Just a year ago in an Investment Advisor cover story and follow-up (October 2006, "Eureka," and November 2006 Wealth Advisor column, "Digging Deeper"), we described a strategic framework to determine the potential wealth management opportunities from clients' tax returns. Information from tax returns, we said, could help you to better understand your clients and to help you provide appropriate investment solutions for them.
As we all know, taxes are not a one-time event. Like an annoying relative, they keep coming back year after year. But fortunately, unlike an annoying relative, taxes can be a good thing in at least this one way: they let you enhance your relationship with clients.
To accomplish this, it is important to keep up with the tax changes and their respective planning opportunities. This article will help you do just that, as well as suggest some planning opportunities for today's market conditions and provide you with items to keep you "in the know" (i.e., noteworthy tax-related items that may be of interest to your business as they affect affluent individuals).
Wealth Enhancement Opportunities
We all know children can be taxing, especially teenagers. Unfortunately, beginning in 2008, they will be even more so, when the "kiddie tax" will be expanded to include children up to 19 (it had been 18) as well as dependent, full-time students up to age 24.
As you will recall, the purpose of the "kiddie tax" is to discourage people from transferring investments to a child just because they are in a lower tax bracket (i.e., shielding income from taxation). The kiddie tax consists of a series of rules that determine the tax on a child's investment income. Here's how it works: In 2007, the first $850 of a child's investment income is tax free and the next $850 is taxed at his or her own rate. But any unearned income in excess of $1,700 in 2007 is taxed at the parents' presumably higher tax rate. Please note that these limits are adjusted for inflation.
Why all the hubbub over this? Some people, perhaps your clients included, were holding off shifting assets, and having their children sell them from 2007 to 2008 when a 0% capital gains tax rate would apply to those in the two lowest-income-tax brackets.
However, if your clients have kids who are 18- to 23-years old by the end of the year, there is still time to act before January 1 and take advantage of the 5% rate on long-term capital gains available to taxpayers in the two-lowest brackets, versus being subject to their parents' 15% (most likely) capital gains tax rate in 2008.
Now is the time to look through your book and your clients' tax returns. Do you have clients with appreciated securities or perhaps concentrated positions (see Schedule D or Schedule B) and have children in this age range (on the front of the tax return)? Ask your clients if they are considering making a large purchase (i.e., a car) in the next year. Perhaps it would make sense to transfer the funding assets and sell before year-end. Do you have any accounts in the children's names in that age bracket and do you have their tax returns? Look for Form 8615–"Tax for children under age 18 with investment income." If the children have reached 10 years of age, should the assets be sold to pay, for example, future college tuition, in 2007, so that, upon sale, only 5% is subject to tax versus next year when it would be 15%? Also, clients who are grandparents and tend to gift would benefit from a discussion regarding acceleration of gifts.
Parents looking to save for college will find that saving money for the children's education in their children's own names is not tax effective. The benefits of saving through 529 plans will be even more powerful under the new tax changes. Remember, as long as the money is used for qualified college expenses, withdrawals from 529 plans are tax-free and avoid the kiddie tax issue altogether.
Since we are talking about 2008, you'll want to keep this in mind as well: For plan distributions after December 31, 2007–from 403(b), 401(k), and 457(b) plans–participants will be able to directly roll over to Roth IRAs. The rollover is still subject to existing Roth conversion rules, which have a $100,000 modified adjusted gross income (MAGI) limitation (but the MAGI limitation is gone in 2010!). This is important because a direct Roth IRA rollover avoids the IRA aggregation rules, and may be advantageous for clients with substantial after-tax contributions in their employer plans. To see if a client has changed jobs recently, look on page two of the client's Form 1040 under the taxes paid section or on Schedule A to see if that client had moving expenses.
Wealth Transfer/Charitable Giving
