Congress may be making up the details as they go, but that’s no reason to keep your bread-and-butter households in the dark on their planning options.
It’s hard to take what we know about the tax bill seriously until we see what (if anything) actually survives the negotiation process. We’ve all seen Washington promises evaporate in the bright light of day before.
But that’s no excuse to let your clients get blindsided if any of this actually happens. Proactive advisors get ahead of the scenarios and are ready to move the instant we see the planning landscape shift.
After all, even if nothing is set in stone yet, your people still want to know you’re alert. And as time ticks away, they may not have a lot of time to make literally last-minute tax optimization moves once the final bill finally comes up for a vote.
Shake off paralysis
I’m more than a little shocked that we haven’t seen more talk about the planning ramifications of the tax bill as we know it.
Too much of the discussion has fixated on how much broad socioeconomic brackets stand to gain or lose, and not enough on how professionals can help people maximize the opportunities on the negotiating table.
Ideally the professionals will step up now that we’ve seen which provisions pass the House and align with what the Senate Finance Committee is apparently contemplating. While amendments and reconciliation can still change the details, the broad parameters are finally set.
If the bill passes next month, those are the parameters that will guide tax planning for years to come. And if it doesn’t, your clients still want to capture every break they can.
Start with the most basic rule of tax planning: defer the taxable event if you see your marginal rate declining in the future, but pay it now if you see rates going up.
By historical standards, individual income tax rates are already on the low side, especially for highly compensated professionals, and unless the Treasury’s growth targets are accurate the federal government’s going to need to find revenue down the road.
Statistically and fiscally, the pendulum’s going to have to swing the other direction sooner or later. That means taxes on the people who make the most money — the client class — are probably closer to a long-term bottom than a top.
Given those odds, it’s going to be important to apply current rates to as much career income as possible. Generally that means converting tax-deferred wealth to after-tax vehicles, by which we mean shifting to Roth retirement assets.
It doesn’t have to happen immediately, since right now all individual income cuts Congress is talking about are set to expire in 2025. But an eight-year planning horizon should give your clients a reasonable amount of time to lock in the new rates where they can.
I flirted with scenarios where it might even make sense to take a taxable distribution in order to pay the tax bill on converting the rest of the nest egg, but all that’s hypothetical — and there’s no urgency right now in any event.
Get current breaks now
We might only get 2-3 weeks to maximize deductions before they go away.
If Congress flashes a green light, now is the time to cluster those medical expenses clients may have been putting off, double down on mortgage or student loan interest and even prepay state, local and property taxes.
Even making an extra payment a few weeks early can pay off by defraying hundreds if not thousands of dollars of ordinary income for 2017. Odds are good your clients are already familiar with the AMT, so it’s not like grabbing their deductions will raise IRS red flags.
The logic here is simple and compelling. You always want clients to take breaks every year they’re eligible because the tax code is always a work in progress — loopholes open and close, but the goal is minimizing the lifetime liability where you can.
And even if the bill stalls in the Senate until next year, grabbing the deductions won’t rob 2018 of any opportunities that might not be there 6-12 months from now. Nothing is lost.
We know what Congress is thinking. At best, these deductions will squeak through the process. Otherwise, this is the last shot.
That said, while clustering expenses into 2017 makes sense, it generally makes sense to defer taxable events until 2018 when the IRS drag should be at least a little lower.
It’s probably too late to sell a big house in order to skirt the proposed rules that make it harder to exclude a lot of capital gains on that side.
And unless there’s a twist in the broad capital gains framework, it doesn’t make a lot of sense to stack a lot of losses in 2017 or let winning long-term bets ride into 2018. We may see this shake out in year-end tax selling, in which case I’m sure we’ll all need to hold onto our hats.
Earned income, on the other hand, is probably worth pushing into the new tax year where possible. Needless to say, if your clients can structure that income as pass-through profit and not a working salary, so much the better.
We’re going to see a groundswell in professional incorporation if this passes. You can add value running the numbers and weighing in.
That’s a good thing because when tax rates decline, the amount of space advisors have to squeeze value out of tax optimization gets compressed.
Think about the shrinking role municipal bonds have played in HNW portfolios since the Bush tax cuts took the bite out of passive income. The margins are just too narrow to translate easily into real money.
When the IRS claimed up to 35% even on qualified dividends and 20% on long-term capital gains, an advisor could probably find ways to shave 1%-2% from that overall drag and make clients happy. It gets harder as income tax rates converge on the capital gains math.
We’ll do a lot more of that math as Congress gets closer to a do-or-die moment. But for now, it’s good to get the conversation started. Run your clients’ numbers under various scenarios. Let them know you’re ready to move.
