More On Legal & Compliancefrom The Advisor's Professional Library
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- Dealings With Qualified Clients and Accredited Investors Depending upon an RIAs business model and investment strategies, it may be important to identify “qualified clients” and “accredited investors.” The Dodd-Frank Act authorized the SEC to change which clients are defined by those terms.
Martin Shenkman of Shenkman Law in Paramus, N.J. doesn’t hesitate to tell it like it is about tax planning in 2012: “This is not a normal year,” he says. However, that’s no excuse for what he sees as two huge mistakes that advisors and their clients often make as they quiver with uncertainty over what Congress may or may not do this year regarding taxes.
Those two mistakes? Acting like an ostrich and looking for a magic bullet to fix everything.
Mistake No. 1: Doing Nothing in 2012
Many investors, he says, are so freaked out by the fact that it’s not a normal year that they’re mimicking ostriches and burying their head in the sand, afraid to do anything at all. “The ostrich approach is not very effective unless you’re an ostrich,” he warns. Those who mimic the big bird are waiting to see what, if anything, gets decided out of a myriad of possibilities with the tax code as the Bush-era tax cuts approach their sunset at year's end.
However, Shenkman (left) warns that “wait and see will become wait and pay” if they continue to do nothing. He suggests protecting assets, particularly through gifting and trusts, as well as consider transferring some dividend-paying equities into an IRA where taxes will not become an issue.
The $5 million gift tax exemption could become a thing of the past if laws change--President Barack Obama, he says, is talking about reducing it to $3 million, and he reminds us that “for a long time we had a $1 million gift exemption. There’s no guarantee that won’t come back” if the government needs to raise funds–and while many people don’t think they’re anywhere near that in assets, they could be in for an unpleasant surprise.
He points out that even many clients who are not ultra-wealthy could find themselves in a bind if there are changes reducing that $5 million–particularly unmarried partners, who will find it more difficult to transfer assets back and forth. “Evaluate [ownership of] assets now,” he advocates, and make any changes “while it’s still easy to do.”
Another category of clients who should consider trusts and estate planning, in light of possible tax code changes, is anyone who could be subject to a lawsuit or malpractice claim. That, he adds, “includes everybody.” Not only doctors but also members of boards of directors, owners of businesses or real estate that could be beset with hazardous waste claims–such clients of yours, he warns, need to look at asset protection.
“With a $5 million exemption,” explains Shenkman, “you shift assets to a trust and you’re done. If [the amount is reduced to] $1 million, you have to use much more costly and complicated and risky techniques to shoehorn wealth into a trust like that.”
He adds that more than 20 states have “decoupled from the federal estate tax system” so the need to place assets into a trust to shelter them can be even more important, because individuals can be beneficiaries of the trust should they need money, get the assets out of the estate, and save a significant amount of estate tax in the process.
Individuals can also use the current $5 million exemption to equalize giving–say, for a couple with two grown, married children. Shenkman provides an example: If one child has five children and the other has only one, and the parents have been gifting the annual limit, the family with one child has received considerably less money than the family with five children. The $5 million exemption will allow the parents to even that out–to “equalize those prior gifts.”
Mistake No. 2: Taking the Wrong Steps in 2012
Some clients might go to the other extreme and seek a magic bullet, making simplistic decisions on what are complex matters. Some are deciding to sell assets now to avoid an increase in capital gains tax, without thinking things through. “Why realize a capital gain today, when you could harvest losses to eliminate that gain?” he asks. “It’s not clear that capital gains will increase.” He also suggests that advisors and their clients look at the whole picture: “If you have a rental property, why would you sell something to realize a capital gain?”
Instead, he suggests, take a multidimensional approach rather than “letting the tax tail wag the investment dog.” That way, even if one purpose of a tax planninng strategy becomes moot because a tax increase or other eventuality does not come to pass, it will still serve other ends–such as an insurance policy purchased to pay estate taxes, but with other needs in mind as well. That way, even if the estate tax does go away, the purchase will still serve a purpose.
Even if capital gains rates and dividend rates rise, he warns, it doesn’t make sense to make decisions based only on taxes. “Don’t go for investment allocation that doesn’t make sense just because you’re anticipating a change in the tax law,” he warns.
Estate planning could change, too; Shenkman mentions the “green book” tax proposals in Obama’s budget. “He will hammer very hard on almost every technique that the wealthy use in estate planning,” warns Shenkman. “If people who can benefit from it don’t take advantage of it soon, it may be gone by the end of the year.”
In fact, Shenkman's office is not booking annual reviews for clients in November and December, anticipating that people will suddenly decide to shelter whatever assets they can at the last minute. “Everyone will call at the last minute,” he says, pointing out that “even if you can turn documents around quickly, you still have to open bank accounts and get trust companies to accept trusts; it doesn’t happen overnight. Assets still have to be transferred.”
Add to that the fact that your clients rushing at the last minute of 2012 may not have thought through all the implications of such a move, there is the chance that they may be “missing the point of what’s relevant to them, and at year end they may have to rush through and not do things the way they really want.”
A Sit-Down After Tax Season
Shenkman also suggests that clients consider booking time with advisors–all their advisors–after the rush of tax season is over, and asking advice rather than telling advisors what they want. Much of the time, he says, clients will tell advisors what they want and that’s what advisors will give them.
However, he recommends to clients that they “sit down with your accountant once a year, after April 15, and say, ‘Tell me what you think may be of interest and use to me.’ Somebody independent, not selling, who has the review of your financial life and you can’t spend an hour of money to hear what they have to say? Especially with all this uncertainty.”
Better yet, he adds, is to sit down with the whole planning team–CPA, estate planning attorney, and investment advisor–and discuss everything from insurance to tax returns, perhaps on a conference call. “We do web conferences,” he says; “they’re incredibly efficient. It’s fascinating what a meeting of minds does to come up with ideas for clients,” he adds. “No one advisor has a lock on all the right ideas.”
One last thing: even if tax rates go up, it will not be a catastrophe, since even the new proposed rates being bandied about by President Obama are not egregious by historic standards. “People don’t need to panic over them; they just need to plan.”
See AdvisorOne’s Special Report, 22 Days of Tax Planning Advice for 2012, throughout the month of March.
See the article listing the complete schedule of tax planning stories for the month.