Tax advising for the high-net-worth client, part 2

If you have high-net-worth (HNW) clients or want to make this segment a niche for your practice, you should become more familiar with the strategies include in part 1 of this article. In part 2, we’ll cover charitable giving, and estate and gift tax planning.

Tax planning for charitable giving

Charitable giving is an integral part of a HNW client’s overall wealth management strategy. Assisting with this part of a client’s wealth lifecycle can help build a stronger relationship, and better potential outcomes for the client and the charitable impact they would like to make. Understanding your client’s passions or goals will provide the rationale on making charitable giving a part of their overall wealth strategy, and give them the joy of doing great work.

When I meet with clients as part of our planning, we discuss the impact of charitable giving based on their passions, goals, and dreams. I regularly advise that the client should give to the charities of their choice, not necessarily to realize a tax savings, but to positively impact the charity they love and support, and fulfill their overall charitable mission. I also add that if they want to make charitable donations and have the financial wherewithal to do it, the client should make enough donations so that they can itemize their deductions for tax purposes. As part of their charitable giving strategy, the client can also consider setting up the following types of entities:

Qualified charitable distribution of IRA assets. Individuals age 70½ and older can direct up to $100,000 per year tax-free directly from their IRAs to operating charities through a qualified charitable distribution (QCD). By reducing the IRA balance, a QCD may also reduce the donor’s taxable income in future years, lower the donor’s taxable estate, and limit the IRA beneficiaries’ tax liability. One thing to pay attention to is that under the SECURE Act (Setting Every Community Up for Retirement Enhancement) of 2019, if the client makes a QCD and a tax-deductible charitable contribution, the client may lose the QCD tax benefit and might have to include the QCD as taxable income.

Donor-advised funds: The donor-advised fund (DAF) allows for the client/investor to contribute cash, capital, appreciated assets to a fund, retain control over when and where to contribute the assets, and realize an immediate itemized deduction (30 to 60%) of the client’s AGI. Donating appreciated assets such as stocks, bonds, and other investments allows for these items to be removed from the client’s taxable portfolio without incurring potential capital gains tax.

Keep in mind that this strategy is only beneficial if the client’s total itemized deductions – medical expenses, state and local taxes, mortgage interest, and charitable contributions – are greater than the standard deduction based on the tax filing status. The administrative costs can potentially reduce the amount of funds available to donate. It is important to work with your client’s investment advisor when executing this strategy. You should also include your client’s estate attorney in conversations related to the DAF to ensure that the fund is set up according to the client’s wishes, now and when they die.

Private foundations: A private foundation is similar to a DAF, except that the itemized tax deduction is limited to 30% of AGI, and subject to a 1-2% excise tax on all investment income.

Gift and estate tax planning

The federal estate tax exemption is $11.7 million per individual or $23.4 million per married couple. While the majority of us won’t have an estate greater than this threshold, we should still advise our clients on potential tax planning strategies. Work with the client’s estate attorney and investment advisor to ensure that the tax strategies align with the client’s overall goal of generational wealth transfer. Another reason to emphasize estate tax planning is that potential federal tax law changes to lower the estate tax exemption and the gift tax exclusion may become a reality for your HNW clients and families. Working with your clients and keeping them abreast of these potential changes is another way to be proactive and help them have options if the tax laws change. 

Some tax planning ideas include the following:

Gift giving. Under current tax law, a client can contribute up to $15,000 in cash ($30,000 for a married couple), each, to as many individuals as they choose and are not required to report it to the IRS. One way to maximize the amount of the gift given to an individual is to have each spouse provide a gift of $15,000, each, with a per-person lifetime exclusion of $11.7 million. This exclusion means that you can give up to $15,000/year, and as long as the cumulative amount of gifts to an individual does not exceed $11.7 million, the client does not have to file a gift tax return. This strategy is an excellent way for your client to transfer some or all of their estate tax free. Again, keep in mind that tax laws may change; it will be important to know of any changes to help your client make changes, if necessary.

There is an exception to the gift-giving exclusion. If your client wants to pay tuition or medical bills on an individual’s behalf, paying the school or hospital directly can help avoid the gift tax return requirement.

If your client owns property such as stock or investment securities that have shown a drop in value, your client should avoid giving property that will produce an income tax loss if sold. The value of the gift is fair market value +/- any adjustments at the date of transfer, and the client cannot recognize the loss. In this case, your client should consider selling the property, claim the loss for tax purposes, and gift the proceeds from the sale of the property. This strategy is a win-win for your client. They get the potential tax benefit of a capital loss and are still able to provide a gift.

If your client owns property that appreciates in value over time, the property is gifted at the donor’s adjusted basis at the date of transfer. Therefore, the recipient of the gift may be subject to income tax on a capital gain. If the property remains in your client’s estate, the property receives a step-up in basis at the date of death. You and your client will need to evaluate whether it is more efficient to gift the property with potential income tax implications or include it as part of your client’s estate at the time of death.

Estate tax planning. Discussing the implementation of a trust – grantor, irrevocable, charitable remainder trust, for example – with your client and their estate planning attorney is a great way to help your client protect their assets and allow them to properly transfer generational wealth to their heirs. Trusts are established to provide legal protection for the trustor’s assets, so make sure those assets are distributed according to the trustor’s wishes. With this approach, your client can save time, reduce paperwork, and, in some cases, avoid or reduce inheritance or estate taxes. Due to the complex nature of trusts, your client’s estate attorney should be involved at every step.

Wrapping it up

Our goal as our HNW clients’ trusted advisor is to help them manage their assets, income, and estate to achieve their personal and financial goals over the course of their lifetime. Tax planning is key, but not the only element of a well-developed plan. Working with all members of your client’s team – the investment advisor, estate and business attorneys, and others – will help solidify that you are your client’s trusted advisor. You will retain them as a client for life. What could be better than that?