A wealth management firm highlights how a new US administration, bringing possible sweeping changes in areas such as estate and corporate taxes, are creating an usually acute headache for HNW individuals handling estate planning.

Proposed sweeping changes to US tax laws under President-Elect Donald Trump and his Republican allies, such as a sharp cut to corporate tax rates and a possible repeal to estate taxes, could trigger major changes in the country’s wealth sector, an advisory firm predicts.

While usual caveats apply to any proposals becoming law, the fact that Trump is entering the White House next month with the Republicans holding the Senate and House, means tax planners face some tricky calculations. In particular, if it is possible that US estate taxes and gift taxes are repealed, does it make any sense for high net worth individuals to sort out end-year planning issues now or wait to see what happens in 2017 if taxes are slashed?

“It is unclear what’s going to happen and people are in a real bind,” Michael Delgass, chief executive of Sontag Advisory, a New York-based firm, told Family Wealth Report. (To see a profile of Sontag by this publication, click here.)

The US Treasury recently proposed sweeping changes to the way valuation discounts are applied to gift and estate taxes. If those proposed regulations are finalized and made effective, they could drastically restrict those valuation discounts. There is a risk, though, that Congress might try and stymie the Treasury proposed regulations, so that they would not be finalized.

The Treasury proposals cover a new three-year lookback (regarding gifts transferring control of family businesses to another family member that resulted in the lapse of a voting or liquidation right would now be subject to a three-year lookback); assignees (a new rule captures transfers to an “assignee” who has been given an interest in a family business but not officially admitted by the other partners, and limited valuation discounts (adding restrictions on discounts in liquidations and redemptions). 

To some extent, the uncertainties are inevitable results of a change in political regime; it is also arguable that the US hasn’t seen as significant a potential set of tax changes since the Reagan-era tax reforms of the 80s.

“Family business owners [thinking of the proposed Treasury changes] might be worried that the window of opportunity for them in giving is closing. On the other hand, they might not want to act right away,” Delgass said. “It is very difficult to plan around,” he continued.

“To some extent people have adopted a sort of wait and see approach,” he said, arguing that clients, thinking that a new era may be about to take hold, are reluctant to spend money on buying insurance, getting appraisals or using lifetime allowances if it turns out these moves will not be needed.

Corporate taxes and family offices
Delgass also argues that if Trump/Congress delivers on promises to cut US corporate taxes - currently up to 35 per cent and above international averages - it will affect how family offices operate.

At present, family offices are structured in many cases like private equity partnerships rather than corporates; income is treated as much as possible like a capital gain. With changes to treatment of carried interest and a cut to taxes on corporate profits, family offices are likely to restructure as corporate holding entities, a structure not much used since the 1980s. “Family offices are likely to look more like a corporation and an operating business,” he said. (A “carried interest” is a way of allocating return - typically to a private equity or hedge fund manager - that allows the recipient to retain capital gain treatment on it.  This concept has come under attack by some as a way of disguising the fact that this return is actually fee compensation and not truly investment gain.  Family offices often use this structure as part of a structure that maximizes investment-related deductions, while still preserving capital gain treatment on appreciation of their investments.)

Among other measures, Trump has proposed to compress and lower tax rates, as well as limit itemized deductions. 

As Sontag explains on its website, Trump’s proposal would reduce individual tax brackets from seven to three for ordinary income and amend the capital gains brackets accordingly. (For joint filers, this means that (i) income under $75,000 would be subject to a 0 per cent capital gains rate and a 12 per cent ordinary income rate, (ii) income between $75,000 and $225,000 would be subject to a 15 per cent capital gains rate and a 25 per cent ordinary income rate, and (iii) income over $225,000 would be subject to a 20 per cent capital gains rate and a 33 per cent ordinary income rate. In addition, Trump’s proposal limits itemized deductions to $200,000 for joint filers.