA, you aren't subject to required minimum distributions (RMDs) when you reach age 70½.
The 2013 increase in the top federal tax bracket and the Medicare surtax on investment income encourage a second look at how and when investment income from a trust is distributed. Since a trust is often taxed at the highest rate, a beneficiary may be in a lower tax bracket. These changes also mean the allocation of investments between taxable and tax-exempt investments need to be reconsidered.
Dynasty trusts, where assets can grow indefinitely without being subject to gift, estate or generation-skipping transfer taxes, remain one of the most effective planning tools available to families. Moreover, dynasty trusts now have historically high tax-exemption rates. Currently, there is wide speculation the Treasury Department may issue new rules on these trusts, and these changes could diminish potential tax savings.
Minority interests in a business can be transferred into a partnership or limited liability company at a discount to their stated value. By reorganizing the legal structure of personal or family assets to accommodate the transfer of business interests, gift and estate taxes can be reduced. The IRS has historically challenged valuation discounts with limited success. However, many tax professionals anticipate the Treasury Department will issue new rules to restrict or eliminate the use of valuation discounts.
As these strategies suggest, substantial tax-saving opportunities are available to families and investors. However, the rules governing these opportunities are constantly changing. Looking ahead and planning are the key to finding the right tools to reduce future tax liabilities.
This material is provided for illustrative/educational purposes only. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation. ©2016 The Bank of New York Mellon Corporation. All rights reserved.