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How COVID-19 can impact income & estate taxes


Individuals 05.07.2020 4 MIN READ

 

A volatile market and low interest rates brought on by the COVID-19 pandemic may seem worrisome at face value. But on deeper analysis, there are a few ways to mitigate these losses from an income tax planning and estate tax perspective. Let’s walk through the various options to save on your taxes in the current environment.

Income Tax Opportunities

 

Consider converting to a Roth IRA

If you have a traditional IRA, now is a good time to consider converting it into a Roth IRA. Let’s first understand why you would want to convert a traditional IRA into a Roth IRA to begin with. One big reason is that at the time of withdrawing funds from a traditional IRA, any money you’ve earned on the investments in your account is taxable, along with all contributions you may have deducted from your taxes before withdrawal. On the other hand, withdrawals from Roth IRAs are not taxable, as these accounts are set up with post-tax income. Another benefit of Roth IRAs is that your money continues to grow tax-free regardless of your age, unlike traditional IRAs which force you to withdraw money in the form of required minimum distributions each year after the age of 72 (70.5 years, in case you hit that number before 2020).
 

Why it matters now

  • Any tax that you may pay while converting from a traditional IRA to a Roth will be paid on the current value of your investments. With the pandemic negatively impacting most investments linked to the market, it is likely that the value of your traditional IRA is lower than before the pandemic affected markets. This means your income tax liability from a conversion at this time will be lower than before
  • Under the provisions of the SECURE Act, if a trust is named the beneficiary of a traditional IRA and certain requirements are met, IRA assets must be paid to the trust within 10 years. This means the IRA assets are taxed at the top trust income tax rate of 37% to the extent it is retained in the trust. If these IRA assets are distributed to a beneficiary in a lower income tax bracket instead, the IRA will no longer get the protections of the trust. Switching to a Roth IRA avoids this problem
     

Tax Loss Harvesting

The gains your investments make are subject to capital gains tax in the normal course of business. Tax loss harvesting is a way of reducing this tax liability, by selling off investments that made a loss.
 

Why it matters now

  • With the COVID-19 crisis negatively impacting markets, there’s a chance that some of the capital gains that your investments may have made in the earlier part of this year were offset by losses following the stock market volatility. This is the perfect time to reduce any capital gains tax you may owe for the earlier gains, by selling off your loss-making investments during this period
  • A caveat to keep in mind—you will not be permitted to write off a loss-making sale if you purchase the same or substantially identical security 30 days before or after the loss-making sale. This is called the wash-sale rule
  • Reach out to your Ayco advisor to help you understand which of your investments qualify for tax loss harvesting before you make any hasty moves
     

Estate Tax Opportunities

 

Now is the time to gift

Gifting assets, such as securities, to your loved ones may incur lower taxes given the possible reduction in their value during the current crisis. Keep in mind that the current gift tax exemption is $11.58 million and the annual gift tax exclusion is $15,000, as you plan your gifting. These limits may be subject to change if a Democratic candidate wins the Presidential election in November, so now is the time to act.
 

Fund your trusts

A combination of low interest rates and reduced asset values makes this the perfect time to fund any trusts that you may have set up for your heirs or for charitable purposes. This includes trusts like the Grantor Retained Annuity Trust (GRATs), Charitable Lead Trusts (CLTs) and Intentionally Defective Grantor Trusts (IDGTs).

  • GRATs can typically be “zeroed out” without any gift tax liability. Create a longer-term GRAT for assets that are expected to perform better in the future, while taking advantage of the current low interest rates to enjoy asset growth without eventual tax liability
  • CLTs can also be zeroed out like GRATs. Use income-producing or appreciating assets to fund a CLT, taking advantage of the current low interest rates. If the trust is a nongrantor CLT, any amounts that go to charity can be claimed as a tax deduction by the trust
  • In the case of IDGTs, you can take advantage of the low interest rates by selling assets to a grantor trust. As a grantor trust, any gains recognized from the sale will not be recognized or taxed
     

Refinance notes to trusts

It makes sense to refinance outstanding loans at lower rates, when interest rates drop. This extends to any outstanding notes to trusts or loans to children, as well. If you have an existing IDGT in place, make sure you don’t miss the opportunity to refinance at these lower rates.
 

Opt for late allocation of GST exemption

The GST or Generation Skipping Transfer tax applies to trusts or gifts given to younger skip generations (e.g., grandchildren). With the GST exemption, only the portion of gifts or transfers that exceeds $11.8 million are taxable.

With a likely drop in value of your trust assets in the current scenario, you might want to consider delaying the allocation of the GST exemption. With proposals from Democratic candidates to lower the GST exemption rate to $3.5 million, now is a good time to opt for late GST exemption allocation.
 

Valuation of assets for deaths in 2020

If the value of assets belonging to a loved one who passed in 2020 has reduced since the coronavirus pandemic, it makes sense to opt for an Alternate Valuation Date (AVD) which is six months after death to reduce federal and state estate taxes. Discuss this option with an estate attorney, as this move can impact the tax basis of the assets in the hands of the estate’s beneficiaries.

As we’ve seen above, even though the current crisis in world markets may have negatively impacted many of our investments and assets, there are ways to mitigate losses and preserve value in this situation. If you have access to an Ayco advisor, reach out to discuss your options with them to understand the impact on your taxes as well as your future finances.


 

 

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