ce: actionable tax planning strategies for the current

PUTNAM INVESTMENTS For financial professional use only. Not for public distribution.PPT241_ML 324795 1/21 1

Welcome and thanks for joining us today. Clients have real concerns on the impact taxes will have on their wealth, and are interested in solutions to help them meet their most important objectives in light of the impact of taxes: saving for retirement, funding college education, having enough income in retirement, and transferring wealth.

During our session today, we will present actionable planning strategies to share with clients and prospects.


Here are our topics for discussion today:

We’ll start off with a quick review of the current tax landscape• For the bulk of our discussion, we’ll examine actionable strategies taxpayers should consider given

current tax laws• Lastly, we’ll share some thoughts on how Putnam can help with your client conversations around taxes


Let’s begin by taking a look at the current tax landscape, which has been in place since 2018 following the Tax Cuts and Jobs Act (TCJA) signed into law in late 2017. Overall, tax rates are lower, individual deductions have been scaled back, the standard deduction has been doubled, the Alternative Minimum Tax (AMT) has been scaled back, and estate and gift taxes are not an issue for most families.


Currently taxpayers benefit from a favourable tax environment, from income taxes to estate and gift taxes. But, as we mentioned on the previous slide, there will be a need for more revenue to deal with the nation’s debt issue at some point.


Here’s a look at key tax figures for 2021. As a reminder the top ordinary income tax rate before passage of the Tax Cuts and Jobs Act (TCJA) in late 2017 was 39.6%.

One area of significant change in the tax code is deductions. With the standard deduction nearly doubled, more taxpayers will claim the standard deduction and less with itemize deductions on their return. Before the tax law roughly a third of taxpayers itemize. Going forward, tax experts predict that approximately 10% will itemize.

Mortgage interest — capped at $750,000 in debt, down from $1 million before tax law. For example, if you have a $900,000 mortgage, you can write off interest based on $750,000 of that debt, not the total amount. This debt can include a second mortgage, but the total debt cannot exceed $750,000 for the interest deduction. Interest on home equity lines of credit may still be deductible if proceeds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. Consult with a tax professional for more information.

State and local taxes (SALT deduction) — taxpayers are limited to a total deduction of $10,000 from local property taxes, as well as state/local income and sales taxes. For example, if you have $12,000 in property taxes and $15,000 in state income taxes, you can only deduct a total of $10,000 on your return.

Other deductions repealed under the TCJA include:• Casualty losses (unless a federal disaster is declared) • Alimony payments are no longer deductible, and alimony received is not considered taxable income• Moving expenses (except for members of the armed services)

Lastly, examples of miscellaneous deductions (which are now eliminated) include unreimbursed job expenses, certain membership dues, investment fees, and tax preparation expenses.


After the Tax Cuts and Jobs Act, fewer estates will be subject to the estate tax. This is because the lifetime estate/gift exemption amount was increased to over $11 million per individual. That means that a married couple can effectively shelter over $22 million in net worth from estate taxes. Of course, these rules sunset after 2025 when the exemption amount will revert to current levels (adjusted for inflation).


The SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019) became law on December 20, 2019. With a broad range of provisions governing retirement plans, plan participants, and individual retirement savers, this legislation brings the most significant changes to the retirement industry since the Pension Protection Act (PPA) of 2006. The new law is designed to expand access to retirement accounts, promote participation, and preserve savings. At the same time it introduces new restrictions on deferring taxes for inherited retirement accounts.

Most non-spousal beneficiaries are required to fully distribute inherited account balances by the end of the 10th year following the year the account owner dies. There is no requirement for annual distributions, the account just has to be fully liquidated by the end of the 10th year. Prior to the new 10-year rule, beneficiaries could opt to “stretch” required distributions based on their remaining life expectancy, allowing remaining amounts to retain tax-deferred status. This change applies to inherited accounts (both traditional and Roth) for deaths occurring after 2019. Exceptions to the new 10-year rule apply to certain account beneficiaries who are still allowed to calculate required distributions based on remaining life expectancy:• Spouses• Beneficiary is disabled or has a chronic illness• Beneficiary is not more than 10 years younger than the deceased account owner• Beneficiary is a child of the deceased owner who has not reached the age of majority. In this case, once the age of majority is

reached, the 10-year clock begins. Effective for beneficiaries where the account owner died after 12/31/19; existing “stretch” distributions from inherited accounts are not impacted until the current beneficiary dies, after which the 10-year rule applies to successor beneficiary(ies) (unless an exception applies)


Here’s a chart highlighting distribution options or various beneficiary types.


Right before the 2020 election, the House Ways & Means committee introduced a broad bipartisan bill to expand retirement plan participation and savings. The legislation, Securing a Strong Retirement Act of 2020, is a follow-up to last year’s comprehensive retirement package, the SECURE Act. The Senate may begin putting together a similar proposal as this bill moves through the House. The bill is being referred to as “SECURE 2.0” and includes numerous provisions to expand the rules around retirement savings plans and accounts. Most provisions are designed to expand already popular provisions to help workers save and to help retirees retain assets. Other provisions address issues of flexibility and increasing access to retirement savings plans for more workers.Here are some examples of what’s included in the current version:1. Require auto-enrollment in retirement plans - Require 401(k), 403(b) and SIMPLE plans to automatically enroll participants in the plans upon becoming eligible. Employees may still opt out of the plans, with some exceptions for smaller plans2. Modifications to required minimum distributions (RMDs) - Increase the minimum age for taking an RMD age to 75 from 72. Also, reduce the penalty for not taking an RMD to 25% of required balance from 50%. Eliminate the RMD requirement for an individual with an aggregate retirement account balance (IRAs and defined contribution retirement plans) that does not exceed $100,000.3. New catch-up contributions for those age 60 and older - For 2021, catch-up contributions for those age 50 and older are $6,500 for retirement plans and $3,000 for SIMPLE IRAs. For those age 60 and older, the new legislation would increase these amounts to $10,000 and $5,000, respectively (both indexed for inflation)4. Enhancements to qualified charitable distributions (QCDs) - The maximum amount of a QCD would increase to $130,000 per account owner from $100,000. QCDs are currently available with IRAs only. The legislation would extend QCDs to retirement plans. The IRA charitable distribution provision would be expanded to allow for one-time distributions to charities through charitable gift annuities, charitable remainder unitrusts, and charitable remainder annuity trusts5. New retirement benefit for those with student loan debt - Employers would be allowed to make

https://waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/documents/2.0Sectionbysection_final.pdf

PUTNAM INVESTMENTS For financial professional use only. Not for public distribution.PPT241_ML 324795 1/21 ‹#›

matching retirement plan contributions for participants making “qualified student loan payments”


While we’re in a relatively favorable tax environment currently, what does the future hold? Taxpayers need to consider the risk of higher taxes for these 3 reasons. Can steps in planning be taken now to prepare for the risk of higher taxes. Are we in a relatively short “window” of favorable tax rates?


Let’s consider fiscal pressures at the federal government level that may lead to a change in tax policy in the future.

$3.1 trillion– the latest federal budget deficit approached exceeded $3 trillion for the first time ever

72% - most federal government spending is on “auto-pilot” meaning that it is allocated to mandatory programs like Medicare and Social Security or utilized to service interest cost on the current debt level. The percentage of mandatory (vs discretionary) spending has been increasing over the past decade or more.

16.4% - this is the % of revenue per GDP that the federal government collected in 2019, significantly lower that the average of the last 50 years

2034 – according the latest Social Security Trustees annual report, the trust fund will be depleted in 2036. This means that benefits would have to be provided solely from current receipts. If this occurs, an immediate benefit cut of roughly 25% would be required.


In addition to fiscal risk, there is political risk as well. Here are some examples of tax-related proposals that were outlined by the Biden campaign leading up to the 2020 election.


Based on research of tax-related policies proposed by the previous administration when Joe Biden was vice president, here are additional provisions that may be introduced under a Biden administration.


We have covered the current tax landscape and factors which may lead to increased taxes in the near future. Now, what should clients be considering given the current tax environment?


Here are some planning themes we’ll explore in more detail.


We’ll start off by planning for the loss of certain deductions. Taxpayers — especially those who are committed to regular charitable donations — may see the appeal of “lumping” deductions into one year and itemizing deductions on the tax return for that particular year. For example, instead of making consistent charitable gifts each year, consider making a large gift in one year or funding a donor-advised fund if that allows you to itemize deductions on your tax return. In other years claim the expanded standard deduction. Depending on the situation, this may result in tax savings.


Another idea around charitable giving is to make donations directly out of an IRA through a qualified charitable distribution (QCD). The provision allows retirees age 70½ and older to donate up to $100,000 tax free from their IRA each year. Generally, when you take a distribution from your IRA, it is treated as taxable income. Under this provision, made permanent in the 2015 federal spending and tax package, those assets are excluded from income if the distribution is made directly to charity.

The distribution is not included in your income so you avoid the potential negative consequences that regular IRA withdrawals in retirement can create, including taxes on Social Security benefits. Distributions excluded from income are also equivalent to a 100% deduction. Normally, charitable contribution deductions are limited to a lower percentage (or are eliminated altogether) for taxpayers who do not itemize and take the standard deduction.

It’s important for clients to consider their tax situation before deciding whether to make a charitable contribution from the IRA.


How can taxpayers plan for the limitation on deducting SALT and also mortgage interest (interest on aggregate housing debt of $750,000, down from $1 million prior to the TCJA). Transferring ownership of a residence into another legal structure such as an irrevocable, non-grantor trust (or LLC) will allow an additional deduction for SALT and mortgage interest. In this example, the clients own their primary residence outright while the vacation home is owned by their non-grantor trust. When considering this type of strategy, it’s critical to work with a tax and legal professional with knowledge on specific state statutes. For example, for those with New York residences, putting the home in the LLC or the trust could potentially trigger the state’s 1% mansion tax, which is levied on sales of homes of at least $1 million. Also, taxpayers whose primary residence is Florida may not be able to use the strategy either because of complex rules related to the state’s homestead exemption.

One big issue with having a non-grantor trust own a residence is the loss of capital gains exclusion upon sale. To avoid loss of the capital gains exclusion on the sale of a primary residence, the trust owning the house could be converted to grantor trust status two years before the sale of the residence. This would satisfy the two of five year ownership test for the Section 121 exclusion. Another issue with non-grantor trusts is income taxation — the trust tax brackets are not favorable with the highest tax bracket of 37% applying once taxable income within the trust reaches just over $12,000.


The repeal of miscellaneous 2% deductions impact many areas for taxpayers, including the deduction for investment advisory fees. An investor could choose to have an investment fee deducted directly from their retirement account for that portion of the fee. Treasury regulations allow this without imposing taxes or an early withdrawal penalty upon the distribution to pay the fee (Treasury regulation 1.404(a)-3(d)).


An incomplete non-grantor trust (ING trust) is a trust in which income is accumulated or paid out to beneficiaries who live in a state with no income tax or an income tax with lower rates. To avoid the state income tax, the trust cannot be categorized as a “grantor trust” under the income tax laws of the state in which the settlor resides. To avoid any federal gift-tax implications, contributions to the trust must not be treated as gifts for federal gift-tax purposes. A transfer that is not a gift is often referred to as an “incomplete gift,” usually because the donor retains the right to change the trust’s beneficiaries. For an ING to be effective, the assets must be legally located in a state that has no state income tax, the settlor must not be the only beneficiary, and all distributions from the trust must be approved by a “distribution committee” that consists of the settlor and at least two other beneficiaries. The “distribution trustee” must at all times be composed of enough members to avoid giving any member of the committee, including the settlor, the unilateral power to benefit himself or herself.

Our example assumes an ING trust domiciled in Nevada, referred to as a NING trust. In addition to saving state income taxes, the ING is also a “spendthrift trust” under Nevada law, which means that its assets are not subject to the claims of any beneficiary’s creditors. Because the settlor is a permissive beneficiary, this trust is considered a self-settled spendthrift trust, which is subject to special rules. A self-settled spendthrift trust established under state law is referred to as a domestic asset protection trust (DAPT).

These types of trusts do not fit every situation. It is not a trust that avoids all taxes or that allows the settlor to retain control or to receive a guaranteed income. The ING is probably not appropriate: (a) for a person who lives in a state without an income tax or in a state where the state income tax rate is not that high, (b) for a person who will need regular income distributions; or (c) for a person who is not willing to take the chance that state tax law may be changed to trigger an income tax on the income of a ING. In addition, the cost of establishing and administering the NING has to be taken in to consideration in evaluating the ING’s benefits.


Lastly, states may take legislative action to tax assets held in these types of trusts in the future. In fact, in 2014 the state of NY passed a law that prevents the avoidance of tax through the use of incomplete non-grantor trusts (frequently referred to as DING trusts when established in Delaware, NING trusts in Nevada, or WING trusts in Wyoming). To close this loophole, this law treats DING, NING and WING trusts as grantor trusts and taxes a New York resident grantor on the income, regardless of whether it is distributed. Other states with similar restrictions on using INGs include CT, DC, IL, LA, ME, MD, MI, MN, NE, OH, OK, PA, UT, VT, VA, WV, and WI.


A thoughtful strategy utilizing Roth accounts can be an effective way to hedge against the threat of facing higher taxes in the future. Younger investors or taxpayers in lower tax brackets should consider using Roth accounts to create a source of tax-free income in retirement. It is virtually impossible to predict tax rates in the future or to have a good idea of what your personal tax circumstances will look like years from now. Like all income from retirement accounts, Roth income is not subject to the new 3.8% surtax and is also not included in the calculation for the $200,000 income threshold ($250,000 for couples) to determine if the surtax applies. IRA owners considering a conversion to a Roth IRA should carefully evaluate that transaction since the option to recharacterize, or un-do, a Roth IRA conversion is no longer available.

This chart compares tax brackets created under the TCJA with the previous brackets (married filing a joint return). Taxpayers benefit from lower marginal tax rates throughout the brackets. The lower tax rates effectively lower the cost of converting traditional IRA assets to a Roth IRA. In particular, some taxpayer may see opportunity with converting assets up to a income threshold of $250,000. At that point a married couple is in a 24% marginal income tax bracket vs. 33% tax bracket under the “old” rules. In fact, here’s a comparison of how $250,000 of ordinary income is taxed under the new brackets vs. the old brackets:

New brackets: Tax on $250,000 of taxable income = $48,579

Old brackets: Tax on $250,000 of taxable income = $57,717

In the chart, we set an income level of $250,000 since that is the threshold for the 3.8% surtax on net investment income. Above this threshold, investment income (capital gains, dividends, investment interest, etc.) is subject to an additional tax of 3.8%. For taxpayers without investment income subject to this tax, the “cost” of a Roth IRA conversion above that income level would be less.


However, it’s important to note that the TCJA also eliminated the recharacterization option so, beginning in 2018, there is no chance to “undo” a Roth IRA conversion after the transaction has been completed.


Prior to the TCJA, many practitioners believed that it made more sense to execute a Roth IRA conversion earlier in the calendar year, which would provide a longer timeline for recharacterization. For example, a client converting in January 2017 would have until their tax filing deadline (plus a 6-month extension if desired) to decide whether or not to keep the conversion in place — effectively October of 2018, roughly 20 months! Now that the recharacterization option has been repealed, this strategy is not available anymore. Under the new rules, it may make sense to wait until later in the calendar year before converting. This provides a better chance for the taxpayer to understand what their taxable income looks like for that year, and conversely, how a Roth IRA conversion may impact their tax situation. Some may find it useful to spread a Roth IRA conversion among several smaller conversions throughout the year — like dollar-cost averaging — so they are not locking in to one market price on the conversion.

Of course, the same principles apply on whether a Roth IRA conversion may make sense. For example, does the client expect to be in a higher tax bracket in retirement or believe that tax rates will be higher in the future? Does the client hold after-tax assets within the IRA that will not be taxed upon conversion? Do special tax situations apply such as an NOL carry forward or charitable contribution carry forward?

Overall, more care and analysis is needed before proceeding with a Roth IRA conversion since there is no option to undo the transaction afterward.


With the drastic increase in the basic exclusion amount (BEA) or, as some refer to it, the lifetime gift/estate exclusion, some prior planning may not be applicable anymore. One strategy that may not apply for many clients is the Credit Shelter or A/B trust arrangement. This was utilized to ensure that the lifetime exclusion of the first deceased spouse was not lost at their death. Now that the portability provision applies, many of these trusts are not needed anymore (although these trusts can still provide other important benefits such as asset protection which must be considered, or state death taxes if applicable). One major issue of an AB trust is the loss of step-up in basis on assets held within the bypass (B) trust following the death of the second spouse. Use of the portability approach can preserve a step-up in cost basis at the death of both spouses. With the BEA over $10 million, most families no longer have to worry about federal estate taxes. This example highlights how a traditional CST works.


With financial planning shifting from a focus on federal estate taxes to income taxes, here are some other considerations to maximize, or preserve, step-up in cost basis at death. It’s important to note that tax law is always changing and there could be a risk in the future of step-up in basis at death being modified or limited, at least for some taxpayers.

Avoid gifts to younger family members — If federal estate tax is not a risk, families may benefit from transferring appreciated assets to heirs at death to secure a step-up in cost basis.

Gift low basis assets — Conversely, there may be a benefit to gifting appreciated assets to older family members who may have limited life expectancy. It’s important to consider other factors such as long-term care planning. Assets gifted to older relatives would generally be subject to the asset test for Medicaid purposes. Note: Under Section 1014(e), the stepped-up basis rules do not apply to appreciated property acquired by the decedent through gift within one year of death.

Incorporating swap powers (under Sec. 675(4)(C)) within trusts — This swap power creates grantor trust status, which means the trust is not considered a separate taxable entity for income tax purposes; the grantor is responsible for paying taxes on trust assets. The grantor retains the power to swap property within the trust. A grantor should consider swapping high basis assets in return for low basis from a grantor trust (the low basis assets owned by the grantor at death would receive a basis adjustment under §1014). If the grantor does not have ready low basis assets like cash to swap, consider borrowing cash to swap for low basis assets within the trust. Also, the grantor may wish to swap assets that have declined in value into the trust, so as to preserve the loss on the grantor’s death (avoids a step-down in basis at the grantor’s death because the loss assets would not be owned by the grantor at death).

Spend down retirement assets — These assets do not benefit from a step-up in cost basis at death and are generally taxable to heirs who have to distribute funds via RMDs. It may be more prudent for some


retirees to spend down their IRAs for example and preserve taxable, appreciated assets for transfer to heirs upon death. Of course, there are other factors to be considered like the impact on income taxes by withdrawing more funds out of a pretax retirement account. Lastly, some assets may benefit more than others with step-up in cost basis at death. For example, depreciated real estate or MLP interests where the taxpayer has benefited from depletion may be good candidates for estate inclusion to achieve step-up.

Discount planning – Some HNW families may have pursued aggressive valuation discounts in the past to maximize wealth transfer when the BEA was much lower. These valuation discounts set a lower cost basis on asset, which may have an adverse effect on income taxation. Valuation discounts may not be appropriate for those who determine that a federal estate tax risk will not apply.

With the complexity of this type of planning, it’s critical for taxpayers to consult with a qualified tax and legal professional.


The increase of the BEA by roughly $5 million per individual allows higher-net-worth clients the ability make additional lifetime gifts in order to reduce the size of their estate. Since the gift and estate tax changes under the TCJA sunset after 2025, one of the key questions was whether large lifetime gifts made under the temporary increase in the BEA would potentially be “clawed back” into the estate of the the party making the gift once the law sunsets and the BEA reverts back to the level in place in 2017 (adjusted for inflation). The Treasury Department addressed this in proposed regulations by confirming that no clawback rule would apply in this case. This provides HNW families with an option to manage future federal estate taxes by using the additional increase in the BEA to make large lifetime gifts now before the law sunsets or a future Congress changes the rules before then. In addition, since the estate and gift tax was not repealed during with the passing of the TCJA, many HNW clients may feel that federal estate tax repeal is unlikely at this point. Additionally, efforts to lessen or eliminate valuation discounts via Section 2704 were abandoned were withdrawn by the Treasury Dept. in late 2017 but could return at some point in the future.


Careful designation of beneficiariesDesignate beneficiaries who may be in lower tax brackets and leave other assets (such as appreciated stock outside of retirementaccounts which benefit from stepped-up cost basis at death), to higher-income heirs. Pass the retirement account to more beneficiaries which will spread the inherited balance among more taxpayers. This may help control bracket creep for heirs by allocating taxable income across more tax returns. While two beneficiaries could spread the inherited retirement income across amaximum of 20 separate tax returns (2 heirs x 10 years), leaving the account to five beneficiaries could spread that income across 50 tax returns (5 heirs x 10 years). Leave account balances to spouses who are not subject to the 10-year rule.

Tax-efficient timing of distributionsHeirs will want to plan distributions from inherited retirement accounts in conjunction with their income and other tax variables. For example, some heirs may benefit from pro-rating withdrawals from the retirement account over 10 years. Other heirs may want to withdraw more during years when income is lower or deductions (charitable contributions for example) are higher.

Advanced strategies to considerA charitable remainder trust (CRT) may be an option to benefit from a tax deduction and provide income to non-spouse heirs over a longer time period than 10 years. The account owner designates the CRT as the beneficiary. Upon death, the IRA is transferred tax-free to the charitable trust which can provide income for heirs based on lifetime payments or a twenty-year term, with the remainder interest retained by the charity. Some retirement account owners may see a benefit from funding life insurance premiums with account distributions while living, as a means to create a legacy for the next generation. If the life insurance is properly structured within an irrevocable, life insurance trust (ILIT), it can pass assets to heirs free of income and estate taxes at death.


The TCJA established a 20% deduction of qualified business income (QBI) from certain pass-through businesses. Specific service industries, such as health, law, and professional services, are excluded (but NOT engineering and architecture) at certain income limits (fully phased out at $214,900 in income for individuals and $429,800 for couples. However, joint filers with income below $329,800 and other filers with income below $164,900 can claim the deduction fully on income from service industries. This provision would expire December 31, 2025.

Here is a detailed flowchart showing how the deduction applies depending on the characteristics of the business.


A net operating loss (NOL) may occur during a tax year in which business deductions exceed income, resulting in negative income. Historically, taxpayers could apply this NOL deduction to prior tax returns, at least two years prior, and in some cases as many as five years. This was referred to as an NOL “carryback.” Alternatively, the taxpayer could apply the loss to future tax returns for a maximum of 20 years. This was referred to as an NOL “carryforward.”

Small-business owners who operate as pass-through entities may take advantage of an NOL. In the case of a sole proprietor, business income and expenses are reported on Schedule C, which is used to calculate net business profit or loss. This figure is then carried over to the taxpayer’s 1040 form and combined with other income (spousal income, unearned income from investments, etc.) Generally, if the business loss being reported on Schedule C exceeds all other income reported on the 1040, an NOL deduction may be available, depending on the circumstances. For other pass-through business entities, such as an S Corp, partnership, or LLC, the calculation of an NOL is more complicated. In these cases, a business loss for a particular year is first applied to the taxpayer’s cost basis in the business. Once the basis in the entity is reduced to zero, an NOL may apply. Additionally, entities generating passive income (from real estate activities, for example) are subject to the passive loss rules and may be limited when calculating a deduction for NOL.

Changes to the tax treatment of NOLs• Beginning in 2018, taxpayers are no longer able to carry back NOLs, but instead may carry forward

NOLs for an unlimited number of years• Taxpayers are allowed to deduct NOLs only up to 80% of taxable income in that year• New limits are imposed on deducting “excess business losses” - the TCJA introduces a limitation on

“excess business losses,” meaning business owners are restricted from deducting business losses in excess of $250,000 per taxpayer (individuals) or $500,000 (married couples filing a joint return). Business losses above this limit must be carried forward to the following tax year. This new limit and


other changes related to NOLs apply to businesses other than C corporations from 2018 through 2025.

ce: actionable tax planning strategies for the current

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