Issuu

NEWSLETTER

#togetherwestand COVID-19 Resource Center On your road to recovery, lean on Sax for up-to-date information relevant to your state and business.

Now is the time to prepare for the road to recovery. With changes constant and released guidance on-going, lean on Sax to stay in the know with the most recent updates so you can best position your business to regain strength.

VISIT OUR COVID-19 RESOURCE CENTER HERE:

LOAN PROGRAMS

TAX ALERTS

BUSINESS RESOURCES

STATE UPDATES

WEBINARS

SUPPORT YOUR LOCAL BUSINESSES

Sax Focus • www.saxllp.com Page 2

SAX FOCUS NEWSLETTER

IN THIS ISSUE

CANNABIS CORNER

MANUFACTURING & DISTRIBUTION CORNER

Important Considerations for Prospective New Jersey Cannabis Business Owners Written by: Adam Holzberg, CPA, MBA

Combating the Escalating Issues Facing the Supply Chain Industry Written by: Joshua Chananie, CPA

NOT-FOR-PROFIT CORNER

REAL ESTATE CORNER

Charitable Planning Strategies Amidst a Tax Overhaul Written by: Joy Matak, JD, LLM

Biden Administration's Potential Impact on the Real Estate Industry Written by: Stuart Berger, CPA

TAX CORNER

TRUSTS & ESTATES CORNER

Addressing the Top 8 Questions on the Employee Retention Credit Written by: Gina Perrone, CPA, MST

Planning NOW for the Estate Tax Overhaul Written by: Joy Matak, JD, LLM

18 WEALTH MANAGEMENT CORNER Questions to Ask Before Paying Off a Mortage

The information contained within this newsletter is provided for informational purposes only and is not intended to substitute for obtaining accounting, tax or financial advice from a professional.

Sax Focus • www.saxllp.com Page 3

CANNABIS CORNER

Important Considerations for Prospective New Jersey Cannabis Business Owners

Written by:

Adam Holzberg, CPA, MBA Senior Manager aholzberg@saxllp.com

ecent estimates for the New Jersey cannabis market range from $540 million to $740 million in revenue – and that is just for the market’s first year. These figures are expected to continue to increase and reach $1 billion in revenue by 2023. It is fitting that the emerging cannabis market is also known as the “green rush.” What’s the Status of the New Jersey Cannabis Market? In the November 2020 election, New Jersey residents voted to approve a constitutional amendment to legalize recreational cannabis by 67%. While the Garden State faced obstacles for the legislation to pass, New Jersey Governor Phil Murphy signed the legalization of adult-use cannabis into law on February 22, 2021. The Cannabis Regulatory, Enforcement Assistance, and Marketplace Modernization Act (“CREAMMA”) created the framework for the legal recreational market and established the Cannabis Regulatory Commission that will begin drafting the regulations for the new market. Applications for business licenses will then become available, and the Commission will select licensees based on the strength of the applicants. This process is expected to take six to nine months, which is ample time for operators seeking to enter the market to develop and submit an application. However,

the market is extremely competitive, and essential decisions must be made quickly to ensure the appropriate team, processes, and business plan are in place when applications become available. Prospective New Jersey cannabis business owners should consider the following items when submitting an application to enter this new industry: NJ Cannabis Business Licensing When entering the NJ Cannabis market, six different licenses will be available to applicants. While many licenses are specific to cannabis dispensaries and growers, other areas should be considered based on the business owner’s experience. For example, an applicant with a background in logistics and supply chain would benefit from a Class 4 Cannabis Distributor license. A lifelong wholesaler could transition easily to the cannabis industry by seeking a Class 3 Cannabis Wholesale license. An operator’s individual strengths and background should ultimately determine the license that is pursued. This process will yield stronger applications for licenses as well as greater success as cannabis business owners.

Sax Focus • www.saxllp.com Page 4

IMPORTANT CONSIDERATIONS FOR NJ Capital As cannabis remains illegal on the federal level, many traditional lending options are not available to cannabis businesses. While some institutions in the secondary markets are willing to lend, the interest rates are significantly higher than those of traditional companies. Many in the cannabis space have turned to the alternative of raising capital by selling equity. Therefore, it is crucial to know how much capital can be raised from one’s professional network to fund the startup and operating costs until a profit is generated. Alternatively, cannabis business owners must consider the amount they are willing to spend until their businesses generate a profit. However, there are income limitations for those who want to enter the market with decision-making authority. New Jersey will not approve applications if any individual with a financial interest, who also has decision making authority within the cannabis business, had an adjusted gross income in the preceding taxable year of no more than $200,000 for single filers, and no more than $400,000 if filing jointly. Potential Challenges Cannabis license applicants should be aware of additional considerations and potential challenges that are unique to the cannabis industry. Business owners must address these areas when applying for a cannabis license. The new regulatory Commission will award points to cannabis applicants based on various criteria including, but not limited to: • Real estate; • Insurance coverage; and • The applicant’s plan to comply and mitigate the impact of IRC Section 280E. For a business owner in most industries, obtaining a location and insurance would not be complicated. However, before New Jersey passed the bill to legalize the recreational use of cannabis, about 70 municipalities preemptively banned cannabis businesses. While the bill voided these previous ordinances, it is still likely that many municipalities will once again pass the ordinance to ban cannabis establishments. Once a “cannabis-friendly” municipality is identified, it may be difficult to locate properties to lease that are in properly zoned areas. Landlords may be hesitant to lease to cannabis companies for the following reasons: 1. Many landlords have mortgages on their properties. Often, these mortgages contain language to allow the lender to call the loan due if the property is being used to conduct any illegal activities, which cannabis will fall under due to its status at the federal level. In addition, obtaining new financing or refinancing existing debt may raise issues for landlords as banks may be unlikely to provide loans to properties with tenants in the cannabis space.

2. If any damage or property destruction occurs on the premises, the landlord’s insurance may deny the claim because “illegal activities” occurred at the property. Before leasing to cannabis tenants, landlords will have to ensure insurance coverage for losses, or they would need to secure new insurance carriers. Insurance Coverage Concerns regarding insurance coverage will impact cannabis companies as well. Not all insurance companies will insure companies involved with cannabis, and therefore options may be limited. However, proof of insurance will be one of the criteria that is scored on the license applications and must be considered. Tax Implications Cannabis companies face unique tax complications. IRC Section 280E prevents expenditures in connection with the illegal sale of drugs. 280E disallows cannabis companies from taking many of the same deductions that other industries are allowed. Cannabis companies cannot deduct any operating expenses and are limited to expenditures related to the cost of goods sold, such as inventory costs. As a result, cannabis companies will pay taxes on their gross profit instead of their net income, increasing their tax liability. Strategic tax planning is necessary as early as possible to mitigate the impact of 280E. Is it Worth It? While challenges in the cannabis industry exist, the right team of advisors with in-depth knowledge in this emerging space is essential to assist operators in addressing them. Based on the success of companies in other states where cannabis is legal, the rewards appear well worth the obstacles. In addition, despite a global pandemic, nationwide cannabis revenue increased by 67% in 2020 to nearly $18 billion in revenue. This growth is not solely based on new states opening recreational markets. Established markets in Colorado and Oregon saw a 26% and 29% increase in annual revenue, respectively, compared to the prior year. Prospective business owners should begin developing relationships with attorneys and financial advisors, such as Sax Cannabis Advisors, to help navigate these difficulties and optimize success in the cannabis market. For questions about the cannabis market and assistance with your cannabis business, contact Sax’s Cannabis Advisory Practice. 

Adam Holzberg, CPA, MBA is a Senior Manager at Sax and specializes in increasing the overall operational efficiencies, financial reporting best practices, and internal controls for clients. As a member of the Sax Cannabis Practice, Adam supports companies from seed to sale in a variety of areas including but not limited to: innovation and growth strategies, attestation services, tax compliance, and pre-licensing consulting. He also assists clients by making meaningful introductions to other advisors in the cannabis industry such as attorneys, bankers, and insurance. He can be reached at aholzberg@saxllp.com.

Sax Focus • www.saxllp.com Page 5

M&D CORNER

Combating the Escalating Issues Facing the Supply Chain Industry

Written by:

Joshua Chananie, CPA Partner jchananie@saxllp.com

Sax Focus • www.saxllp.com Page 6

COMBATING ESCALATING ISSUES Ongoing

technological advances and increasing customer demands had been keeping professionals in the quickly evolving supply chain industry on their toes. Cut to 2020 and more unprecedented challenges came about with the pandemic, and businesses continue to navigate its effects today. Some businesses have thrived amidst the adversity, some businesses continue to keep steady while making the necessary modifications to re-position their companies, and some businesses are unclear as to what the best way to move forward is. Certain challenges such as labor shortages existed prior to the pandemic, but old challenges have re-surfaced making it even more difficult to maintain profitability and keep customers happy. Here are some top issues in the industry to be mindful of and how to combat them: 1. Materials shortage: For those who have attempted to build a deck over the last 12 months for example, you have experienced the pain of the lumber shortage. Lumber is just one of many products and materials for which there is current scarcity. As the coronavirus pandemic continues to ravage overseas (i.e., China, India) it has taken workers out of factories which has significantly slowed down production to very low levels. The result is very long lead times and significant price increases due to increased demand and low levels of product. How do you combat this? If your business is impacted by materials shortage, diversify where the products are sourced from and diversify the product lines which you offer. Set clear expectations with customers up front as to potential lead times and cost increases. 2. Freight Costs For those who receive goods from overseas, you have experienced increases in freight and shipping costs. Those are largely attributable to: • Fewer sailings (to reduce sailings with half empty vessels) • Container shortages

How do you combat this? Work with your financial institution to determine ways to minimize potential out-of-pocket cash burden by utilizing certain borrowing strategies including PO financing, letters of credit and/ or suggest modifications to your current borrowing base collateral formula to include inventory being built or in-transit to increase borrowing capacity. Also, it seems that factories are open to negotiate settlements on existing payables which would free up future cash flow (as they look to collect on their own receivable insurance). Finally, if these options do not provide enough of a stop gap for you then it could be time to entertain the sale of your business. The acquisition market especially by private equity is hot and there may not be a better time to consider an exit strategy. 4. Man vs. Machine or Man & Machine Access to labor has become increasingly difficult to certain industries during the pandemic, primarily due to pay scale and skillset. Trade skill and years of experience often cannot be duplicated, but technological advances in warehousing and reporting (data analytics, ERP) can provide for better (more timely, more accurate) information and efficiency in product movement and development. How do you combat this? Embrace the change. Whether it be moving your sales platform from brick and mortar retail to online (e-commerce) or investing in a new piece of equipment to speed up manufacturing time or add new features (value) to your current product – it will keep you on the cutting edge. In addition, the implementation of a new ERP system would provide helpful data to help you manage your inventory to the proper levels so that you are not overbuying inventory, thus preventing the challenges identified in points 1, 2 & 3. We are not suggesting you replace people, but rather that the two can be mutually beneficial to each other. For any questions or more information on combating the issues facing the supply chain industry, feel free to reach out to Sax’s Manufacturing & Distribution Practice. 

• Added surcharges for empty containers (going back to China) How do you combat this? The more flexible you can be, and the more options you have available, the better the chance that you can ship on a schedule that fits your needs, at a price that fits your budget. There are global freight forwarders that are experts in containerized shipping. A forwarder that works with all the steamship lines can potentially offer additional alternatives.

Joshua Chananie, CPA is a Partner with Sax and Leader of the firm’s Manufacturing and Distribution Practice, concentrating on advising clients on the key areas critical to their success. With more than 15 years of experience, Josh specializes in distribution and inventory management, shareholders agreements, profitability, succession planning, financial strategy, operational efficiencies, risk management and tax challenges. He can be reached at jchananie@saxllp.com.

3. Access to Liquidity The materials shortage is causing not only a drain on products but also a drain on cash. Prices increase based on supply and demand but in addition to the increase in price, many factories are asking for a percentage of cash up front in order to build product in lieu of payment terms. The challenge of having to manage cash for which borrowing bases (asset-based loans) do not provide for under its normal formula has become increasingly difficult.

Sax Focus • www.saxllp.com Page 7

NOT-FOR-PROFIT CORNER

Charitable Planning Strategies Amidst a Tax Overhaul Written by:

Joy Matak, JD, LLM Partner jmatak@saxllp.com

he recently proposed “For the 99.5% Act” would bring dramatic changes to gift and estate taxes while proposals in both houses of Congress and the White House would impose immediate income taxation on gifted and inherited gains. This tax overhaul could be the costliest in generations, if enacted. Here are just some of the structural changes we might see: • Slashing the estate tax exemption down from $11.7 million to $3.5 million, with significant tax of around 50% on inherited assets exceeding that threshold. • Elimination of valuation discounts in most situations. • Structural changes to the tax code that would reduce efficacy of traditional estate planning tools like grantor trusts and dynastic planning. • “Deemed realization” on transfer: Assets transferred by gift or at death to be treated as sold for income tax purposes with gain recognized and taxed to the transferor. Since some of the proposed legislation could be retroactive to the beginning of 2021, charitable planning may be a family’s best chance to take advantage of significant planning opportunities under current law.

Gifts of Appreciated Stock to a Qualified Charity Deemed realization of inherited gains could pose an opportunity for charitable giving in order to avoid the devastating impact of a capital gains tax on death. By making gifts of appreciated long-term capital property to a qualified charity, a taxpayer can avoid gain recognition and achieve a present income tax deduction up to the fair market value of the asset. In 2021, such transfers are deductible up to 100% of adjusted gross income and any unused charitable deduction may be carried forward to offset income earned for up to five years. Taxpayers considering this strategy should only donate appreciated property held for at least one year and one day. A qualified charity receiving appreciated stock will need to have a brokerage account to accept the shares and a Board Approved policy of how to handle investments once received. A Beneficial Charitable Trust Structure to Consider The charitable lead annuity trust (“CLAT”) has emerged in the current planning environment as a beneficial strategy to consider. A CLAT separates the current and future interest in property so that a qualified charity receives an initial annuity for a term of up to 20 years and anything left over winds up with noncharitable beneficiaries,

Sax Focus • www.saxllp.com Page 8

CHARITABLE PLANNING STRATEGIES

allowing a donor to accomplish strategic wealth transfers for the benefit of family members, as illustrated in the following example: Artemis owns a stock portfolio worth $10 million, which is expected to continue to grow at a rate of 5.5% annually, generating about $550,000 of taxable income to Artemis. Artemis establishes a 20-year CLAT and funds it with the portfolio. The CLAT pays its own taxes during the initial term, thereby eliminating Artemis’s annual tax burden by the taxable income earned by the portfolio. The CLAT will make annual charitable contributions to a qualified charity in an amount determined based on current interest rates. A properly administered CLAT established when interest rates are lower than expected growth should result in a transfer to noncharitable beneficiaries at the end of the initial term of assets that should be worth more than the original $10 million portfolio. Under the rules governing CLATs, the noncharitable transfer will be $0 for gift tax purposes, allowing Artemis to benefit a qualified charity while also pushing out wealth to heirs – all without triggering estate, gift or income taxes.

Conclusion Despite challenges charities encountered in recent years, 2021 presents an opportunity to take advantage of increased incentives for charitable giving. Donors will be focused on their charitable intent, and non-profits should stay in the know with how these tax incentives and their timing can be leveraged for donations to their mission. Sophisticated strategies can be very powerful but require skilled and thoughtful practitioners. In this uncertain, ever-changing tax environment, collaboration between and among professional advisors and charitable organizations could be essential to limiting tax exposure and crafting transfer strategies that incorporate charitable giving goals.  Joy Matak, JD, LLM is a Partner at Sax and Co-Leader of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning. She can be reached at jmatak@saxllp.com.

Sax Focus • www.saxllp.com Page 9

REAL ESTATE CORNER

Biden Administration's Potential Impact on the Real Estate Industry

Written by:

Stuart Berger, CPA Partner sberger@saxllp.com

Sax Focus • www.saxllp.com Page 10

POTENTIAL IMPACT ON REAL ESTATE The last 15 months have been surrounded by uncertainty amidst the COVID-19 pandemic. Now, several substantial policy initiatives have started to take shape under the Biden Administration with regards to income tax and wealth transfer (estate planning). While these proposed changes would be significant to all, there are policies that would be specifically significant to the real estate industry. Here is an overview of the most important updates real estate professionals need to stay in the know about: Like-Kind Exchanges Currently, a Section 1031 like-kind exchange is a critical tool utilized by many investors and sellers of real estate. By following specific procedures, it allows taxpayers to use the proceeds from the sale of a property to purchase a new property or properties (within 180 days) and to defer paying income taxes on the gain from the sale of property currently owned. Biden’s American Families Plan would eliminate 1031 like-kind exchanges in cases where the gains are more than $500,000. Under current tax rates, long term capital gains from the sale of property are subject to a 20% Federal income tax rate. Under Biden’s plan, individual long-term gains would increase to 39.6% for taxpayers earning over $1 million per year, or higher if subject to alternative minimum tax. Eliminations & Repeals The Tax Cuts and Jobs Act (TCJA) increased the bonus depreciation percentage from 50% to 100% for qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023. The amount of allowable bonus depreciation is then phased down from 2023 to 2026. Biden’s plan may eliminate the bonus depreciation rule for commercial property. Instead of currently being able to expense such improvements, taxpayers would get a depreciation deduction for periods up to 39-years. Biden’s proposals also include the repeal of various tax law changes that were included as part of the TCJA, returning the top individual income tax bracket to 39.6% for those with income of more than $400,000.

Step-up Cost Basis The Biden Administration is calling for an end to the “step-up” of cost basis when real estate is inherited. This step-up rule currently allows taxpayers who inherit property to reset the cost basis of the property to the market value at the time they inherit it, not when it was purchased. This step-up provides additional depreciation deductions for business property and a reduced tax burden for heirs upon the sale of the property. Estate Planning Techniques The Biden Administration is open to the tax provisions provided in the Obama Administration’s “Green Book” that would limit the availability of tax benefits obtained through popular estate planning techniques, such as grantor retained annuity trusts (GRATs) and intentionally defective grantor trusts (IDGTs). The tax reform may also reduce or eliminate the availability of discounts for family-controlled entities that do not engage in an active trade or business. Affluent individuals who have not already fully used their federal gift and generation skipping lifetime exemptions may wish to proceed sooner rather than later to implement tax planning strategies after reviewing the potential impact of estate tax law changes and considering potential risks of retroactive application. In Conclusion As all the above items are just proposals at this time, only time will tell which ones will be adopted. Tax reform does indeed seem very likely, especially as stimulus spending and pandemic losses have crunched federal budgets and increased the deficit. Now is the time to plan and take advantage of any opportunities that exist before it is too late. You should be actively speaking with your trusted advisor as you prepare for the worst and hope for the best. Act now, but act with caution. Should you have any questions with regards to the proposals in Congress that will directly impact the real estate industry, please reach out to Sax’s Real Estate Practice.  Stuart Berger, CPA is a Partner at Sax and founder of the firm’s Real Estate Practice. For more than 30 years, Stu has provided industryspecific tax and advisory services, with an emphasis on helping familyowned businesses realize their full potential and maximize tax benefits. He can be reached at sberger@saxllp.com.

Transfer of Real Estate Significant changes to the transfer of real estate and estate tax planning have been proposed. President Biden’s tax plan would cut the federal estate, gift and generation-skipping transfer (GST) tax exemptions from $11,700,000 per individual ($23,400,000 per married couple) to their 2009 levels of $3,500,000 per individual ($7,000,000 per married couple) – and potentially drop the federal gift tax exemption as low as $1,000,000 per individual ($2,000,000 per married couple) – all without indexing. The Biden plan would increase the federal estate and gift tax rate from 40% to 45% and eliminate the step-up in basis for inherited assets as detailed below.

Sax Focus • www.saxllp.com Page 11

TAX CORNER

Addressing the Top 8 Questions on the Employee Retention Credit

Written by:

Gina Perrone, CPA, MST Senior Tax Manager gperrone@saxllp.com

The Employee Retention Credit (ERC) is a hidden gem that is coming to life now that the Paycheck Protection Program (PPP) funds are exhausted. The ERC was enacted to help employers who continued to employ workers during the troubled times caused by the pandemic to provide much needed relief. But beware, there are misinterpretations about the ERC that could lead to false conclusions of ineligibility or incorrect assumptions about its application. As we work with clients to leverage this relief opportunity, we want to share the Top 8 Questions that have come up to help make sure your company does not miss this cash refund opportunity: 1) Can employers with a PPP loan also claim the ERC? Yes. At the onset of the ERC, employers could obtain a PPP loan or claim the ERC, but not both. This changed in late December 2020 with the passing of the Consolidated Appropriations Act, 2021 (CAA) which allows employers to take advantage of both the PPP and ERC. Employers can now qualify for the ERC retroactive to March 13, 2020. Further, the ERC is extended to the end of 2021. One caveat – you cannot double dip, meaning wages used for PPP loan forgiveness cannot be used to claim the ERC.

2) Are PPP and ERC eligible costs the same? No. Qualified payroll costs for the ERC and PPP include gross wages and qualified health insurance. However, for the PPP, payroll costs also include payment of retirement benefits and state or local tax assessed on employee compensation. 3) Does the Employer need a significant decline in gross receipts to qualify? No. The reduction in gross receipts is only one of two tests that must be met to qualify. An employer with business operations that were fully or partially suspended due to a government shutdown order may also qualify for the ERC. 4) Does an essential business qualify if business was suspended? Yes. Even businesses deemed essential and allowed to continue operations can still be considered partially shutdown and therefore eligible for the ERC. Was the business unable to continue its activities in a comparable manner resulting in a more than nominal impact on business operations? Were some business locations shutdown and not others? Was there a disruption in business or shutdown of supply chains or vendors? Answering “yes” to any of these questions could deem a business partially shutdown.

Sax Focus • www.saxllp.com Page 12

EMPLOYEE RETENTION CREDIT

For example, a supplier of an essential business may be unable to make deliveries of key goods or materials due to governmental shutdown or restrictions causing the essential business to not continue operations as normal. In this scenario, the essential business, though allowed to continue operations, would be considered subject to partial shutdown and therefore eligible for the ERC. Another example is a restaurant subject to curfews limiting operational hours. Even though the restaurant is allowed to operate for part of the day, it is still considered partially shutdown because the restaurant is unable to operate under its normal hours. 5) Should employers of all sizes look into the ERC? Yes. All you need to qualify is a significant reduction in gross receipts or be subject to full or partial governmental shutdown. The number of employees only comes into play when determining the amount of qualified wages that are eligible for the ERC. For 2020, “small” employers with 100 or less full-time (FT) employees in 2019 can use any wages paid towards the ERC. For “large” employers with more than 100 FT employees in 2019, only wages paid to employees for not providing services count. For 2021, this 100 FT count is increased to 500. “Large” employers should not automatically throw in the towel. They can still qualify for the ERC on qualified health expenses paid for furloughed employees. 6) Is the ERC claimed on the business tax return? No. This is a refundable payroll credit, not an income tax credit. There are three ways to claim the ERC: a. On Payroll Forms – For most employers, this is claimed on quarterly Form 941. If you are claiming the ERC retroactively, you must file an amended Form 941 (Form 941-X).

b. Reducing Federal Employment Tax Deposits – Claim the ERC against the employer portion of certain employment taxes. c. File Form 7200 – If the ERC exceeds the payroll deposit, the employer can apply for an advance refund by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19. 7) Is the ERC taxable? No. The credit is not included in taxable income, however the wages used to compute the credit are not deductible in computing the employer’s Federal taxable income under Internal Revenue Code Section 280C. It is important to also consider the impact on determining state taxable income. Some states (e.g. New Jersey) conform to the federal treatment while others (e.g. New York) do not. 8) Is the work involved in computing and claiming the ERC worth it? Yes. The ERC can put up to $33,000 of cash per employee back into the company! This means an employer with 10 employees may be eligible to claim up to $330,000! An employer with 100 employees may be eligible to claim up to $3,300,000! The ERC serves as an employer-related tax credit providing economic stimulus to infuse cash back into businesses. Take advantage of this! Each company’s unique facts and circumstances determine whether it qualifies for the ERC. Thus, it is always worth having a conversation with a tax professional before ruling out eligibility.  Gina Perrone, CPA, MST is a Senior Tax Manager at Sax and an integral member of the firm’s Tax Department. Gina specializes in high quality tax services and planning opportunities that meet clients’ ultimate goals and objectives. She can be reached at gperrone@saxllp.com.

Sax Focus • www.saxllp.com Page 13

TRUSTS & ESTATES CORNER

Planning NOW for the Estate Tax Overhaul

Written by:

Joy Matak, JD, LLM Partner jmatak@saxllp.com

he tax world may likely change very soon and in a dramatic way as substantial structural changes are in the works. The recently proposed “For the 99.5% Act” would bring sweeping changes to the taxation of estates and inherited gains, while the “Sensible Taxation and Equity Promotion” (STEP) Act would eliminate the step-up in basis that inherited assets currently enjoy.

This article is intended to help you identify some issues and items to discuss with your team of advisors to determine what moves might be worth making. There is a good chance you might benefit tremendously from taking significant action now before it is too late.

This creates a time sensitive planning opportunity as proposed changes would immediately become the costliest in generations if enacted and are so expansive in reach that they may adversely affect millions of families. Taxpayers will need to act NOW or risk losing the closing window of time to take advantage of significant planning opportunities under current law.

To understand where we are going with estate and gift taxes, it's important to understand where we currently are. The 2021 exemption, under current law, is $11.7 million per U.S. taxpayer. That's $23.4 million per married couple.

Background

The exemption is the aggregate amount that can be given away during your lifetime. Under current law, the exemption that currently exists is going to be automatically reduced in 2026. Sax Focus • www.saxllp.com Page 14

ESTATE TAX OVERHAUL

However, Congress is signaling an interest in reducing the exemption and raising taxes now, which is why this topic is so important today. We believe that 2021 could be a last chance planning opportunity. Here are some changes the new plans would bring about: “For the 99.5%” Act • The estate tax exemption would be reduced from its current $11.7 million to a meager $3.5 million. That means you would only have up to $3.5 million to give away at your death. • Lifetime gifting would be limited to $1 million, which could be critical for asset protection planning, not just estate tax. • The tax rate would be increased. Currently, it's a flat 40%.

We could see a change to a graduated tax scale from 45% up to 65% for those with estates higher than $1 billion. • Valuation discounts in most situations would be eliminated. • Technical changes would reduce efficacy of planning techniques like grantor trusts and GRATs. These technical and structural changes are more problematic than the exemption changes and tax rate changes. We believe these are going to really rock the foundation of traditional estate planning. • Tax changes on assets in trust after 50 years are going to require special action by taxpayers. This is in direct contrast to current law that may permit trusts to continue forever without ever being subject to transfer tax. • “Portability” is retained, which is the ability of the surviving spouse to safeguard the first to die spouse’ exemption. Sax Focus • www.saxllp.com Page 15

Example A

Deemed Realization Proposals: Biden plan, STEP Act & “Pascrell” Bill • Transfers by gift upon death – treated as sold for income tax purposes and transferor will recognize gain. • Only the first $100,000 or $1 million (depending on plan enacted) of unrealized capital gains would be exempt. • Legislation is expected to allow taxpayers to pay the income tax that's going to be due on these capital gains in installments over 7 or 15 years (depending on plan enacted) to the extent the tax applies to illiquid assets. • Deduction against estate taxes for any capital gains tax. • STEP Act is retroactive to transfers after 12/31/20; Pascrell Bill effective for transfers after 12/31/21. New proposed tax rate structure: In Example A, you can see the “For the 99.5%” Act’s proposed tax rate structure and how it's going to affect taxed revenue. You’ll also note that this is just the estate tax. In addition to that, there is a possible capital gains tax on debt. So, for example, on an $11.7 million estate, tax could be substantially more than the $5 million shown on the table illustrated. Preemptive Planning Paramount! Fortunately, the current draft of the “For the 99.5%” Act is not retroactive, but there are provisions of the “Sensible Taxation and Equity Promotion” (the “STEP”) Act that will be retroactive to January 1, 2020, so you need to watch your STEP! Effective date of the “For the 99.5%” Act could be as early as July or as late as October, which means plan NOW and complete planning as soon as possible, but with the consideration to the STEP retroactive date.

Advantages of planning now include: • “For the 99.5%” Act suggests that grantor trusts that are established before enactment may be grandfathered. • Valuation discounts should be available until any new laws are enacted. • The time before enactment may be a last chance opportunity to lock in current exemptions by using grantor trusts without entirely giving up access. • Note: No basis step up on assets in trust – if STEP Act becomes law, basis step up on death will not be available. • Remember, moving assets to a trust can protect from suits and claims, elder financial abuse, and your kids divorce, so there may be multiple, even non-tax reasons to act. Valuation discounts will be largely restricted after enactment. To understand what a valuation discount is, it's important to start with the definition of fair market value. Fair market value is defined as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” What does that mean? Generally, giving away a fractional interest would allow the transferor to take discounts to account for the inability to sell or exercise any control over interests – owning 1/4 of an asset is not the same as owning 25% of the gross value of the asset. Both the “For the 99.5%” Act and the Biden administration proposals would disallow any discounts on “nonbusiness assets” based on the lack of marketability or lack of control. From an advisor point of view, this Act is honing in on some of the most powerful planning tools we have used for decades. This Act is a well-crafted plan in terms of restricting valuation discounts. Proposed Valuation rule changes being considered: • Non-business assets of an entity are valued as if the asset was transferred directly. Sax Focus • www.saxllp.com Page 16

ESTATE TAX OVERHAUL • Non-business assets are those assets which are not used in the active conduct of a trade or business. • Passive assets are those which are not used in the active conduct of a trade or business. • No discounts allowed if the transferee and family members have control or majority ownership. GRAT Attack! Grantor Retained Annuity Trusts (GRATs) are a technique sanctioned by the tax regulations that let a taxpayer shift, with limited risk, upside appreciation on assets put into the GRAT out of your estate. That opportunity may soon end. So, GRAT it while you can (but watch your STEP)! Here are some of the proposed changes specific to GRATs: • Minimum 10-year term • Maximum term of the life expectancy of the annuitant plus 10 years • Remainder interest in the GRAT (the gift amount) must be equal to the greater of: Î 25% of the trust’s fair market value of the asset you are transferring Î $500,000 If the “For the 99.5%” Act becomes law, each U.S. taxpayer would be limited to a $1 million gift tax exemption. GRATs are going to become far less effective if these provisions are enacted. Impacts to Grantor Trusts Another way that these proposals create real structural changes to planning is how it affects Grantor Trusts. Under current law, Grantor Trusts are advantageous. They are disregarded for income tax purposes, allowing assets in the trust to grow, while the grantor reduces their taxable estate by the value of the income taxes paid on the income earned by the assets in the trust. The grantor can borrow from and lend to the trust without income tax consequences and the grantor can substitute assets in the trust, whether by purchasing the assets using a Note or by swapping other assets of equivalent value. The flexibility of grantor trusts allows a grantor to freeze the value of the grantor’s taxable estate while allowing assets in the trust to appreciate. The proposed legislation would dramatically alter the benefits of grantor trusts: • Value of assets transferred to a grantor trust after enactment of the proposed law would be included in the grantor’s taxable estate less any taxable gifts made to the trust. • Distributions from a grantor trust during the life of the deemed owner would be taxable gifts, less any amount already treated as a taxable gift. • Under STEP and the Biden proposal, transfers from a grantor trust to a beneficiary would be treated as a deemed sale and assessed a capital gains tax. • Existing grantor trusts appear to be “grandfathered” to the extent that they are already funded. Changes to Dynasty Trusts The “For the 99.5%” Act also has some interesting changes coming down the pike for dynastic trusts. The inclusion ratio of any trust other than qualifying trust must be 1, which would mean that for any transfers made out of the trust it would be to someone who is a skip person. A skip person is a grandchild or subsequent generation.

The qualifying trust must terminate not more than 50 years after the trust is created, and pre-existing trusts must terminate within 50 years of enactment. The STEP, Pascrell bill and Biden proposal would assess a capital gains tax on assets held in trusts as though the assets were sold. Depending upon which proposal, these deemed sales events would occur every 21 years (STEP), every 30 years (Pascrell) or every 90 years (Biden). This will have a huge impact to dynasty planning. It is important to understand that you can't work around this if you have a trust from 20 years ago – it's affected. Each proposal, if enacted, would apply a deemed sale upon trusts already in existence or created after enactment. Annual Exclusion Gifts You may be using annual exclusion gifts to fund life insurance policies held in trust. Currently, the annual exclusion for gifts is $15,000 per person. Under the proposed legislation, gifts to trust would be capped at two times the annual exclusion in the aggregate, without indexing for inflation, meaning you would only be able to put about $20,000 into any insurance trust without triggering a gift tax. The proposal does not appear to affect contributions to qualified tuition programs (529 plans). For those with life insurance or other plans funded with annual gifts, you should consider shifting value to those trusts that can be used to pay premiums on life insurance policies or prepay premiums, before enactment of these restrictions. The Right Advisors It has been said that it takes a village to raise a child. Similarly, it takes a robust team of trusted advisors to construct a meaningful estate plan. Before making any decision or taking any action, you should consult professional advisors who have been provided with all pertinent facts relevant to your particular situation. We are dealing with an uncertain, changing tax environment that could impact you in big ways, and it is important that you have a CPA, planning attorney, valuation professional (if applicable), wealth advisor, insurance consultant and corporate or real estate counsel (if you're transferring business or real estate interests), in order to ensure that your planning strategies are thoughtful and strategic, based on your short and long term goals. It is vital that your advisory team has in-depth knowledge of the changes that are coming down the pike and how they may impact you specifically. In Conclusion The future is unknown. The ambitious spending plans in Congress arising from significant pandemic losses have really crunched the federal budget and exploded the deficit, making tax increases and significant tax reform much more likely. It is critical that you prepare for the worst and hope for the best. By planning carefully and creatively now, you could take advantage of massive opportunities that may no longer be available come 2022. Act now, but act with caution.  Joy Matak, JD, LLM is a Partner at Sax and Co-Leader of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning. She can be reached at jmatak@saxllp.com.

Sax Focus • www.saxllp.com Page 17

WEALTH MANAGEMENT CORNER

Questions to Ask Before Paying off a Mortgage

Sax Focus • www.saxllp.com Page 18

QUESTIONS ABOUT YOUR MORTGAGE The decision to pay off a mortgage or invest in the market is far from

How diversified are you?

black and white. For those who are close to retirement and already have plenty of other liquid financial assets, paying off a mortgage could be a wise use of cash. Such homeowners aren't likely to be saving a lot because of their mortgage-interest deductions, which tend to be more valuable early in the life of the loan than in the later years, and their investment-asset mixes might be skewing toward low-returning cash and bonds, not stocks. Moreover, many retirees concur that reducing their in-retirement overhead by retiring debt reduces worries and frees up cash for travel and other pursuits.

Some homeowners think of their houses as a retirement-savings vehicle: When it comes time to retire, they'll cash in their equity and downsize to a smaller place. However, the past several years have taught many homeowners that's easier said than done. Many haven't been able to sell when they wanted, and they also haven't been able to receive anything close to the prices they were expecting. Pairing home equity with more liquid stock and bond assets may give you a lot more flexibility to ride out downturns in the housing market.

For others, however, a mortgage pay down might not be the right answer. Although it might seem comforting to own your home free and clear, there's invariably a trade-off involved. You're reducing your investments in more liquid assets in favor of an asset that's not liquid at all. A happy medium for many households might be to balance modest prepayments of mortgage principal with ongoing contributions to retirement-plan accounts. Here are some questions to think through as you make this important decision for your household:

How much is your mortgage-interest deduction saving you?

Is your retirement plan on track? Before paying off a mortgage you may want to spend some time evaluating the viability of your retirement plan. Paying off a mortgage rather than investing in the market may mean having fewer liquid assets for retirement. However, with lower household expenses, you may be able to step up your future retirement-plan contributions; having a paid-off home will also mean that your inretirement costs may be lower. Time horizon is an important aspect of decision-making here. Those with more years until retirement can better harness the compounding benefits of investment assets, whereas those nearing or in retirement and expecting to begin drawing on their investment assets might not get such a big bang from investing more. What's your investment mix, and where are you holding it? The composition of your investment assets and where you hold them are also important considerations. The case for investing in the market rather than prepaying the mortgage gets even stronger if you hold your investments within the confines of a tax-sheltered vehicle and/or you're earning matching dollars on your contributions. On the flip side, portfolios that are heavy on cash and fixed-income securities, especially those that are fully taxable from year to year, are less likely to out earn mortgage interest rates.

Many homeowners assume that it's wise to hang on to their mortgages because of the tax deduction they can take on their interest. But that deduction shrinks as the years go by because home loans are front-loaded toward interest payments. People who have been able to pay down a mortgage for many years may be overestimating the amount of taxes they're saving by having a mortgage, and itemizing deductions may not be saving them much versus the standard deduction. Diversification does not eliminate the risk of experiencing investment losses. Government bonds are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than bonds. Please consult with a financial and tax professional for advice specific to your situation. For questions about paying off your mortgage, contact Sax Wealth Advisors, LLC. About the Author SAX Wealth Advisors is an independent registered investment advisor offering financial services built on integrity and meaningful client relationships. The firm is recognized by the National Association of Personal Financial Advisors (NAPFA) as a feeonly firm and has offices in Parsippany, NJ, Pennington, NJ, and New York City, NY. The firm provides customized investment and financial solutions for individual wealth management, in addition to employer retirement plans. SAX Wealth Advisors is a wholly owned subsidiary of Top 100 accounting, tax and consultancy firm Sax LLP. Fore more information, visit saxwa.com.

Sax Focus • www.saxllp.com Page 19

CONTACT

Parsippany, NJ 973.472-6250 Pennington, NJ 609.737-6600 New York, NY 212.268-9888 www.saxllp.com