John Eadie, CPA, CFA, CFP®, PFS, CLU®, CIMA, CKA® joins Karl Eggerss this week to discuss all the tax proposals floating around and how it might impact your investments and your estate.
Karl Eggerss: Hey, welcome to the podcast this week. My name is Karl Eggerss. Thanks for joining me, we appreciate it as always. Just a reminder, the show is brought to you by Covenant-Lifestyle. Legacy. Philanthropy. If you need any help with your finances, wealth management, maybe you’re concerned about your taxes and looking for strategies to try to minimize those, 210-526-0057 is our telephone number, or just go to creatingricherlives.com. There’s even a place on there to schedule a free 15-minute conversation. It’s just a quick get to know you, see what Covenant can do for you, you can tell us kind of what you’re dealing with and see if there’s a match there and if not, great, you might get some information or it could lead to a meeting to dive a little deeper.
All right. Well, on this episode, we’re going to be talking to John Eadie who’s been on the podcast before. He’s the Founder and CEO of Covenant and my partner, glad to call him my partner. You guys have had a lot of questions lately about taxes, and we’re going to dive into that really deeply with him today because we know there’s a ton of proposals out there, there are changes coming our way, whether you like it or not. And I don’t like it but there are changes coming our way that relate to your taxes. We’re going to go through some of those and what’s maybe likely to happen and how to prepare for some of that and just outline, again, the things that are being proposed by the president and some things being proposed by some Congress people. So, that’s coming up in just a bit.
Real quick, the markets this week, you knock it down and it just keeps coming back. The Dow Jones was up over 2.5% this week, the Standard and Poor’s up a little over 1%, Small Caps were kind of flat on the week and the Standard and Poor’s 500 was up a little over 1%. But another strong week, again, when you look at things like gold was stronger this week, the gold miners up very strongly, but pretty strong across the board in a lot of different areas, your strongest areas were the metals and mining because of gold and silver. So the miners, the steel miners all up almost double digits, oil and gas, exploration and production companies up over 8% as well, materials, home builders, up over 5%. Commodities continue to go up and I’ve been talking about that lately, a lot of people noticing lumber prices, noticing corn prices, noticing copper prices.
If you’re trying to build something right now, continuing to move higher, how do you hedge yourself? You own those things that’s pretty cut and dry, pretty easy to do. So that continues to push higher, and we had that really weak jobs number and when it first came out on Friday morning, missed, a huge miss on the estimates when it first came out. We saw people buy gold, we saw people buy bonds, we saw people buy technology stocks, all the things that would benefit from lower interest rates. I tweeted out a comment saying, “How long before the market rallies?” Because they realize, “Wait a second, if this is a weak jobs report, then the Federal Reserve is back in play.” They’re not going to raise rates anytime soon and they’re going to keep the spickets on and keep pumping the money which is what Wall Street likes.
And sure enough, it didn’t take, but maybe 30 minutes or so and all of the sudden, we started to see the futures rise, bonds start to pull back and given up some of their gains, and lo and behold, we had a pretty strong day on Friday with the Dow Jones rallying over 229 points. So again, that’s the issue we’re in here. We have the money being printed, we have the stock market going up, we have the economy doing well, but it’s not doing so well that perhaps the Feds were going to raise rates tomorrow. So are we in that Goldilocks? But something’s got to give at some point, but right now, again, if you’re positioned properly, you are making a good chunk of money right now and it’s happened in a lot of different ways. All right. But let’s jump right in to our interview with John Eadie. All right. Our guest today is John Eadie, he is my partner and the CEO of Covenant. John, welcome back to the podcast, it’s probably been, well, it’s been several months, right?
John Eadie: It has been. Glad to be back Karl and lots of talk about today so looking forward to the conversation.
Karl Eggerss: Yeah, I usually bring you in when there’s tough things to talk about.
John Eadie: Gee, thanks.
Karl Eggerss: We have something tough to talk about today, which is, all these different plans that are floating around out there. People are very concerned about their taxes going up and rightly so, and just to kind of set the table, there’s a lot of things we don’t know yet. And so we’re going to talk about some things being floated around out there, but in terms of action items, we’re just trying to get our listeners to think about things they may have to start doing in the future. But that doesn’t mean you have to do anything today because we really don’t know the rules just yet. And just to add to the confusion, we have the American Rescue Plan, which is enacted by President Biden, then we have the American Jobs Plan which is proposed, and then we have the American Family Plan proposed, so we’re not going to even talk about which one’s which, but the bottom line is, I think we do know there’s going to be more complication and there’s going to be higher taxes, we just don’t know what form or fashion.
So let’s run through that John, because I think we do have the president’s plan and there’s also some congressmen floating some different proposals out there as well. This is very confusing. I don’t think anybody should think it’s not confusing, it is confusing. And so we’re going to try to clean it up just a little bit. Let’s start with the big picture. What are some of the things that you think are being talked about right now that are, I don’t even want to say likely to happen because we don’t know, but what things are being floated out there right now?
John Eadie: Yeah. I think I’ll back up a little bit and start with kind of the action items of what to do, and I think right now patience is going to be a big word, but that’s a delicate balance because we know all of our attorney friends that may want to enact planning for our listeners are going to get hit really hard towards the end of the year and they’re going to be very, very busy, so you don’t want to jump too fast and you don’t want to wait too late. So just kind of that word of caution there. But this kind of really got started with a lot of the things that Bernie Sanders actually put out when he was running for president last year and those have continued into some of the conversations across a number of Congress folks over the last three or four months as this is beginning to unfold.
And then last week, we saw President Biden touch on some of the things that he was thinking about from a tax proposal. The challenge with this is that, well, I’ll start with this, the more straight forward stuff, the one thing that is consistent across all of these folks is Corporate Tax Reform, and that’s simply raising the rates back up from the low levels that they’re at today
John Eadie: … To maybe something more in the high 20, low 30% rate. And so, that’s probably going to be one of the easiest things to get pushed through. Now, exactly how that works is maybe a little more challenging. For our business owning listeners, that may be something that comes back in and may impact your personal planning as much as your business planning.
On the personal side, a lot of this has to do with income tax planning. Everybody has heard the top income rates are going to probably go from 37 back up to 39.6, which is where they were a couple of presidents ago, so that’s not a huge increase. For those of us in Texas and in states that have state income taxes, probably the biggest thing is whether they’re going to eliminate the cap on deductibility of your state income taxes, sales taxes, property taxes. Right now, everybody can deduct up to $10,000 and that’s really hurt a number of people, particularly in high state income tax states. But even those of us in Texas with higher property taxes, it catches up with most folks that are homeowners or other real estate owners. But I think that will come back and their cap won’t be there in the same way it is today. That’s a good thing and may offset for those higher earning taxpayers some of that increased tax rate.
Those are kind of the pretty straightforward things on the income tax side, other than the capital gains changes, and that’s what everybody is talking about. And while it hits the headlines, it scares investors in a big way, it’s going to be very, very limited, at least the way it’s been proposed and proposed across the board. This is pretty consistent that the proposals have said, “We may raise capital gains rates to the same as ordinary income rates,” or close to 40%, maybe a little higher with some of the other little add on taxes that are out there, but it’s only for people that have income over a million dollars a year. It’s going to be very, very limited. But for those that are in that situation or those that might be selling a business or selling a ranch or a family farm or any of that kind of stuff, it could really kick in and cause some real problems… Or differences. Not necessarily problems, but differences in the way they may have been doing their planning for their families or for their businesses over time.
Karl Eggerss: Is there any distinction between short term and long term?
John Eadie: Well, it won’t matter, because it’ll all be taxed at 40%. But the other thing that I think a lot of people kind of glaze over and certainly the media doesn’t talk a lot about, is the fact that it’s only the portion of the gain over a million dollars of income that would be taxed. If somebody makes $800,000 a year in compensation, and then they sell something that creates a long term capital gain that might otherwise have been taxed at 20% in today’s world, it gets taxed at the higher rate. But if they sell something with a gain of $400,000, it’s only the $200,000 over the million that gets taxed at the higher level, and the other 200 below a million will still be taxed as it is today.
It’s pretty complicated and it gives rise to a lot of planning things. You just throw out things like doing installment sales instead of a big sale all in one year to spread out that gain over time, if you can manage that million dollar income level. There’s a lot of planning that will get done and be creative. And I was telling lots of folks, I trust the people in our industry implicitly. I think we got a lot of smart people that, no matter what they do, we’re going to figure out ways to best plan around those things as well.
Karl Eggerss: I mean, there is a distinction between… President Biden’s is definitely geared more towards income tax, whereas some of the proposals out there are going after estate taxes, more corporate taxes. I’ve seen 35% on corporate taxes. The estate taxes, there’s one congressmen that’s talking about kind of ratcheting it up at different levels and it continues to escalate on estate tax. But President Biden seems to be more geared around income tax, is that correct?
John Eadie: Yeah, I think so. He’s really focused on the corporate income tax, the individual income tax. The capital gains tax probably as much or more than anything. All of these are geared towards taxing the most wealthy citizens in the US, is really what they’re after in their belief, having them pay their fair share.
Karl Eggerss: I had a listener ask me after last week’s podcast, “Karl, what is fair share?” Well, all right, we can have a debate about that for months with 20 different people. I mean, that’s the big issue, and there’s a camp out there that says, “Good. The wealthy need to pay more,” and that’s an opinion. And then, there’s others that say, “Well, if they pay more, then more than likely there’s less benefits and less money to go around for potentially those employees,” if they’re an employer. That’s all true, and there’s right and wrong on both of those. But I think, again, we don’t know what’s going to happen specifically. But I think the things we do know is that taxes are going up probably on the income tax side, probably on the capital gain side.
The elimination of the stepped up basis is very debated, and so is the 1031 exchange, which defers capital gains on real estate when you swap it into another property. Under certain conditions, you can defer those capital gains. Those are things that seem to be more contested than just tax rates going up. I think tax rates are going up, but on the stepped up basis in the 1031 exchange. Have you heard anything that leads you to believe there’s a chance neither one of those do happen?
John Eadie: Yeah. Let’s start with some of the estate stuff that is being thrown around out there. I mean, even though it’s not in Biden’s plan, or I have not seen it written this way, a lot of the other Congress proposals do include a significant reduction from the lifetime exemption that you can give or pass at death to your heirs or, really, to anybody you want to give it to. Today, that’s about $11.7 million per person. A married couple can pass almost $24 million estate or gift tax free during their lifetimes or at death. And under most of the proposals, the talk is to reduce that 11.7 per person back down to either three and a half or five million. I’m going to guess that probably ends up at somewhere closer to that five or five and a half million. That’s where it-
Karl Eggerss: Per person?
John Eadie: Per person. Yeah. $11 million or so for a couple, 10 or $11 million for a couple. And the reason I say that is that’s kind of where it was under the Obama administration and so, the Democrats can get behind a number like that. Republicans may not like it, but it’s better than three and a half, I guess, is the easiest way to say that. But I’m not putting any money in Vegas on any of these projections [crosstalk 00:15:47].
Karl Eggerss: Well, and a lot of people don’t know there is sunsetting of current law anyways.
John Eadie: Right.
Karl Eggerss: That’s going to happen. Things are going to change one way or the other in the next few years, more than likely.
John Eadie: Well, and I think that’s why Biden’s not pushing the
John Eadie: … estate tax changes because that’s going to happen at the end of 2025 anyway, so why fight it through Congress? And so just let that happen. There’s others that want to raise the rates right now. The top rate is 40% on an estate that is taxable. There’s been talk of pushing that to 45%, 50%, maybe even as high as 55% on an estate. So those are out there, but back up to your question on the step-up in basis, this is probably going to be one that is a big, big challenge. Congress has tried to change this many, many times over the years, there has been an elimination of step-up a couple of times, most recently back in, was it, 2010 when there was no estate tax in that particular year. Step-up in basis went away that year. But it’s really, really hard to get that one through, because think about the situation where a family has worked so hard to build a business.
And really most of those business start with zero basis because they start from scratch, and maybe it turns into a $10 million business and then all of a sudden they pass away today, the value of that business becomes $10 million and the heirs, if they sell it down the road, may not have a very large gain and be taxed on that growth. And under the elimination of step-up in basis, if that same business passes on to the heirs and they sell it, they’re going to have a $10 million gain. Now, back to what you said, some people think that’s right. Some people think that’s crazy to have to bear that burden to pay tax on something that somebody worked so dang hard to build over their career. And so that one’s a big challenge and it would change the way we do planning.
There are a lot of things like gifts, and they would do the same thing on a gift transfer so that if I didn’t pass away and pass that business on, I just decided to give it to my children in trust, there could be a tax at that point in time of the gift. They’re talking about a million dollar exemption or a two million per couple exemption on those gains, but it still could be quite painful from the standpoint of, if I don’t have other liquid assets, am I going to have to sell my business just to pay the tax on this thing? Or am I might have to go out and buy a bunch of life insurance? Life insurance works on the death situation. It doesn’t do much good on the gifting situation.
Karl Eggerss: Yeah, I was going to say, for some folks that aren’t real familiar with how estate taxes work and so forth, don’t forget, it’s not just about your net worth. Your insurance proceeds are also added to your estate. A lot of people forget that that’s part of your estate, so you could be under the threshold and then all of a sudden get pushed up once your life insurance proceeds are added to that. And, of course, there’s simple things that some people are doing. For example, given the $15,000 per person if they want to gift to somebody and if you have a son and daughter-in-law, and you’re a married couple, you can give away $60,000 because each of you can give away 15 to each of those people. So there’s little things people can be doing.
I think the scariest thing, John, and you and I talked about it offline a little bit, was some of these proposals being floated out there by some of the Congressmen and Congresswomen are actually retroactive. So it’s not as if it’s, “Hey, this is going to kick in, in 2022, so you have six or seven months to do all this planning,” some of it, you may not be able to do. It just depends.
John Eadie: Well, I think that’s right, because, not to get super technical on all this, but just to throw out the alphabet soup of estate planning, things like GRATs and defective trusts, and some of the other things like that are great ideas for planning when you know there’s a change to maybe go ahead and do some of those. But that’s the exact reason that some of these proposals are trying to be retroactive on some of this stuff, particularly from a gifting standpoint, so that we as advisors and attorneys can’t run around and do a bunch of planning that would eliminate some of the tax revenue that might come in should those laws be in effect today. But retroactivity, I said, step-up basis might be a challenge. I think retroactivity may be an even bigger challenge, but I’m not going to put anything past anybody because there is a need to generate as much revenue as possible to support the Infrastructure Bill that’s being put out there before Congress today.
And so it will be interesting to see how some of that stuff plays out. It’s going to be challenging, even the little things like you just talked about, the $15,000 per person. One of the proposals is going to limit that to $30,000 per year per donor. So if I’ve got five kids, I have to spread $30,000 around among those five. But if I only have two, I can give each of them 15. Well, that just doesn’t feel right to me. I mean, that doesn’t feel fair. But fairness was never a thing in legislation. It was certainly never a thing with the IRS. So it’ll just be interesting to see where all this shakes out and how we end up. It’s pay attention, be cautious, be a little patient, but be ready to work really hard to get something done before year end, if there’s opportunities to do so.
Karl Eggerss: Yeah, the last two, three years, maybe more, people have really been on the markets and the election, how it’s going to affect the markets and the markets, this and the markets that, and COVID with the markets. I’ve been saying, I think the financial planning side is going to be more important than the next couple of years than the investment management side, obviously, if you’re allocated properly. But I do think there are some actionable things people could be doing right now, but it does start with the planning. For example, in your example of wanting to give some money away to kids or grandkids, if you’re wanting to do that and you clearly have your retirement set up to where you don’t need that money, there’s no reason why people shouldn’t necessarily start doing that right now.
And I think, again, once you know your goals and objectives, you can work backwards and say, “What things can I be doing today under current law that may not change or I can at least start that because if it’s not retroactive, I can get that ball rolling?” I don’t think everything is sit and wait, but I do think the majority of what you’re saying is true as far as being patient, because we just don’t know, and you can cost yourself a lot of money in preparation, estate tax preparation, all sorts of things, and it’s all for not. And so I think that’s the challenge.
John Eadie: Yeah. And I think one of the things, I am certainly no attorney and I haven’t even really talked to anybody about this, but my concept on some of this stuff is to say, particularly if you’re worried about, I’d love to use I can fund 11,000,007 for a gift to somebody today and use up my exemption, I’ve got to believe there is language that can be written into that type of transfer document that says, “If I do this, I want to do this, but if the exemption goes down to $5 million, I want to be able to take back the excess over the exemption that’s in place because of retroactivity.” I’ve got to believe that’s going to be possible to have this claw back provision, if you will. So if that is possible, talk to your attorneys about it and see what
John Eadie: … they think and what their opinion is, and if it can be done, go ahead and get started today. There’s really no reason to wait, and that’s the point. That was a long-winded way of getting to go ahead and get started on some of those today, but the gifting to kids, charitable planning’s not going to change, do as much of that as you might want to do, all of those kinds of things.
Karl Eggerss: So things like irrevocable life insurance trusts, the acronym’s ILIT, some of those, would those be effected? I mean, if somebody has, and just to set this up, if somebody has an estate that’s underneath some of these limits, but perhaps they have a large life insurance policy, usually what people do is they put that in, what’s called an irrevocable life insurance trust and it helps that situation. Could those be affected under some of these proposals?
John Eadie: Well, the thing I’ve seen specific to these life insurance trust is that they may be includable in the estate, that you won’t be able to continue to keep them excludable in the estate, because, like you said, today, if you create this and the language is done right in the document, that life insurance proceeds are excluded from the estate calculation. But I’ve just seen slivers of conversations around whether that will even be possible going forward. I mean, things like grantor retained annuity trust, right now, great planning for if you have property that’s got a potential for great appreciation, that still may work, but today you can do one for as short a trust for two years. Under all the new proposals, they have to be a minimum of 10 years. And I get why they do that, but it’s very different planning and getting somebody to commit to something for two years versus 10 is a very different conversation with a client from that standpoint.
Karl Eggerss: Yeah, and just to let you guys know that are listening, we do have a nice two page little cheat sheet. It’s a yes or no and it’s essentially saying to the high income tax payer, how might President Biden’s tax plan affect me? If you want this, just reach out to me, it’s Karl, with a K, dot Eggerss with two S’s, at covenantmfo.com. And we’ll send it to you. A couple of things, John, that stand out as a highlight here is we’ve heard about 401Ks maybe not being 100% deductible, so you would essentially get a capped rate of 26%. So if you’re in a higher tax bracket, all of your 401K is not deductible. So that could effect high income earners. We also have this donut hole, so right now, if you’re an employee, you have social security being withheld from your paycheck, half is paid by your employer, half paid by you, the employee, and it’s up to a certain limit of $142,800.
Well, that may stay into effect, but then there’s going to be a donut hole where you don’t have more social security withheld, but once you get over 400, it starts to kick in again. Some of this is going to be terribly confusing, complicated, and so I think, number one, you’re going to see audits go up because, in fact, President Biden has put some more budget towards that, but also you may see tax preparation fees go up because this is going to get very complicated.
John Eadie: Well, it is. So payroll systems are going to have to change in a pretty big way to capture all of that stuff. And so is it going to cause companies to try to get creative for their higher earners to come up with some type of benefit, if you will, that’s not considered compensation to avoid some of that? I don’t know what that might look like, but it’s going to be challenging. I think it’ll be interesting to see how deferred comp plans may come back into vogue in a big way to be able to spread income out over a much longer period of time, particularly for people approaching retirement.
Karl Eggerss: I was thinking the same thing, that 400,000 is this magic number, how many business owners or employers they change the structure and try to stay under that 400, but have the compensation be paid in a deferred comp or some other type of way. And I think that’s highly, highly plausible. So, again, we’re going to continue this conversation in the next few weeks, as we know more, but the things that I think people can be doing right now is getting your financial plan up to date to know where everything is, how everything’s titled, how everything would flow if you were to die today or your spouse was to pass away today. Know all of that now so that when certain things happen, you can shift and pivot pretty quickly. You don’t want to be scrambling and saying, “I don’t even know how much my net worth really is.”
So I would encourage you if you need help with that, reach out to us. We can certainly help you out. Put that in a plan so that not only does it make sure that your retirement needs are covered, your philanthropic needs are covered, your legacy needs are covered, but also, from an organizational standpoint. When you see it all in front of you and you know exactly what your net worth is, including your life insurance proceeds and how things are titled, there may be some things to do today, but at the very least you’re set so that when these changes come, you can act very quickly. So if you need help with that, don’t hesitate to reach out to us here at Covenant. You can just go to creatingricherlives.com. So, John, this isn’t going to be your last time on here in the next few weeks and months, because we’re going to probably have you on more than any other guest, maybe except for Oliver. He’s on quite a bit, but we will have you back. I appreciate the insight and stay tuned. Keep your pencil sharp.
All right. Again, I want to thank our guests, John Eadie, my partner, for coming in. Appreciate the time, and hopefully that cleared up a little bit about what’s going on with taxes and so forth. Again, if you need our help and consultation around your taxes, your estate, your investments reach out. 210-526-0075 or just go to creatingricherlives.com. Remember, all of this is about planning. The more you can plan in advance, the more you can pivot when you know what some of these rules are going to be, and there may be some things to do today. All right, you guys have a great weekend. Don’t forget, creatingricherlives.com. We’ll see you right back here next week on the podcast. Take care, everybody.
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