Strategies to be in the best position when markets return to normal
It’s no longer news that COVID-19 has prompted cascading marketplace changes and policy responses. The news these days is around how fast-moving and complex the changes are — which makes it even more important to find tax strategies that will put you in the best position when the markets normalize.
The strategies outlined here are not novel, yet “they should always be considered,” said Daniel Potter, managing director, Family Wealth Planning, Grant Thornton. “The current situation of low interest rates and low values merely accentuates their wisdom.”
This list is not intended to be exhaustive or to provide an in-depth analysis, but rather to show that opportunities can arise in extreme economic environments.
Income tax planning
If you’re seeking to minimize an income tax impact, consider:
- Converting Roth IRAs. The current depressed value effectively lowers the cost of the conversion.
- Harvesting capital losses. Consider selling assets at a loss to offset capital gains realized on other assets.
- Exercising stock options, unwinding net unrealized appreciation positions. Despite the differences in tax treatment, the rationale for both actions remains the same: The lower the fair market value, the lower the recognized income.
Gift, estate and generation-skipping planning
If you’re engaging in estate planning, you may want to take advantage of current low-interest rates and apply freeze strategies to low-value assets:
- Implementing low-interest-rate strategies. To capitalize on the current low interest rates, consider:
- Grantor retained annuity trusts
Such trusts are relatively low risk but lack flexibility.
- Intentionally defective grantor trust sales
While such sales pose more relative risk, they also offer greater flexibility.
- Related-party Section 453 installment sales
- Charitable lead annuity trusts
Remember that these need a clear charitable purpose.
- Private annuities
- Split-dollar life insurance, loan method
- Refinancing promissory notes
This assumes that notes were created when applicable federal rates were higher. Make sure the terms of the old and new loans are consistent. Any discrepancies may complicate valuation.
- Implementing low-value strategies.In addition to the strategies noted above, consider the following to take advantage of temporarily depressed valuations and allow your beneficiaries to participate in enhanced future appreciation on the transferred assets:
- Taxable and tax-free gifting. Low value results in a low-transfer tax cost and higher future appreciation outside the taxable estate, which benefits recipients of the gifted property.
- Trust taxable distributions for generation-skipping trust (GST). To the extent a trust is not completely exempt from the GST, consider making a trust distribution to a beneficiary who is a “skip person.”
- Late allocation of GST exemption. To the extent the value of the gifted property has declined since the date of transfer, it may be more efficient to intentionally file a late-return GST exemption.
- Exercising a power of substitution. Substitute tax-free assets with a greater appreciation potential at a current low value with assets having less future growth potential.
You should consult with a tax professional to take a deeper look at how to plan your tax strategy properly in these uncertain times.