Year End Planning Ideas

By: Randall A. Denha, J.D., LL.M.

As we enter the homestretch of 2023, it’s the perfect time to reexamine plans and action items. There are plenty of items to address, and it’s best to do so sooner rather than later. When you review year-end estate planning or business transition concerns, you have many worthwhile considerations, ranging from year-end gift-giving to tax issues.

Below is a list of items you might want to consider as you plan for the end of the year and future transitions.

Year-End Gift Giving

Federal gift tax exemptions are at an all-time high. These are use-it-or-lose-it exemptions that have year-end implications. Now is also the time to take advantage of valuation discounts available to closely held business interests. Assets to consider for 2023 gifting include:

• Marketable securities
• Business interests, which include outright gifting and the use of family businesses and other entities to remove future appreciation from taxable estates. These entities currently qualify for valuation discounts, which offer great opportunities to leverage your estate and gift tax exemptions. These valuation discounts could be at risk if certain tax changes occur.
• Charitable gifts
• Appreciated long-term capital assets

Keep in mind that it takes time to analyze, consider, and plan for lifetime gifts, especially large lifetime ones, so the sooner you start the process of planning for gifts, the better. Getting an early start is especially critical if you are contemplating gifts that must be made by year’s end.

Make Annual Exclusion Gifts

The IRS gives you a gift tax annual exclusion each year, and in 2023, the annual exclusion is $17,000 per donee. This means that you can gift up to $17,000 per donee without using any of your lifetime federal gift exemption ($12.92M in 2023, or $25.84M for a married couple). For example, if you have two children and four grandchildren, you can make annual exclusion gifts totaling $102,000 ($204,000 if you and your spouse make annual exclusion gifts) without using any of your lifetime exemption. If you’re not ready to make larger gifts, annual exclusion gifting is an easy way to reduce your taxable estate.

One option for younger children or grandchildren is to make these gifts into a 529 Qualified Tuition Plan. You can gift five times the annual exclusion amount ($85,000 in 2023) in a single year. You can also pay medical expenses and tuition directly to the provider or institution without using any lifetime federal gift exemption or annual exclusion amount.

Estate Planning

Year-end estate planning entails several potential concerns, including estate and gift-tax planning rollbacks, potential tax reform, and whether your current estate plan could use a tune-up.

• Estate and Gift Tax Exemption Rollbacks: The current federal estate and gift-tax exemption amount for 2023 is $12.92 million per person. This exemption is temporary and, absent legislative change, is scheduled to roll back to the level set by prior federal law in 2026. After rollback, the exemption will be $5 million in 2012 dollars, adjusted for inflation—less than one-half of the current maximum.
• Gifts: Given the expected reduction in the estate and gift-tax exemption, we encourage you to confer with estate planning attorneys and other professional advisors of your choice to discuss whether a lifetime gift makes sense for your family. It is vital to engage in these discussions sooner rather than later: You shouldn’t wait, because the window for making large gifts may be closing!  If you are ready to make larger gifts, you can transfer even more wealth to your descendants without paying gift tax. In addition to the gift tax annual exclusion discussed above, the IRS gives you a lifetime gift and GST exemption, and in 2023, the lifetime gift and GST exemption is $12.92M. This means that during your lifetime, you can gift up to $12.92M before the end of 2023 without paying gift tax by using your lifetime gift exemption. On January 1, 2026, the lifetime gift and GST exemption is scheduled to drop back down to $5M adjusted for inflation (likely around $6M in 2026). If you can afford to make larger gifts now, you can maximize the wealth transferred to your descendants, as the gifted assets and all of the growth in those gifted assets is removed from your taxable estate and not subject to estate tax at your passing. The IRS has ruled that those who make lifetime gifts until 2026 which exceed the lifetime gift and GST exemption will not be penalized. However, this is a “use it or lose it” proposition. When the lifetime gift exemption drops down in 2026, those who haven’t made larger gifts (greater than $6M) before then will have lost the opportunity to gift the higher pre-2026 lifetime gift exemption amount.

Though nothing is imminent, Congress can always pass legislation earlier to reduce the lifetime gift exemption amount before 2026. If you can afford to do so, you should consider making larger gifts to a spousal lifetime access trust (if married) or another GST-exempt trust for descendants, as that trust will be outside your taxable estate and can be structured to provide for multiple generations without ever being subject to estate tax.

• Intra-family loans can also be used to freeze assets in your estate while giving the intra-family borrower the opportunity to invest those assets to outperform the interest rate due on the loans. For intra-family loans, the IRS publishes the AFR each month for short-term (up to three years), mid-term (more than three years and up to nine years), and long-term (more than nine years) loans, which is the minimum rate you as lender should charge for intra-family loans. For example, you can loan $1M to a family trust for a three-year term at the September 2023 AFR rate of 5.3%. The family trust can invest the $1M loan proceeds in a high growth stock portfolio that appreciates at a rate of 8% annually. The loan will be paid back to you with 5.39% interest, but the family trust will benefit because it can invest those proceeds to generate a rate of return that exceeds the annual interest rate owed.
• Check Your Plan: The end of the year is always a good time to review your estate plan and ponder whether it could use revision.

Year-End Charitable Giving

You have many opportunities to make substantial charitable gifts that reduce taxes. You can gift cash or appreciated assets to a public charity or a donor advised fund. For charitable cash gifts, your income tax deduction is generally limited to 60% of your AGI and for charitable gifts of appreciated assets held for longer than one year, your income tax deduction is generally limited to 30% of your AGI. If the deduction is not fully used in the first year, it can be carried over for an additional five years.

You can also provide for charities by setting up charitable remainder trusts or charitable lead annuity trusts. Charitable remainder trusts can provide a guaranteed amount to you either for life or up to a 20-year term, and at the end of that period, the remaining trust assets are distributed to the charities named in the trust document. If you have a concentrated and highly appreciated asset, charitable remainder trusts can sell the asset and reinvest in a diversified portfolio that provides you with income each year, perhaps after retirement. No tax will be due on the sale, but the tax burden will be spread out and passed along to you gradually as you receive distributions each year. Charitable remainder trusts provide you with an immediate income tax deduction subject to the same AGI limitations as described above.

By comparison, charitable lead annuity trusts provide a guaranteed amount to the charity for a term of years, and at the end of the period, the remaining assets can be distributed to your descendants named in the trust document. Charitable lead annuity trusts set up as grantor trusts can provide a large upfront income tax deduction to offset a high-income tax year and enable you to transfer appreciated assets to your descendants without using gift exemption. However, the AGI limitation for grantor CLATs is generally limited to 30% of your AGI for grantor CLATs funded with cash or 20% of your AGI for CLATs funded with appreciated assets held longer than one year.

Finally, if you are 70.5 years or older, you can make qualified charitable distributions from a retirement account up to $100,000 subject to downward adjustments for deductible IRA contributions made after you turned 70.5.

Year-End Planning For Income Tax Issues

A few ideas to consider for individual tax planning ideas are:

• Engage in tax bracket management,
• Reduce exposure to the 3.8% Net Investment Income Tax and Internal Revenue Code Section 199A Limits,
• Consider income shifting,
• Perform Roth IRA Conversions,
• Bundle deductions,
• Consider creating a Charitable Remainder Trust,
• Maximize contributions to retirement plans,
• Consider an Internal Revenue Code Section 453 deferred installment sale,
• Utilize tax-efficient investing,
• Consider creating a Charitable Lead Trust or other charitable tax strategies
• Employing Family members.

I highly suggest having a meeting with your tax professionals prior to year-end and discussing the above suggested strategies.  That said, the following technique is one that is often overlooked but has real impact.

Employing Family Members. Wages for the services of one spouse who works for the other spouse are subject to income tax withholding and Social Security and Medicare taxes but not to the Federal Unemployment Tax Act (FUTA). You can hire your children to work in your business as well. Payments are subject to income tax withholding, regardless of the child’s age. However, payments for the services of a child under age 18 are not subject to Social Security and Medicare taxes if the business is a sole proprietorship or a partnership in which each partner is a parent of the child. In addition, payments to a child under age 21 are not subject to FUTA.

Payments for the services of a child are subject to income tax withholding as well as Social Security, Medicare and FUTA taxes if they work for: (1) a corporation, even if it’s controlled by the child’s parent, or (2) a partnership, even if the child’s parent is a partner, unless each partner is a parent of the child. Wages that you pay to a parent are subject to income tax withholding and Social Security and Medicare taxes but are not subject to FUTA tax. In addition to being able to deduct wages paid to a family member as a business expense, a key tax benefit is that any child, regardless of age, can contribute to an IRA provided he/she has earned income.

Your children can also contribute to a Roth IRA. If your child is a minor (under age 18 in most states; under age 19 or 21 in others), you will need to open a custodial account.

Insights:

• Contributions to an employer-sponsored plan must be made by December 31, 2023, to qualify for the 2023 tax year.
• The 2017 Tax Cuts and Jobs Act roughly doubled the standard deduction for most taxpayers.
• An additional 3.8% surtax is levied against investment income for high-income taxpayers.

Business Transition Planning

Businesses and their owners emerged from the pandemic in a mixed state. Some deferred exit planning as workforce challenges, rising costs, and declining valuations tightened budgets and persuaded owners to focus on steering their firm through rough waters. Other executives used the pandemic to reposition and grow, or in some cases, accelerate retirement. Nationally, although about 53% of businesses hope to go to market, approximately 83% of them either lack a transition plan or their plan has not been documented and communicated. Despite challenging market conditions, now is the time to design a successful future transition.

Deals are occurring at a slower pace, though, with greater focus on due diligence. Healthy companies looking to execute transition plans in the near term have sale opportunities. Although mergers and acquisitions slowed in 2023, businesses with strong financial positions or unique market opportunities remain attractive for both strategic and financial buyers.

The structure of the transaction often depends heavily on the tax implications, including income, state, and estate taxes. Advanced planning, including estate and gift planning, will be vital.

Planning for a business transition to retirement is a multifaceted endeavor. By aligning personal and business goals, crafting a solid financial plan, addressing tax and estate considerations, and assembling the right team, you can ensure a successful and fulfilling transition. Start early, stay organized, and adapt your plan as needed to achieve your desired outcome.  A few key areas to consider in planning for a smooth business transition, include the following:

1. Alignment of Personal + Business Goals: Begin by evaluating whether your personal, financial, and business goals are in sync with a business transition. Consider how selling the business will help achieve your personal objectives, and plan for a seamless transition to avoid unnecessary stress.
2. Finding Purpose: Business owners often grapple with a loss of identity and purpose after selling their business. Before proceeding, define what you want the next phase of your life to entail. Consider legacy, helping family members, starting a new venture, or other aspirations.
3. Comprehensive Financial Planning: Develop a well-structured financial plan that integrates all your assets and income streams. Calculate the after-tax proceeds needed to support your desired lifestyle and wealth transfer goals post-sale. Explore different financial scenarios related to the sale.
4. Tax Planning: Selling a business has complex tax implications, influenced by factors such as business structure and sale type (stock or asset). Early consultation with a tax professional can help mitigate tax consequences. Consider options like installment sales to spread tax liability.
5. Estate Planning: Revisit your existing estate plans, taking advantage of the current gift and estate exemption. This exemption may change, so explore strategies to shield a larger portion of your assets from estate taxes if your financial plan permits.
6. Charitable Giving: If inclined, consider charitable giving in the year of the business sale to offset tax burdens. Explore tax-advantaged options like donor-advised funds or charitable trusts in collaboration with a financial advisor.
7. Preliminary Due Diligence: Ensure all documentation and operations are prepared for a smooth transition. This includes updating contracts, securing insurance, and ensuring IT systems are up to date.
8. Financial Statements: Prior to transitioning, ensure your financial records are organized and capable of withstanding third-party scrutiny. Conduct an internal audit, establish key performance indicators, and track metrics to enhance transparency and attract potential buyers.
9. Establish Your Team: Different exit strategies exist, and the appropriate one depends on your goals. Assemble a team that understands your objectives, assesses the company’s value, and collaborates with you to identify the right transition option.
10. Ongoing Process: Transition planning is not a one-time event but a continuous process. It takes time to execute successfully.

Reminder:

Shell Companies + Beneficial Ownership

Starting Jan. 1, 2024, businesses created in or registered to do business in the United States will be required to report information about their beneficial owners to the Financial Crimes Enforcement Network (FinCEN). Beneficial owners are the persons who ultimately own or control the company.

These entities include corporations, limited liability companies, and any entity created by filing documents with a state Secretary of State’s office. This encompasses limited partners, limited liability partnerships, and most business trusts—but not Schedule C businesses or general partnerships.

However, there are more than 23 exemptions available, including for large operating companies (those with 20 full-time US employees) or highly regulated companies such as public accounting firms, securities dealers, and investment companies and advisors. The exemptions mainly cover businesses that are already highly regulated by the federal government.

These requirements are part of the Corporate Transparency Act and aim to unmask shell companies—legal entities that exist on paper but have no physical presence, active business operations, or significant financial assets. While shell companies have legitimate purposes, they are also used for questionable or criminal activity, from tax evasion to money laundering.

If you created or registered your company before Jan. 1, 2024, you must file by Jan. 1, 2025. Companies registered on or after Jan. 1, 2024, have 30 days to file. FinCEN will not accept beneficial reporting information prior to that date.

Reports must include your company’s legal name and any trade name or “doing business as,” street address, the jurisdiction in which it was first formed or registered, and Taxpayer Identification Number.

Each of your company’s beneficial owners must provide their legal name, birthdate, address, and identifying number from and image of an approved document, such as a driver’s license or passport. FinCEN defines a beneficial owner as an individual who “exercises substantial control” over your company or who owns or controls at least 25% or your company. While FinCEN says it will keep the reporting process as simple as possible, the reporting portal is not available yet.