$3.5 Trillion Spending Plan - What you need to know Part 2

Hey everyone, welcome to We're Talking Money. Got another episode today, still talking about the three and a half trillion dollar spending plan, likely to be voted on before a year in. Lots to talk about. We're gonna keep the show going, episode two today. Dustin, what do you think?

Episode two, we've got about seven topics. We'll go through probably about four fairly quickly. They're a little bit easier to understand, and then we're going to spend the majority of time on some that are a little bit more complicated. But we are looking forward to talking to you, and be right back.

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Welcome back to episode two of the tax changes that are coming our way. So we're going to start off, just for sake of time, we've got a lot of information, so we're going to freeze through the first four. They're a little bit easier to understand, and then we'll spend a lot of time on the later ones.

But the first one that I want to bring up is the restriction on use of business losses. So this one can be a big one, especially for a lot of business owners or a lot of entrepreneurs who have more than one business. It used to be where if you had one business that was doing extremely well, maybe you went to start another business, you're investing a bunch of capital into that business, you could use the loss on this business to offset on this business. That is no longer the case. They're probably not going to have that. You can carry forward losses, but no longer between two businesses.

Yeah, it's unfortunate. And all I would add to that, Dustin, is the lion's share of businesses in this country are exactly what you described. They're entrepreneurs. We are an entrepreneurial land. This is all about self-employed small businesses, all the way down to the mom and pops. And now what we're saying is when they have multiple businesses, we don't get to use those law, we don't get to cross-use those losses or to offset gains. Big change.

Absolutely. The next one we wanted to walk through is the caregiver expense new credit. This one's pretty straightforward. It's a four thousand dollar credit for fifty percent of qualified expenses incurred from caring for a relative living at home unable to perform the activities of daily living. One piece to note here is the benefit does phase out if taxpayers' income exceed 75 000, but better than nothing.

It's better than nothing. It's a gimme, a freebie if you will. But it's really not designed for... so many parts of the tax plan are really focused more on high income earners, business owners. That's really where you see the effect. But I think this is great because you get a lot of people who might be nearing retirement, maybe they're just not working a lot, maybe they're a part-time worker or something like that, and they want to try to stay at home and care for an aging loved one, whatever the case may be. It's a nice little tax credit. And it's a four thousand dollar credit, not a deduction, so it's a dollar for dollar offset, so it's pretty valuable.

Yep, absolutely.

All right, so what's next? Oh, I get why you all of a sudden went quiet. I got to go over this darn Section 2032 thing. Look, folks, I'm going to save you the boredom here. Section 2032 focuses clearly on farm and farmland, farm business. So here's what I'm going to tell you. There's actually some benefits in this new three and a half trillion dollar tax bill that's coming down the pike. I don't want to get into the details, but I'll leave it at this.

You're going to lose this big estate tax exemption. The 11.7 million is coming down to 5.8. That's bad news. But the good news is the Ways and Means Committee added language for farms, specifically for farms and farming, that best use of property won't hold the same for farms as it does for a traditional business. And they're going to give some offsets here which can literally reduce the value of the land and allow you to reduce that value, and therefore get more of that property passed through to your heirs or keep it in the family, whatever you want to do, without having to be so concerned about this reduction in the estate tax.

So 2032 is a long set of rules. Maybe we do a show on that one day, Dustin. But if you're in the farming world or farming business, or your family has a big family farm you want to keep, let us know. We're glad to talk through some of that with you in greater detail. Just give us a call or shoot us an email. We're happy to go over that with you.

I... makes my life a little easier when I just hand it off to Phil and let him take the really complicated ones. That works out well for me.

Well, I'm not gonna try to say anything except I wasn't paying attention on that one, and when you stopped I thought, oh my goodness, it must be my turn. So my apologies if there was a pause. That was all on me. So we're good to go.

So the next tax change is the valuation for non-business assets. So how it works today is in a family limited partnership or an LLC, if you have these marketable securities and other non-business assets, you can structure the LLC in a way where there's voting or non-voting in the shares, and then you can discount the non-voting shares, and so because of lack of marketability is what they call it. And so now with non-business assets they're going to take that away completely. So whether the shares are marketable or non-mark or not as marketable, voting, not voting, controlling, not controlling, you're not going to be able to discount those anymore for non-business assets or securities, other assets.

Why is that so important? Well, we've used family limited partnerships and LLCs with our clients in their estate planning efforts for years, and for decades those have been very powerful tools. To your point, Dustin, you can have a 10 million dollar business in one of these family limited partnerships, and mom and dad, who maybe they created the business and they're the owners today and make all the decisions, you're going to have the children, for example, as owners, but minority and non-voting. And heck, you can even have a majority owner but non-voting. And the idea is that you freeze the estate, you freeze the value, and so instead of that business going up in value on the parent side of the ledger, it's happening on the kids' side.

The way that they are able to make that really high leveraged move is because of those discounts that you talk about. If it's worth 10 million a day, they might be able to gift to the kids something that looks like it's only worth, say, six million, six and a half, because they take that big 35 discount for lack of marketability. So you can imagine on a business that's 5, 10, 15, 20 million dollars in value, that is a game changer. And it essentially says to the estate planning world that family limited partnerships are going to be flipped on their head, and it's going to disappoint a lot of people.

Going to require a lot more planning now, which I think you said in one of our shows, this opens the opportunity, opens the door for new opportunistic planning if this thing passes. Lots more planning to do. May not want to hear that, but I still think there's lots of opportunity to plan and build your estate so that it's still going to get where you want it to go when you want it to go there.

Absolutely. So these next three are a little bit more complicated. We want to take a little more time on these ones, and we'll start with this additional tax, or the tax surcharge on high income individuals, trusts and estates. So what this looks like is it's an extra 3 percent tax on marginal adjusted gross income in excess of 5 million for married taxpayers, and here's where it can get powerful, and one hundred thousand on trusts and estates. So the five million seems like a really, really big number for married taxpayers, but then when you're only talking about a hundred thousand for trust or in a state, now all of a sudden you're probably going to have that three percent tax more often than not on something like that.

And so what that looks like is now we're up to 42.9 percent when you add in the new highest tax bracket of 39 percent roughly, and then you add in that extra three. Now all of a sudden we're pushing 42.9 on a lot of those. Gonna start going up pretty quickly.

And look, it's not unusual. You go around this country and you look at all of the self-made millionaires, if you will, so the very wealthy people who have created these businesses and they're kicking off large, large sums. This is one more way to get into your wallet. And so you may not be someone that's making five million off of your business, but your business might be growing, and your business might have all the ability, might have the capability of doing five or ten or twenty million dollars a year in net revenue. Certainly not in common. So keep that in mind. This may not affect you today, but if you have a trust and your trust is generating more than a hundred thousand of income, watch out. It's already going to get hit with the highest tax rate, which is 39.6, right, going to be the new one, and now you're going to add three more to that. So if you have trusts that are creating income, be aware.

Yep, absolutely. The other, I guess the next one that we want to talk about here is this net investment income tax, and that's going to be applied to trade or business income. I'll let you dive into that one a little bit.

Well, that's the big difference, right? It used to be that we didn't have to worry about this. It was just on certain investment income. Now they want to expand this to hit all business income. That's a big change. And so I've had a number of clients say to me, "Well, Phil, it's only 3.8 percent." Well, right, but listen to how this works. If you have a joint tax return, for example, all business income with more than 500 000 on a joint return and 400 000 for single filers, you're going to get hit with this new 3.8 net inc, or net investment income tax. So if you happen to be at that 40 level, now you got another four, you're up to 44, plus your state. We're starting to knock on the door of 50 percent. That's a lot of tax.

And so I think where this really becomes, or where this is going to be recognized the most and where it's going to affect the most people, are those same entrepreneurs that we talked about who have S corps, for example. That'll be the place where it gets hit the most. And why is that? It's a pass-through entity. So no matter what you make at an S corp... I hear people talk about retained earnings, and I hear people talk about leaving money in the company. It doesn't matter where you leave it. If that S corp earns it and it's not an expense, it's on your tax return. It flows down to you as the owner, and you're going to pay tax on it, and it's going to add to the calculations which will determine if the NIIT, or the net investment income tax, is going to affect you. It's a big deal. Four percent, do the math on that. Half million dollars, that's another 20 grand in tax. A lot of money.

Yep, absolutely. And one thing I did want you to talk about too, that I made a note here, was tax loss harvesting. So...

Well, we could do an entire show on that.

But that's something that we use inside of our portfolios. Maybe we'll have Roger come talk about that. But if you want to get, we want a nice overview for sure, just high level.

With this kind of tax coming on, I think it's so important, Dustin, to watch your portfolio closely, because all of the income now that you were earning on those investments, in addition to that, now take your business, all of that adds in the equation of determining if this NIIT is going to hit you. So if you had gains in your investment account, great, you did well. But during the year, if there are some losses going on in there that you could harvest, i.e. sell the asset or sell the security, take the loss, now that loss is on paper, it's recognized, and we can use that at the end of the year to offset gains, which will help reduce tax overall.

So the big picture, the high level picture, Dustin, you want to take losses throughout the year as you see them and be willing to do that, knowing full well that you're going to stay fully invested. But you want those losses, you want to accumulate those to the extent that you can to offset all the gains. Powerful technique. And if you've never used loss harvesting, now is a good time to learn

how it works. If you don't want to learn it, you can work with a firm like ours to take advantage of that very technique. Makes a huge difference.

Another little nugget in there is you can wait 31 days and you can actually buy the stock right back. So you take it while it's lost, sell it, take the loss with all your other gains, hopefully, in your portfolio, and if you do want to hold that position, in 31 days it's not considered a wash sale, so you're good to go to buy it again.

The wash sale rule, yeah, very important. You don't want to ignore that one. And that includes similar stocks. If you're holding a Home Depot, for example, and you want to sell it to take a loss, and you say, well, I want to stay in the hardware space, in that sector, and you go buy Lowe's, for example, that would unfortunately trigger the wash sale rules. You couldn't do that. But 31 days, all you have to do is wait 31 days, go back in, you're good. Perfect. Yup.

Well, the final tax change of episode 2 is going to be this Section 199A deduction of qualified business income. Well, that's a big one. This is a big one, so we wanted to spend a little more time on this one. And essentially what this one looks at is, as part of the 2017 Tax Cuts and Jobs Act, they provided a deduction of 20 of all income for qualified businesses. So what the heck was Trump thinking? What was he thinking when he did that?

I can tell you one thing: a lot of business owners, love him or hate him, a lot of small business owners really enjoy that 20 deduction, and I think it's on the chopping one. Yeah, unfortunately it's not going to be there, it looks like, for very much longer.

So essentially they're changing it. It was 20, no cap. Now there is going to be a cap on there, and so the maximum deduction that's going to be allowed is going to be 500 000 for married filing jointly and 400 000 for single filers, and again ten thousand dollar deduction for trusts and estates, which is very, very small in the grand context of things.

Look, when you think about that trust limit, might as well take it to zero. A trust has income, it quickly exceeds that amount, a trust of any size. So that's such a low number. I don't, to me, why even put it there?

But let's go back to the married filing jointly and the individuals. One of the things that we talked about is a married filing jointly situation, 500 000 is the maximum that they can take on this 199A business deduction, or 20 business deduction. And so a lot of people could quickly do the math and say, man, they're earning 2.5 million dollars a year, I'm not going to feel sorry for them.

But the issue is these businesses that are employing the lion's share of people in this country, all of a sudden they have been planning for expansions, they've been planning for hiring more people, etc., etc. And so they then build their lifestyle on the remainder. So they're doing a great job putting people to work and trying to build something, and then all of a sudden you take a person, or take a business, or a family rather, with a business kicking off five, six million dollars a year out of an S corp. They would normally get a million dollar deduction on this 199A program. This thing, if it gets abolished or reworded, reworked the way that they're proposing, they just lost half of that million dollar deduction, right? So they lost 500 000 just like that. That's a big move. It's a big, big move.

So I'm not saying that it's right or wrong, but I believe that it's confiscatory, for sure. If we put that in place and it made sense to help drive business and build a better economy... I'm still playing with the numbers, trying to figure out if it makes sense or not, but boy, it's an aggressive move on the tax code. I don't think it helps at this point. I think we're in a different place in the economy, maybe, but it's a pretty aggressive change.

Yeah, this might be one of the biggest impactful ones. So when we talk about planning, bringing it back to plan, what can we do when we see something like this, or what should the business owners out there be thinking about? And so now it's really getting high level and extensive with your benefits programs. So maybe instead of just having a 401k, now you have profit sharing on there. Maybe instead of doing 401k with profit sharing, now you're adding a cash balance or some type of pension or some type of deferred comp for your executives. And so there's a lot of different things that you can do in terms of having more tax deductibility through the business to be able to lower your income if you're not going to get the deduction anymore.

And generally, if you can let that go to your employees, they're going to be happier, you're going to be able to attract better talent and be able to retain better talent, and a lot of times people will be working harder too if they know that they have that profit sharing in the background.

Yeah, there's no doubt about that. I think looking at your profit now, looking at these margins, if you have healthy margins in your business and you happen to fit into the context of this discussion, benefits are a great place to look. Rewarding employees, look at your labor costs. Do you have all of your execs at the right level, or your more rank and file, or your wage earners, are they at the right level? Check all those things. You want to make sure that you're paying your people right. Tight job market right now, people are jumping ship for few dollars, or rather a small change in their compensation. Make sure you got that right.

To Dustin's point, cash balance plans, pensions, 401ks, profit sharing. And then what about the things that you need to do to your business to become more competitive, to be ready for the future? We call it being future ready. And so is that something that you need to look at? Where can you spend in a really good way that's going to give you ROI, so your return on that investment? You need to be thinking that way, because if you don't, and you're fortunate enough to have large income from that S corp, you're getting ready to lose a lot of it, because it's going to go away. So if you're going to lose a half million, might as well spend that amount in the right way to benefit you and your company and hopefully your employees.

So it's a huge tax change. This thing is going to be felt. A lot of people say it's not going to affect me. It's going to affect a lot more people than you realize. Absolutely, for sure.

Well, folks, that does it for episode two. Is that it? That's it. That didn't take long, episode two. So we have one more episode, at least, just on the tax code, and then we've got a bunch of great information that we want to put out there. Be sure to like, share, so everyone can get the content.

And again, as I always say, in the comments, as we share these things on LinkedIn, Facebook and everywhere else on social media, there's anything you want to talk about, any questions that you may want to have answered, let us know. We can easily do a little snippet or a little show on any of those, but happy to do it. We'd love to hear from you. Tell us what you want to know, tell us what you want to learn. How can we be better delivering education to you? That's what these shows are all about. So let us know. Send an email, talk to us via social media, talk to us on our website. Tell us what you want to hear, we'll build a show around it. Until next time, Dustin, I'm Phil. You all take care, we'll see you later.

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