Over the past few decades, federal taxes have generally
trended lower.

That era may be coming to an end, especially for well-off
individuals.

The major factor to consider is that our country might
finally be forced to confront the issue of ongoing huge federal budget
deficits—which have been made that much bigger by costly federal COVID-19
relief measures.

Can you protect what you currently possess from a possible
oncoming federal estate and gift tax threat? Maybe.

Before suggesting a strategy to (hopefully) dodge the
threat, let’s first cover the necessary background information. Here
goes.

Today’s Federal Estate and
Gift Tax Picture

The Tax Cuts and Jobs Act (TCJA) drastically increased the
unified federal estate and gift tax exemption from $5.49 million for 2017 to
$11.58 million for 2020—with inflation adjustments scheduled for 2021-2025. If
you’re married, your spouse is entitled to a separate exemption in the same
amount.

If you make cumulative lifetime taxable gifts in
excess of the exemption amount, the excess is taxed at a flat 40 percent rate.
If you pass away with an estate valued at more than the exemption amount, the
excess is taxed at the same flat 40 percent rate.

Taxable gifts mean gifts made in one year to one individual
that exceed the annual federal gift tax exclusion. The exclusion for 2020 is
$15,000, and it will probably stay at that number for the next few years
(unless our duly-elected politicians reshuffle the deck).

If you make taxable gifts during your lifetime, you won’t actually
owe any federal gift tax until the cumulative amount of such gifts exceeds the
unified federal estate and gift tax exemption. Excess gifts reduce your unified
exemption dollar-for-dollar, but only a few very generous individuals ever
actually owe federal gift tax.

Snapshots of Earlier
Federal Estate and Gift Tax Regimes

Today’s federal estate and gift tax regime is far more
taxpayer friendly than the regimes that existed earlier in this century.

• For 2000, the federal estate
  tax exemption was $675,000, and the maximum tax rate was 55 percent.
• For 2005, the exemption was
  $1.5 million, and the maximum tax rate was 47 percent.
• For 2009, the exemption was
  $3.5 million, and the maximum tax rate was 45 percent.
• For 2010, but just for that
  one year, estate executors could opt for a zero federal estate tax bill in
  exchange for giving up tax-basis step-ups for certain assets inherited by
  beneficiaries of the deceased individual.
• For 2015, the unified federal
  estate and gift tax exemption was $5.43 million. The tax rate on
  cumulative lifetime gifts in excess of the exemption and estates valued in
  excess of the exemption was a flat 40 percent.
• For 2020, the unified federal estate and gift tax
  exemption is $11.58 million. The tax rate on cumulative lifetime gifts in
  excess of the exemption is a flat 40 percent. The tax rate on the estate
  of an individual who passes away this year with an estate valued in excess
  of the exemption is a flat 40 percent.

The Portable Exemption
Privilege

Since 2011, we’ve had so-called federal estate and gift tax exemption
portability for married couples. If one spouse dies without using his or
her exemption, the surviving spouse is allowed to inherit the deceased spouse’s
unused exemption.

Scheduled Federal Estate
and Gift Tax Regime for 2021-2025 and Sunset Provision Scheduled for 2026

For 2021-2025, today’s version of the Internal Revenue Code
stipulates that the unified federal estate and gift tax exemption (currently
$11.58 million) will be adjusted annually for inflation.

The flat tax rate on excess lifetime gifts and excess estate
values will remain at 40 percent.

So far, so good. But a so-called sunset provision stipulates
that the exemption for 2026 will revert back to the 2017 amount of $5.49
million, with a cumulative inflation adjustment for 2018-2025. About $6.5
million is a good guess for the 2026 exemption amount if the sunset provision
takes effect for that year.

The flat tax rate on cumulative lifetime gifts in excess of
that number and estate values in excess of that number would remain at 40
percent.

The Looming Federal Estate
and Gift Tax Threat

There’s no guarantee that today’s super-favorable federal
estate and gift tax regime will survive beyond this year.

What actually happens to the federal estate and gift tax
regime (if anything) will depend on events. The current regime might survive,
or it might be trashed and replaced with something not nearly so taxpayer friendly.
Possible outcomes could include:

• The existing taxpayer-friendly
  regime stays in place through at least 2024 (the next general election
  year).
• The portable exemption
  privilege is repealed, and the effective date of the aforementioned sunset
  provision is accelerated to January 1, 2021. The 2021 exemption would be
  about $6 million.
• Starting next year, we go back
  to the 2009 regime with its much-smaller $3.5 million exemption, 45
  percent maximum tax rate, and no portable exemption.
• Starting next year, we get
  something much worse. For instance, we could go all the way back to the
  2000 regime with its skimpy $675,000 exemption, confiscatory 55 percent
  maximum tax rate, and no portable exemption. Ugh!

What to Do?

Very good question. Here’s one idea. If you have an estate
in the large-to-very-large category, put yourself in position to make large-to-very-large
gifts before year-end to reduce the value of your taxable estate.

You can shelter the gifts from the federal gift tax with
this year’s unified federal estate and gift tax exemption. Remember, it’s that
hefty $11.58 million.

Considerations

1. Depending on the assets on your personal balance sheet,
it could be easy or hard to position yourself to make large-to-very-large gifts
before year-end. You may need to make some moves to get into position.

2. Depending on who would receive your large-to-very-large
gifts, you may need to take some extra steps, such as setting up trusts for
some or all of your intended gift recipients.

3. If you’re married, remember that both you and your spouse
are entitled to separate unified federal estate and gift tax exemptions.

4. If your spouse passed away after 2010, we hope the
executor of your spouse’s estate filed Form 706 (the federal estate tax return)
to elect to take advantage of the portable exemption privilege. If so, your
exemption is that much bigger. If not, consult a good estate planning pro to
see if the election can still be made. If so, it could make a big difference in
your favor.

5. If you make gifts to someone who is more than one
generation beneath you (like a grandchild or great-grandchild), the federal
generation-skipping transfer tax (GSTT) can become a factor. The GSTT is
sneaky. It can come into play with gifts to a trust that will eventually
benefit someone who is more than one generation beneath you. Talk to your estate planning pro about the GSTT, especially
if you’re considering making a gift to a trust.

If you or a loved one is giving this a good look and would
like my input, please call me on my direct line at 408-778-9651.

IRS Enables Millions to Qualify for the $100,000 IRA Grab and Repay

New IRS guidance expands the possibilities for what is an
adverse COVID-19 impact on you for purposes of taking up to $100,000 out of
your retirement accounts and repaying it without penalties.

First, let’s look at the rules as they existed before this
new IRS guidance. The CARES Act created the first set of favorable rules, and
those rules are still in play.

What the CARES Act Says

A coronavirus-related distribution from your qualified
retirement plan, Section 403(b) plan, or IRA gets two tax benefits:

1. If you withdraw and keep the money, you pay no 10 percent
   early withdrawal penalty and you can spread the income equally over tax
   years 2020, 2021, and 2022. You also can elect to include it all in tax
   year 2020, if you want.
2. You can repay the money within three years of the
   distribution date and pay no tax or penalty on the amount.

Under the CARES Act relief, you qualify for a
coronavirus-related distribution if

• you, your spouse, or your dependent is diagnosed with
  COVID-19 with a CDC-approved test;
• you experience adverse financial consequences as a result
  of being quarantined, being furloughed or laid off, or having work hours
  reduced due to COVID-19;
• you experience adverse financial consequences as a result
  of being unable to work due to lack of childcare due to COVID-19; or
• you experience adverse financial consequences as a result
  of closing or reducing your business hours due to COVID-19.

And then there are two additional CARES Act rules for
coronavirus-related distributions:

1. You can’t treat more than $100,000 per person as a
   coronavirus-related distribution, and
2. You must take the distribution on or after January 1, 2020,
   and before December 31, 2020.

IRS Expands Relief

With the new IRS relief, you now also qualify for
coronavirus-related distributions if you experience adverse financial
consequences because

• you, your spouse, or a member of your household has a
  reduction in pay or self-employment income due to COVID-19;
• you, your spouse, or a member of your household has a job
  offer rescinded or start date for a job delayed due to COVID-19;
• your spouse or a member of your household is quarantined, is
  furloughed or laid off, or has work hours reduced, due to COVID-19;
• your spouse or a member of your household is unable to
  work due to lack of childcare due to COVID-19; or
• your spouse or a member of your household owns or operates
  a business that closed or reduced hours due to COVID-19.

Household

For purposes of applying the additional factors, a member of
the individual’s household is someone who shares the individual’s principal
residence.

Merriam-Webster defines a household as

• those who dwell under the same roof and compose a family,
  and
• a social unit composed of those living together in the
  same dwelling.

You have to think roommates living together create a
household, and if one of them is affected by COVID-19—say, lost his or her job
and stopped contributing to the rent—the remaining roommates were adversely
affected and should be entitled to the IRA grab and repay strategy.

Your Repayment Options

You have many repayment options, as we explain below. To
make this easy, let’s say you grab $30,000 from your IRA today and you want to
know how you can repay the $30,000 with no taxes or penalties. Here are five
scenarios:

Scenario 1. You repay the $30,000 before you timely
file your 2020 tax return:

• You don’t include any of the $30,000 in income on your
  2020 tax return. You pay no taxes or penalties.

Scenario 2. You elect to include all $30,000 as
income on your timely filed 2020 tax return, but then repay the full $30,000
sometime between filing the 2020 return and July 15, 2023:

• You amend your 2020 tax return to remove the $30,000 from
  income and claim a refund of tax paid on that amount.

Scenario 3. You include $10,000 as income on your
timely filed 2020 tax return, but then repay the full $30,000 sometime between
filing the 2020 return and July 15, 2023:

• You claim $10,000 of income on your original 2020 tax
  return, and
• You later amend your 2020 tax return to remove the $10,000
  from income and claim a refund of tax paid on that amount.

Scenario 4. You include $10,000 as income on your
timely filed 2020 tax return, but then decide to repay $10,000 of the total
$30,000 distribution, which you do on March 1, 2022:

• You claim $10,000 of income on your 2020 tax return,
• You claim no income on your 2021 tax return (because you
  made the $10,000 repayment prior to filing the return), and
• You claim $10,000 of income on your 2022 tax return.

Scenario 5. You include $10,000 as income on your
timely filed 2020 tax return, but then decide to repay $20,000 of the total
$30,000 distribution, which you do on November 1, 2021. This one is tricky
because you have two ways to do it:

• You claim no income from the distribution on either your
  2021 or 2022 tax return, or
• You claim $10,000 of income on your 2022 tax return and
  amend your 2020 tax return to remove the $10,000 from income and claim a
  refund of tax paid on that amount.

As you can see, you have many options when it comes to
taking up to $100,000 from your retirement plan. If you would like to discuss
your options with me, please call me on my direct line at 408-778-9651.

For example, you could hire your under-age-18 children, pay
them, say, $10,000 each, and they could pay zero federal income taxes. And you
or your corporation, the employer, would deduct the $10,000 you paid to each of
the children.

The child wins. You win. There’s more.

Schedule C Business

Let’s say you operate your business as a sole
proprietorship, a single-member LLC that’s treated as a sole proprietorship for
tax purposes, a husband-wife partnership, or an LLC that’s treated as a
husband-wife partnership for tax purposes. Good!

That means you can hire your under-age-18 child, and the
child’s wages will be completely exempt from Social Security and Medicare taxes
(FICA tax) and FUTA taxes.

To be clear, the FICA tax exemption applies to the
employee’s share of FICA tax that’s withheld from the employee’s paychecks and
to the employer’s share of FICA tax that your business must pay over to the
Feds. You have to like that!

For 2020, your under-age-18
employee-child’s standard deduction will shelter from federal income tax
the first $12,400 of wages received if the child has no taxable income from
other sources. No federal income taxes for this child. You have to like that too!

You can hire the under-age-18
child part-time, full-time, or whatever works for you and the child. Right now,
children in this age category are probably not attending school, and the school
district’s lengthy summer vacation may have already begun.

In the fall, will your under-age-18 child be attending
school in person or online? You probably don’t know anything for sure at this
point. But in the COVID-19 era, your under-age-18 child’s availability to work
in your business may be at an all-time high.

The wages received by your child can be used to help keep
the family afloat financially. If the family is not so financially stressed,
your child can use some or all of the wages to fund a college savings account
or make a Roth IRA contribution.

What if My Business Is Incorporated?

If you operate your business as an S
or a C corporation, your child’s wages received from the business are subject
to FICA and FUTA taxes, just like any other employee, regardless of the child’s
age.

What if I Hire a Family Member over Age 21?

Do it! The wages received from your business are subject to FICA
and FUTA taxes, just like any other employee. This is the case whether you operate
your business as an unincorporated sole proprietorship, a partnership, or an LLC
or as an S or a C corporation.

Tax Advantages for Your Business

When you hire a child or other family member, your business deducts
the wages paid.

• If you operate the business as a sole proprietorship, a single-member
  LLC that’s treated as a sole proprietorship for tax purposes, a husband-wife
  partnership, an LLC that’s treated as a husband-wife partnership for tax
  purposes, or an S corporation, the wage expense deduction reduces (a) your
  individual federal taxable income, (b) your individual net self-employment
  income, and (c) your individual state taxable income (if applicable).
• If you operate the business as a
  C corporation, the corporation deducts the wages paid to a child or other family
  member. The deductions reduce the corporation’s federal taxable income and
  probably the corporation’s state taxable income (if applicable).
• If your business will be unprofitable this year
  due to the COVID-19 fallout, deductions for wages paid to a child or other
  family member can create or increase a net operating loss (NOL) for 2020.
  If so, you can carry back the 2020 NOL for up to five tax years—back to
  2015. The NOL carryback can trigger a refund of income taxes paid for the
  carryback year. That can really help. An NOL carried back to a pre-2018
  tax year can be especially helpful, because tax rates were generally
  higher in those days.

Keep payroll records just like you would for any other
employee to document hours worked and duties performed (e.g., timesheets and
job descriptions).

Issue W-2s just like you would for any other employee.

If you would like to discuss the tax and financial benefits
of hiring family members, please don’t hesitate to call me on my direct line at
408-778-9651.