The planets may be aligned for advanced tax planning In the last third of 2021.

A bevy of newly announced tax proposals, combined with the impacts of recent changes to tax laws, have created an opportunity for advisors to help their clients adjust and demonstrate value to prospective clients, Ed Slott, president of Ed Slott and Co., said during a Financial Advisor webinar yesterday.

“Let the media do some of your marketing for you,” Slott said. “The tax proposals today, yesterday and the day before have been on the front page of almost every major paper in America. ... We don’t know if any of these things are going to come to fruition. Often they don’t, but clients see them.”

Slott warned that central to the most recent tax proposals, stemming from congressional Democrats’ Build Back Better Act, is a proposal to cut the lifetime gift and estate tax exemption in half.

Currently, that exemption stands at a generous $11.7 million, and more than $23 million for married couples, thanks to 2017’s Tax Cuts and Jobs Act.

“Whether it happens or not, there’s an opportunity to trim down some estates with gifting,” said Slott, who said there are three tiers of tax-free gifting most people fail to take advantage of, two of which won’t count against the lifetime exemption.

The first would be the $15,000 annual gift exclusion, which allows any individual to make non-taxable gifts of up to $15,000 per person per year, to as many people as they want.

The second tier, which Slott calls “one of the biggest loopholes in the tax code,” allows for unlimited gifting as long as those gifts are made for the purpose of paying tuition or medical bills, and are paid directly to the educational or healthcare institution.

“The third tier is actually going ahead and using the exemption while it is here at more than $11 million,” said Slott. “If you don’t use it, you lose it, and if you lock in those exemptions now they won’t be clawed back.”

Slott also discussed proposals that would make it more difficult to get money out of a tax-deferred traditional IRA and into a tax-free Roth IRA, recommending that advisors help their clients look at getting funds out of their traditional IRAs and potentially into a Roth account or a life insurance policy that could be outside of the estate.

That’s because Congress’s proposals are taking aim at Americans with high IRA balances and techniques for higher-income Americans to contribute assets to a Roth account.

“There were some really unbelievable retirement proposals to limit IRA contributions,” said Slott. “They have this thing where they are worried about mega-IRA balances. They’re over-worried in my opinion because it’s a small number of people with big IRAs.”

One proposal would prevent individuals with retirement account balances over $10 million in aggregate from contributing to an IRA if their adjusted gross income exceeds $400,000 for single filers or $450,000 for married filing jointly. Slott pointed out that the proposal imposes a “huge marriage penalty” as two single filers could have $800,000 of income between them and still contribute to an IRA, but a  married couple would be limited to $450,000.

Slott also doubted the efficacy of the proposal.

“What are we talking about here, future contributions? Those are limited to $6,000, or $7,000 if they are 50 or over,” said Slott. “Is this really necessary, to tell someone with over $10 million in an IRA, ‘sorry, we’re really going to let you have it by saying you can’t put another $6,000 in?’ That’s not even one-tenth of 1% of their balance, not even a grain of sand on the beach. I don’t understand that, but it’s a proposal they put out there that probably wasn’t even worth their time—but that gives you an idea of where Congress is going with this.”

Hand in hand with that proposal is another that would raise required minimum distribution amounts for high-balance IRAs for amounts deemed excessive—over $10 million or $20 million.

“Start looking at some clients with large IRAs and think about some ways to cut them down, maybe with Roth IRA conversions which are always good to plan near year's end,” said Slott. “We know the tax rates for today, 2021, but we don’t know what they might be for next year. It might be time to start taking down these IRA balances.”

Another area Congress is taking aim is at “backdoor” Roth IRA contributions, which allow higher-income Americans to move assets into a Roth IRA when they are unable to contribute to them directly.

Backdoor Roth IRA contributions are made via non-deductible contributions to traditional IRAs or workplace retirement plans, which are then moved into the Roth account. One proposal would ban Roth IRA conversions for those with more than $400,000 in annual income as individuals or for married couples filing jointly who have more than $450,000—another imposition of a marriage penalty.

“Here’s the great thing about this—Congress still wants that money from the higher earners. They’re using it to fund this whole package and Congress loves Roth IRAs and Roth conversions,” said Slott. “They only say they don’t like them because it sounds good, but they love the income that comes from them. They’re addicted to the Roth IRA and just can’t quit them because the tax revenue is too good to be true. So the provision to eliminate Roth conversions for anyone above the $400,000/$450,000 mark is not going to go into effect for a decade. The effective date is 10 years from now, after 2031. Why did they even bother?”

Also proposed is an outright ban on the “mega backdoor Roth” conversion using workplace retirement plans, which allowed high-income Americans to put $58,000 into a Roth account this year. If passed, that proposal would be effective next year.

All of these proposals would go along with new, higher capital gains and income tax brackets to increase taxes on high earners.

“One of the things that was a surprise was that the end of the step-up in basis wasn’t in the bill,” said Slott. “That’s because some Democrats were against it. They need 50 votes for this to go through, so anything extreme like ending the step-up in basis ... would have a hard time passing."

Slott recommended that advisors have a plan to act on behalf of their clients before the end of the year, noting that the last major tax legislation, 2019’s SECURE Act, went into effect 11 days after passage.

“We don’t want to wait until there’s a few days in the year to plan. We want to have things ready to go so we can react more quickly,” said Slott. “That’s all in the news, and there’s an opening to get out and get a conversation started. You have the opening to start talking about some solutions whether these things happen or not.”