Estate Tax Planning May Be the Next Surprise for RIA Community

2020 Chicanery Never Ends

Industry Trends

Battling Coronavirus has changed plenty in F1 racing this year, but not the leaderboard.  Lewis Hamilton is still the fastest in his Mercedes (

Road racecourses were originally built with at least one very long straightaway that allowed cars to reach maximum speed before braking for the turn.  As cars became more powerful, the maximum speed attainable on the straights was dangerously fast.  Racecourses added serpentine curves, known as chicanes, to the straights that require cars to slow down and maneuver before resuming a straightaway.  2020 has been a year of one chicane after another, and at this point, I don’t think anybody expects a direct path to 2021.

RIAs Outran Two Challenges in 2020…

After a decade of gaining speed, the outlook for the investment management industry suddenly turned fairly grim in March.  With workforces on lockdown and equities falling, the pricing of publicly traded RIAs unsurprisingly trended downward.  But running an investment advisory practice remotely turned out to be much less impossible than many imagined, and AUM rebounded rapidly with the markets.  As such, Q2 did not turn out to be the industry bloodbath that many imagined, especially in the wealth management space.

2020, however, is full of surprises, and the third quarter is bringing more.  The persistence of the pandemic and the consequent economic strain on many has shifted political winds in favor of the minority party.  If these trendlines don’t roll over between now and November 3, we’ll have a new executive and legislative regime and, with it, a redirection of tax policy.  It’s not too early to start thinking about what impact certain legislative changes will have on the RIA industry, especially with regard to estate tax law.

Estate Planning Rising in Prominence

Investment advisors are not estate planners per se, but estate planning is a necessary part of financial planning for very wealthy clients.  If political winds shift, more of your clients could be subject to estate taxes and, therefore, would benefit from estate planning.  When my career started in the 1990s, the unified credit (the amount of wealth that passes tax-free from estate to beneficiary) was only $650 thousand, or $1.3 million for a married couple.  The unified credit wasn’t indexed for inflation, and the threshold for owing taxes was so low that many families we now consider “mass-affluent” engaged in sophisticated estate tax planning techniques to minimize their liability.

Then in 2000, George W. Bush was elected President, and estate taxes were more or less legislated away over the following decade.  Over the past decade, the law has changed several times but mostly to the benefit of wealthier estates.  That $650 thousand exemption from estate taxes is now $11,580,000.  A married couple would need a net worth of almost $25 million before owing any estate tax, such that now only a sliver of RIA clients (not to mention RIA owners) need heavy duty tax planning.

That may all be about to change.  Joe Biden has more than gestured that he plans to increase estate taxes by lowering the unified credit, raising rates, and potentially eliminating the step-up in basis that has long been a feature of tax law in the United States.

Biden’s Proposed Tax Policies

Basis step-up is a subtle but important feature of tax law.  Unusual among industrialized nations, in the United States the assets in an estate pass to heirs at a tax value established at death (or at an alternate valuation date).  Even though no tax is collected on the first $11.6 million per person, the tax basis for the heir is “stepped-up” to the new value established at death.  Other countries handle this issue differently, and Biden favors eliminating the step-up in tax basis.  Further, he prefers taxing the embedded capital gain at death.  Canada, for example, does this – treating a bequest as any other transfer and assessing capital gains taxes to the estate of the decedent.

Capital gains tax rates are generally lower than ordinary income taxes, of course, but Biden has also suggested that he would raise capital gains taxes for high earning households to equal ordinary income tax rates, which he also plans to increase.  Imagine a $10.0 million portfolio with a tax basis of $2.0 million.  If your client passed today, it might go to heirs free of estate taxes and with a new tax basis of $10.0 million.  If your client pays the maximum capital gains tax rate of 20%, the unified credit and basis step-up would save them $1.6 million (20% of the $8 million gain).  The entire $10.0 million portfolio would pass to an heir tax free.  If, instead, the unified credit is significantly reduced and capital gains rates rise to, say, 40%, the change will cost your client’s estate $3.2 million, and the bequest would be diminished to $6.8 million.  If an estate tax is levied on top of that, the impact will be much greater.

For those who want to minimize exposure to changes in tax law, estate planning can leverage the very low interest rate environment in conjunction with trusts and asset holding entities to transfer wealth efficiently and outside of the reach of the U.S. Treasury.  The problem that may well present itself is the overwhelming demand for these services in late 2020 if the election is decisively in favor of the Democratic Party.  If success in investing is “anticipating the anticipations of others,” this is a good time to think seriously about estate planning before tax planners become as scarce as toilet paper was in April.

What is the Next Chicane?

Where were you when you first realized that the Coronavirus pandemic was a big deal?  I was in, of all places, New York with my family during the second week of March, and I’ll never forget how every day of the week it became more apparent that COVID-19 was going to change the trajectory of this year, if not beyond.  First, the NBA suspended the season, then Tom Hanks – who was in Australia – tested positive, and then – also in Australia – the Formula 1 racing season was suspended about two hours before it was scheduled to start.

F1 resumed on July 5 with the Austrian Grand Prix, and the motorsport, which is essentially a giant logistical exercise anyway, has successfully pivoted schedules, business practices, and financial models to adapt to operating in an environment with plenty of at-home viewers but nobody in the stands.  Even for a business that thrives on making order out of chaos, Formula 1 is going better than expected, and the same could be said of the RIA industry.  But now that you’ve successfully protected, and maybe even enhanced, your clients’ financial well-being and the earnings of your firm, the challenges that loom from political change are coming in fast.  The chicanery of 2020 never ends.