In what appears to be a final deal, the US Senate has approved a tax bill that is likely to cause tax planners considerable work in the coming months, and may even prompt a few family offices and investment firms to consider their structures.

It is all over bar the shouting. The US Senate last night passed the tax overhaul bill by 52 votes to 48, and apart from a last-minute glitch, the package of measures, including a doubling of the estate tax exemption to $11.2 million per person, is scheduled to become law early in 2018. 

The bill now heads back to the House, which approved the bill earlier yesterday by 227 votes to 203.

The wealth management sector has a number of issues to embrace: the estate tax cut, removal of some deductions for local/state taxes that will hit some high net worth clients in high-tax states, and also a corporate cut tax to 21 per cent that might encourage a few of the larger family offices to restructure as corporations, so this publication understands from industry sources.

The estate tax exemption for a married couple would become almost $22 million, which means only about 0.2 per cent of the US population would pay it. (See here for an earlier article on the issue.)

Already, wealth advisors have told Family Wealth Report that the estate tax change is likely to be the most significant change to tax, while the removal of some deductions in the tax code might encourage more families to consider using trusts in low-tax states such as Delaware, New Hampshire, South Dakota and Nevada for tax planning purposes. What appears clear is that the tax advisory industry faces a busy 2018. 

Lisa Featherngill, head of wealth planning at Abbot Downing, the organization that is part of Wells Fargo looking after ultra-high net worth families, says the change to tax deductibility in the rules may sharpen focus on use of trusts in specialist states such as Delaware and others, although the use of such places has been a feature of planning for some time. 

“The lack of deductibility of state taxes exacerbates these issues but is not a defining issue for determining where to establish the trust. Many of our clients prefer long term trusts in Delaware and South Dakota due to the trust laws and lower tax rates,” Lisa Featherngill, she said.

Worldwide tax angst
An issue that did not get much attention outside specialist firms was how the Senate and House bills did not change the current worldwide system of tax through which all Americans, including those living their entire adult lives outside the country, must file a tax return.

Tax enforcement measures, including the Foreign Account Taxation Act, or FATCA, have prompted complaints that expat US citizens struggle to obtain basic financial services. Lobby groups such as American Citizens Abroad have called for the US to adopt a more residency-based, aka territorial, tax code, but so far to no avail. In recent years, a rising number of Americans have renounced their citizenship. 

Family office changes?
Featherngill was asked if in her opinion the proposed cut to corporation tax to 21 per cent from 35 per cent – putting the US in line with most other developed economies – could encourage some family offices, which typically are structured as partnerships rather than C-corporations under the tax code, to think of switching status. 

“The decision to convert to a c corporation requires examination of several issues and thus analysis by the CPA. For example, the analysis needs to compare the impact of the new deduction for business income from flow-through entities versus the reduced corporate rate of 21 per cent, but double taxation of C-corporation income.  The analysis will vary by company based on the tax status of the business and owners,” she said.

Other industry figures who have spoken to FWR in recent weeks have suggested a few family offices might change how they are structured, but as most FOs, particularly single family offices, don’t exist to run as a profit like a standard corporation, a mass change is unlikely at this stage.

Other changes
The changes are slated to reduce US federal revenue by almost $1.5 trillion over the next 10 years, prompting controversy that the country is taking such a step while national debt levels remain high and almost a decade into a stock market bull run. Defenders argue the overall tax code has been a complex mess for too long, with loopholes and exemptions distorting behavior, particularly in the case of corporations  such as Apple and Amazon stashing overseas earnings abroad in tax havens rather than investing in the economy or returning cash to shareholders.

For some US taxpayers, they could face higher total income tax bills – blunting the notion that the bill is “for the rich”, because local and state taxes will no longer be fully deductible from federal levies. A report in the Wall Street Journal noted that the “SALT deduction”, which provides a tax break on state and local property taxes as well as income taxes or sales taxes, will be capped at $10,000 - a change that will mostly hurt people who make relatively high incomes in high-tax states that tend to vote Democratic. GOP lawmakers in New York, New Jersey and California have objected to limiting the deduction, fearful they could lose votes.

Debate on whether such a bill makes inequality wider remains. The Urban Brookings Tax Policy Center reportedly finds (Bloomberg, Dec. 19) that the top 1 per cent of earners would get an average cut of about $50,000 that year, and the top 0.1 per cent would get an average of $190,000.

Mitch Drossman, national director of wealth planning strategies at US Trust, Bank of America Private Wealth Management, reckons that as the tax bill makes almost all individual income tax provisions temporary, with them almost all expiring at the end of 2025, this will store up complexity and political controversy in future.

Hedge funds
A firm acting for hedge funds, Kleinberg Kaplan, say the tax changes will affect professionals working in the sector, and they should consider acting before the end of this year if possible. 

“The tax changes propose to disallow deductions for non-business state and local taxes for taxes paid after 2017. Individuals should generally pay 2017 state and local income and property taxes prior to year-end. They need to remember to take into account the alternative minimum tax in making this determination. One is issue which is being considered is the ability to prepay 2018 taxes and get a deduction in 2017 and, if so, how to make such payments. There seems to be a difference of opinion among tax professionals and this may not work,” the firm said.

The firm continued: “Since the ability to deduct state and local taxes is going away in 2018, it might be preferable to realize gains this year and defer losses so that your income is higher in 2017 and thus your state and local taxes are higher in 2017.”

Another issue, Kleinberg Kaplan said, is whether people in the sector should think of moving to a new state or even country. “With an effective rate increasing from around 52 per cent to around 57 per cent and potentially on more income, some taxpayers might consider moving to a low- or no-tax jurisdiction. The proposed legislation does not adopt changes to taxing US citizens on worldwide income, however. Puerto Rico could still work to reduce taxes substantially. What it means to move and the benefits of moving need to be evaluated,” it said.

Real estate investment trusts
The WSJ noted that there is a a deduction for pass-through businesses – a term meaning income derived from commercial activities that their owners or shareholders pay on their personal income taxes. That deduction includes income that flows to REIT investors through dividends but not the capital gains secured when properties are sold. The proposed legislation allows investors to deduct 20 per cent of the income, with the remainder of the income taxed at the filer’s marginal rate. 

(This publication welcomes thoughts about the specific effects on clients, wealth management firms and other advisors from this legislation as more details emerge in the fine print. Contact the editor at tom.burroughes@wealthbriefing.com)