Crain Currency

Glenmede’s Parthemer explains what family offices need to know about potential tax changes

Much of the debate in Washington centers on the extension or expiration of the 2017 Tax Cuts and Jobs Act. What should family offices know?

I was with a delegation in D.C. recently, and we met with the chief counsel’s office of the IRS — and several areas that we talked about could be of interest to family offices. One of them that can really impact liquidity planning for a family office deals with section 2053, on the deductibility of certain expenses on an estate tax return.

In 2022, the IRS proposed regulations that would really tighten the use of that and shut down the use of what’s known as a Graegin loan, which is a loan that an estate takes out. Regardless of when you pay the principal, the interest is a fixed amount; so it might be 7% for 20 years, and it doesn’t matter when you pay it. By making it a fixed and determinable amount, the interest becomes deductible on the estate tax return. A lot of wealthy families with illiquid assets in the estate take out such loans — they take out a loan from themselves. And then [the interest] is deductible.

Is it 100% deductible or just a certain part of it? 

To the extent that debt is used to pay for estate taxes and administration costs, yes. The IRS has proposed regulations to totally shut down the ability to deduct the interest on those loans.

For a family with illiquid assets, that used to be a tax-efficient way of planning. Now, if they don’t have that, they really need to think about asset allocation and making sure that they have liquid assets or insurance.

Is the impetus for that in terms of fairness or as a revenue source for the government? 

I think in terms of fairness. If you look at the last seven or eight cases from Tax Court about these loans, the results are 50/50: Tax bearers win half the time, the IRS wins half the time.

You know the expression “pigs get fed hogs.”? There was a case recently where the estate had an LLC with over $100 million of cash looking for businesses to invest in. They owned enough of the LLC to get cash out of it. But they borrowed from another family entity — at 25 years of interest payments — and it turned a $7 million loan into an over-$50 million deduction, which the IRS objected to. And the Tax Court agreed with the IRS. If you have any common sense, you look at that, and that seems a little unnecessary.

But maybe there are some circumstances where it really is an appropriate avenue for the estate, especially if their assets are so illiquid. Many of these large family offices are investing in alternatives or private companies, so there’s not any cash in the bank, so that type of loan could help them. If this shutdown gets finalized, it’ll increase the need for more mindful liquidity planning for the estate.

What about the estate tax and overall rates? Any openness to keeping it where it is or lowering it?

I’ve heard no conversation about repeal [of estate tax], no conversation about changing the rates to either be more generous or less.

There could be some planning opportunities for timing of income and deductions. If the itemized deduction for income earners will be capped at 35%, and their tax rate could be 37% or higher, that delta creates opportunities to get the full offset value of their charitable contribution, which is worth more at a higher bracket. Instead of making annual gifts, there could be some reason to defer, paying their fourth-quarter state income tax or paying their real estate tax into January of next year, when they might be able to deduct more of it. They need to pay attention to those kinds of details and see what the right maneuvering would be.

Any room for more tax loss harvesting?

The market’s been a little volatile. Whether or not that’s normal volatility, there’s ways to lose money if you know where to look for it. I like to say that tax loss harvesting is a year-round activity, not a year-end sport. And it should be a habit — as long as it fits in the overall asset allocation — to accumulate those losses throughout the year.

It’s less driven by the tax code and more by market behavior, which can be as a consequence of Trump’s Liberation Day or the tax code or whatever. Regardless of why the markets shift, that creates opportunities, and they should be captured. And there’s no reason to sit on one’s hands.

There was a joint effort by the SEC and Treasury to try to shut down cryptocurrency loss harvesting, and that seems to have no traction at the moment. The reason is the “wash sale” rule — which prevents claiming a loss on the sale of a security if you buy the same or a similar security within 30 days — applies only to stocks or securities. Both the SEC and the IRS have said that for most purposes, cryptocurrencies are neither a stock nor a security.

That said, some companies have an algorithm that every time there’s any movement in the bitcoin holding, for example, it’s immediately sold and rebought, because the wash-sale rule doesn’t apply. There had been some effort to try to quash that, but those efforts are silent. Families with more comfort around cryptocurrencies might want to take a look at that.

Do you see changes on the state level at all? 

There aren’t many when it comes to taxes that are applicable to family offices. But let me connect the dots with the SALT cap. We know that many states and the IRS worked out an arrangement for alternative forms of the cap, but the proposed bill shuts all of those down as a matter of law.

So will states be able to respond with some other form? That may be difficult. They may find themselves trying to figure out a solution, and some smart people will work diligently to help those who would be hurt by the cap.

In the trust and estate area, states continue to try to outdo every other state in order to keep their residents doing their planning inside their state or nonresidents moving their planning to their state.

There may be family offices looking for the jurisdiction with the most favorable private trust company law. So separate and distinct from tax, trust law is a big deal, whether it’s decanting nonjudicial settlement agreements, other flexibility provisions, dealing with CRTs [charitable remainder trusts], any of a variety of ways.

Obviously, there’s been a lot of movement out of New York and out of California for various reasons. Is that continuing, or are some of those states being a little smarter about trying to keep their wealthy residents and taxpayers?

There was a significant amount of movement going back to before COVID, and that blossomed dramatically during the pandemic. It seems to be going back to finding its level. We’re still seeing it but not at the cadence that maybe it was two years ago.

And Northeast states and high-tech states tend to still attract people. When one member of a couple passes away, the survivor wants to move back near the grandkids. So going through all these gyrations to make yourself a Floridian may not be worth it.

It’s important to have a little flexibility and not to let the potential tax savings drive you to change your lifestyle in a way that really isn’t what you want. Just be happy first — if it’s to be near family or to be near the home you grew up in. Let’s just make sure we’re taking all these things into consideration when making decisions.