Maybe you have heard of the phrase “there is no such thing as a free lunch?”
It was first used in part by Fiorello La Guardia, on becoming mayor of New York in 1933, when he said “È finita la cuccagna!", meaning "Cockaigne is finished" or, more loosely, "No more free lunch"; in this context "free lunch" refers to graft and corruption, according to wikipedia.org.
His catch phrase later morphed into the colloquialism that we know today that “there is no such thing as a free lunch.” If fact, a Columbia Law Review of all places used this phrase in the Owlwin Daily Register in 1945.
Most of us would agree that “there is no such thing as a free lunch!”
We have most likely been tricked at least once in our lifetimes into jumping into something that seemed free, only to find out it is anything but free!
I can remember a certain free vacation weekend that my wife and I took where all we had to do was attend a short timeshare presentation. As we learned later, it was very hard to walk out on that presentation without committing to purchase something. I am glad to say, we managed to be one of the lucky few to get out without signing our lives away, but we learned a valuable lesson from that experience that such vacations were anything but free.
So what is your response when I tell you that Congress, of all places, has granted each of us a free lunch with its recent passage of the Tax Cut and Jobs Act of 2017?
Maybe you were as skeptical as I, but its true!
Yes, Congress granted you a free lunch by expanding the estate tax exemption from $5.5 million in 2017 to $11 million in 2018 through 2025.
I can already hear you grumbling, “but isn’t that just for the rich?”
Well yes, and no!
Obviously, for those with estates with assets greater than $5.5 million ($11 million for a couple), this is a wonderful thing and will potentially save their heirs millions in estate taxes.
But it also affects all of us.
Here is how.
The estate tax exemption is not permanent! It sunsets in 2025 back to inflation adjusted 2017 levels, as if this tax act was never existed.
Many believe that Congress will never find the votes to make this exemption increase permanent, so you essentially have seven years to use this “funny money” under a “use it or lose it” scenario.
For the ultrawealthy, they will do what they do best, hire the best advisers to help them plan the best way to use this added exemption before it sunsets. Of course, we can help with this.
The real jewel here is for anyone who owns a business that might generate income in excess of $315,000 (married filing jointly).
That is the threshhold at which a complex series of calculations occur that either phase out (for service businesses) or potentially limit (for all other businesses) the 20% Pass-Through Deduction created under the Tax Cut and Jobs Act of 2017 that allows such business owners to claim a deduction equal to 20% of domestic qualified business income or QBI.
A full discussion of this QBI calculation is beyond the scope of this article, but needless to say it behooves most high earners to stay under the $315,000 threshhold and to claim the full 20% QBI deduction.
So now let me tie the estate exemption in with the Pass-Through deduction.
The new game in town is likely to become using the ”funny money” (higher estate tax exemption) and vehicles like Charitable Remainder Trusts or Grantor Retained Annuity Trusts to make gift tax free transfers and smooth income to stay under the $315,000 threshold.
In other words, it’s all income tax avoidance driven, not estate driven!
Let me now give you an example:
Joe, married and a 33.33% owner in Dental Inc., has $550,000 in pass-through net service business income in 2018. Joe and his non-working spouse have $5,000 of other income and expect to take the new $24,000 standard deduction in 2018.
Based on these facts, below is a summary of Joe’s QBI deduction in 2018:
As you can see the QBI deduction is completely phased out because Joe is in a service business and his income is above the phase out range for married taxpayers of $315,000 to $415,000.
However, what if Joe’s business income instead was $250,000 of ordinary income and $300,000 from the one-time sale of an ancillary business unit.
What if Joe was unable to reach agreement on an installment sale to spread his income with the potential buyer.
Instead, he and his advisors decided to contributed the stock of this ancillary unit to a Grantor Retained Annuity Trust (GRAT) utilizing some of his “funny money” estate tax exemption to cover the prospective gift tax on the transaction. The stock would be then sold in the GRAT and Joe would instead receive back $60,000 per year over five years from this trust, with the balance going to his children as the beneficiaries of the trust.
In this case, Joe’s QBI deduction in 2018 would look like the following:
With the QBI deduction, Joe should realized $46,200 in reduced income in 2018 and potentially the four years thereafter just from proper planning. He also used some of his “funny money” estate tax exemption to cover the transfer tax on the difference between the present value annuity back to him and the fair value of the gift to the GRAT on the date of transfer.
If Joe had a charitable inclination, he could have used a Charitable Remainder Trust or any number of other planning techniques.
The key concept here is that Joe and his advisors were smart enough to realize the benefit of this increased, but temporary estate tax exemption in helping smooth his income so he could fully capitalize on the new 20% flow-through deduction and lower his taxable income.
So maybe there is such a thing as a free lunch? If there is, it came in the form of this Tax Cut and Jobs Act of 2017!
Of course, this is purely a simplified, hypothetical example. We recommend that you consult your tax professional to make sure these planning opportunities are right for you and fit your specific circumstances.
We can help you keep more, make it work harder for you and preserve it for multiple generations! Schedule your free consultation today
Shoot the fireworks and uncork the champagne, this current bull phase is now the second longest in history at 107 months!
Our course everybody celebrates number two right?
We’re #2! We’re #2!
I am sure you heard this chant at the last Florida vs. Florida State game, right? (sarcasm)
Think about it! The longest expansion in history was 120 months from March 1991 to March 2001. This current expansion has just slipped into second place in the history books at 107 months (106 months was the previous second best).
How much longer can it goes is a great question to ask?
However, the Gambler’s Fallacy (not that this is gambling after all its investing) is assuming previous results will change future results. As an example, “I have run this 50 times, so it must be likely to drop now.”
And it really feels like it should be that way. But it's not any more likely on the 50th run or the 500th run.
Are markets random as in the flipping of a coin or are they as much about the underlying fundamentals of a given time period or market?
One could argue either way!
I would personally argue it doesn’t matter. You take what the market wants to give you whether that is 120+ months and a new record long expansion cycle or 107 months and then straight off a cliff.
Forecasting is a losers game!
Instead, we propose you should be ready to react to confirmation that something has changed.
This is the fundimental tenant of trend following, an investment strategy woven into every portfolio we run at InTrust Advisors.
Trend following is agnostic as to the direction of the markets, up or down. In fact this chart could just as easily be inverted for the trend follower.
If you remember back to the last major bear market the thing that crippled most investors was indecision. Do I stay in or get out?
Most investors just froze and did nothing and rode the market to its lows. Yes, it recovered, but it took five long years to do so!
A great many trend followers instead had 30-50% positive performance years in 2007-2008.
How would that have affected your portfolio?
We have solutions to give you or your client’s a great chance to continue making money as long this market wants to keep setting endurance records.
At the same time, we have the tools and experience to keep them from the worst of what may come at any flip of the coin!
Why not schedule an appointment with us today?
On October 3rd, 1913, President Woodrow Wilson signed into law the Underwood-Simmons Act, creating what would be the first modern U.S. income tax.
The tax legislation was only 16 pages and imposed a base tax rate of just 1%. The actual tax code and regulations were just 400 pages in total. The highest tax rate was set at just 7% for individuals earning more than $500,000 or about $12.6 million in today’s dollars.
At that time, the tax was not meant to be permanent but was to pay for the costs of World War I. In fact, the tax rates were cut some four times during the 1920s.
Today, tax code and regulations are more than 70,000 pages in length! It has so many rules and code sections you would need a tax program just to remember them all. In fact, most CPAs today rely a great deal on such software to navigate the ever-increasing code.
It was rather ironic recently when House and Senate Republicans decided that tax cuts and simplification would be a good thing!
The results of their laborious process have been bills from both houses to slash tax rates for both individuals and corporations.
These bills are now in reconciliation, a legislative process of the United States Congress that allows expedited passage of certain budgetary legislation on spending, revenues, and the federal debt limit with a simple majority vote in both the House (218 votes) and Senate (51 votes). The two bills will be combined into a single workable bill that can go to the President for his signature.
The Senate bill alone is 479 pages in length. The House version of the bill is 429 pages in length. Ironically even the tax simplification bills are longer than the original tax code and regulations from 1913.
Both House and Senate versions of the bill reduce tax rates for individual and corporate
taxpayers with subtle differences in the number of tax brackets and income thresholds for each tax bracket. They also either raise the estate tax exemption or phase out the estate tax all together.
Both bills lower the corporate tax rates substantially for both corporate and pass-through entities. The exact brackets, thresholds and rules are beyond the scope of this analysis, but each bill is different enough that it has many anxious to see what the reconciliation process produces.
However, if you stand back and you look objectively at this process, as I am sure the rest of the world has been able to do, this process has been nothing but pure theatre.
Not only did Congress not simplify the tax code, but in all likelihood, they lengthened it. We used to joke when I was in Public Accounting that whenever Congress tried to simplify the code, it just meant more work for us!
A great example of how this process really simplified nothing is how special interest groups managed to keep mortgage interest deductions, charitable and other itemized deductions in the tax code, while at the same time, Congress raised the Standard Deduction so fewer people would be able to deduct such costs.
Although they raised the Standard Deduction to roughly $24,000 in both versions of the tax bill for Married Filing Joint taxpayers, they eliminated Personal Exemptions. For example, my family of four stands to deduct $16,200 in Personal Exemptions in 2017 that in 2018 will now part of the Standard Deduction.
If you add, the 2017 Standard Deduction of $12,700 for married couples filing jointly to the Personal Exemptions and deduct $24,000, my family actually stands to lose $4,900 in deductions in 2018.
In the past, we have also benefited from using itemized deductions to cut our tax bill, but with the new higher Standard Deduction, that is now unlikely in most years. This means I am likely to have higher taxable income in the future before applying the lower tax rates.
Just a quick back of the napkin calculation based on 2017 projected income did show I
stand to possibly save $300 - $500 in taxes based solely on the lower tax rates and brackets, but it was nowhere near the $2,200 that the Tax Foundation estimated I could save.
Now, I am a past Certified Public Accountant so these kinds of calculations are quite simple for me, but how many of us have my kind of tax knowledge?
Even with all my past knowledge, there is much in the tax code that I either do not know or would be hard pressed to apply.
Truth be told, why do we need this kind complexity?
What’s wrong with a 400-page tax code (and regulations) like in 1913 where I would guess most taxpayers understood most of its provisions. Unlike now where you need a team of professionals just to navigate the annual filing requirements.
Think about how much more productive we could be if we were just focused on providing the best service or product possible and not spending and an estimated 8.9 billion hours and $409 billion as a country complying with the tax code, according to the Tax Foundation?
As much as we can dream of a slimmer tax code, the reality is that the length of the federal tax code and regulations have grown steadily over the past sixty years.
In 1955, the tax code and regulations were a mere 1.4 million words in length. Since then, they have grown at a pace of about 144,500 words per year. Where today the federal tax code is roughly six times as long as it was in 1955, while federal tax regulations are about 2.5 times as long as you can see in the chart below.
Washington just doesn’t seem to have the will to actually simplify our tax system and code. It is obvious to most that special interest groups and corporate lobbyists control a large portion of our elected officials and thus what does or does not happen to our tax code.
Obviously, the only thing one can do is fight fire with fire!
That is dig into this mammoth tax code and find the advantages that allow you to prosper while less savvy persons pay more than they probably need to or should!
This is something we help our clients do every day. In fact, I issued a Tax Planning Alert just a few days ago to our affluent clients on a couple of simple suggestions that struck us about the recently passed House and Senate bills.
When these House and Senate bills are reconciled and signed into law, I believe there will even be more opportunities to save valuable tax dollars just by arranging your business or investment affairs in such a way as to minimize future tax drag.
As famed author Robert Kiyosaki likes to say, “it’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.”
We can help you keep more, make it work harder for you and preserve it for multiple generations! Schedule your free consultation today!