Hillary Clinton's tax plan would hit the very rich

The U.S. election poses a giant question mark for advisers. Aside from the prospect of Democratic nominee Hillary Clinton or Republican standard-bearer Donald Trump winning the White House in November and bringing with them their wildly divergent tax agendas, there's no guarantee either of the candidates would be able to codify their policies into law. Ms. Clinton has proposed restoring the estate tax to 2009 levels, which would lower the exemption and raise the tax rate, while Mr. Trump, who has offered scant detail on tax policy, wants to scrap the estate tax altogether. Ms. Clinton has also suggested eliminating a step-up in basis at death and imposing higher capital gains rates on shorter-term investments. The presidential election, as well as proposed Treasury Department rules on business valuation discounts, are the primary items tax and estate planners should heed for clients as the tax year comes to a close, according to industry practitioners. Even though the outcome of the election and potential resulting tax policy, as well as the precise content of the final Treasury rules, are unknown, advisers should examine whether to accelerate planning for clients who've been considering a particular strategy. The trade-off is taking advantage of the current tax environment versus risking the unknown future, they say.

THE ELECTION

Tim Kochis, chief executive of Kochis Global, a consultancy to financial planners that focuses on the developing world, believes congressional gridlock will be such that neither party will be able to push through its candidate's agenda, no matter who takes office. “We have sort of polar opposites in terms of the presidential candidates' preferences,” Mr. Kochis said. “I think the reality of the situation is nothing is going to happen.” "I think the reality of the situation is nothing is going to happen."--Tim Kochis, chief executive of Kochis Global “However, the opportunity for some sort of a surprising compromise could occur,” said Mr. Kochis, former chairman of the Financial Planning Standards Board. “It's possible in the midst of some other legislation we'll see some sweetener take place one way or another.” So all things being equal, it might be best for clients to initiate particular actions they'd been considering, he said. For example, advisers considering a Roth conversion for clients — which typically makes sense anyway if the client has a high IRA balance and can use other assets to pay the resulting tax from the conversion — may decide to pull the trigger this year to eliminate the risk of higher income taxes down the road, Mr. Kochis said. (Related read: Advisers say this part of Hillary Clinton's estate-tax plan is worse than the higher rate) The potential for higher capital gains tax rates following the election also may play into business owners' consideration of whether to liquidate small captive insurance companies, often held by an irrevocable trust, a structure used especially by wealthy business owners to avoid estate tax, according to Charlie Douglas, partner and director of wealth planning at Cedar Rowe Partners. A captive, which helps insure the risks of the business, can elect to be taxed solely on its net investment income when gross annual premiums are $1.2 million or less ($2.2 million or less in 2017). Captives provide current tax benefits for business owners in the form of deductible premiums paid to the captive as ordinary business expenses. When the captive is liquidated and its assets are distributed, however, they are typically taxed at a relatively low rate, as qualified dividends rather than as ordinary income, Mr. Douglas said. (Qualified dividends are dividends that meet specific criteria to be taxed at the lower long-term capital gains tax rate of 20% for high-income earners.) In addition to the possibility of higher tax rates on capital gains and qualified dividends under a Clinton administration, rules that take effect in 2017 impose new diversification requirements that will sharply curtail using captives owned by irrevocable trusts on an ongoing basis for estate and wealth transfer purposes, Mr. Douglas said. This, along with hefty annual administrative costs for small captives, could nudge advisers to recommend liquidation next year, he added. MORE: Read how revocable and irrevocable trusts differ

TREASURY RULES

The proposed regulations would curb tax-planning strategies that lower the valuation of stakes in corporations or partnerships in order to lessen gift and estate tax. Those who had been considering gifting an interest in a family business or a large portfolio of assets wrapped in a limited liability company or partnership should begin the planning process as soon as possible while discounts still exist for such transactions, said Gail Cohen, chair and general trust counsel of Fiduciary Trust Co. International, the private client unit of Franklin Templeton Investments. “There could be a refinement of [the rules], but I think most people anticipate there will be a change effective 2017,” Ms. Cohen said. (More: A comprehensive, searchable database of advisers' fiduciary FAQs) One potential planning technique to take advantage of ahead of final rules involves setting up a grantor retained annuity trust, said Brent Lipschultz, a partner in the professional financial services group at PwC. In a GRAT, assets are placed in a trust, which pays out an annuity every year. A beneficiary receives the remaining assets tax-free when the trust expires. Funding a GRAT with discounted assets could yield a benefit at the end of the annuity period, when the partnership interest is no longer discounted under final rules, Mr. Lipschultz said. Essentially, property would go into the GRAT at a discounted valuation, but beneficiaries would receive it at a higher valuation, he said.

MEDICAL EXPENSES

Advisers may also consider planning around a rule going into effect next year that could affect retirees' deduction of their medical and dental expenses on income tax returns, according to Tim Steffen, director of financial planning in the private wealth management group at Robert W. Baird & Co. 10%Affordable Care Act tax-deduction threshold for medical expenses in 2017 To qualify for a deduction, medical expenses have to be more than a set percentage of adjusted gross income. The Affordable Care Act raised that percentage to 10% from 7.5%. Retirees who are not likely to break the 10% barrier next year may look to bring some 2017 expenses onto this year's return, Mr. Steffen said. That may mean refilling prescriptions a little earlier than usual or seeing the doctor this year instead of in January, for example.

PATH ACT

Further, legislation passed in 2015 —the PATH Act — made permanent a few tax provisions that previously were in question from year to year. This is the first year advisers have certainty that specific planning techniques will be available, such as qualified charitable distributions from IRAs. (Related read: Permanent 100% exclusion of small business gains a long-term tax advantage)