Our Private Client Tax Forum focused on hot topics affecting business owners and high net worth individuals, wealth transfer and business transition trends, ramifications of the Inflation Reduction Act of 2022, and more. Here are the highlights.
Increased IRS funding and enforcement
An impending surge of federal funding to enhance IRS enforcement activities is a reality check for taxpayers and tax professionals after a decade of decreased IRS audit scrutiny on individuals.
The Inflation Reduction Act of 2022, which President Joe Biden signed into law on Aug. 16, commits an unprecedented $80 billion to the IRS, with $46.5 billion earmarked for enforcement. By comparison, the agency spent $13.7 billion on its entire operation in fiscal year 2021.
“It is now time to really rev up our efforts to be better prepared for IRS audits and dedicate more time to documenting tax return filing positions with technical memorandum, and other actions of this nature, to fully support the deductions claimed or positions taken involving transactions,” said Tommy Wright, RSM’s family office tax co-leader.
Commissioner Charles Rettig has stated the IRS will follow the administration’s directive that audit rates will not rise relative to recent years for households making under $400,000. Conversely, the commissioner has signaled the resources will strengthen the agency’s enforcement focus on global high-net-worth taxpayers, pass-through entities and multinational taxpayers with international tax issues.
Although it will take time for the IRS to hire agents to the front line and operationalize new resources, individual taxpayers can begin preparing for increased audit activity by meeting with their tax advisors to discuss positions that were taken on previous returns and identify areas that could be susceptible to scrutiny.
“When you review your return a year after it was filed, this fresh look often uncovers certain errors,” said Alina Solodchikova, who focuses on tax controversy as a principal in RSM’s Washington National Tax practice. “Maybe you would want to file a qualified amended return that would protect you from penalties related to accuracy.”
Individuals can also familiarize themselves with IRS campaign issues to understand their exposure to an examination and to prepare to address issues of interest.
Perhaps the most the important consideration to keep in mind, as Wright said: “Documentation. Documentation. Documentation.”
To learn more, check out: Inflation Reduction Act: What $80 billion in IRS funding means for taxpayers.
Estate planning amid economic uncertainty
High net worth individuals and families can strengthen their estate and succession plans by applying an understanding of how uncertain market conditions and recent legislative developments affect common wealth transfer methods.
Rising interest rates, a high rate of inflation, depressed asset values and activity around mergers and acquisitions can all affect immediate and long-term planning. Although interest rates are rising, they are still historically low, which affects some transfer techniques in ways that are favorable to grantors. Meanwhile, depressed asset values can result in opportunities to transfer value outside of a person’s estate.
On the policy front, the administration’s desire to tighten certain laws governing wealth transfers is worth reiterating ahead of midterm elections in November.
“Not every change has to come from legislation; changes to valuation discounts and grantor trusts can often come from regulation,” said Ben Berger, RSM’s family office tax co-leader.
Additionally, increased funding for IRS enforcement activity will likely lead to greater scrutiny of personal income, estate and gift taxes. Getting quality valuations for assets is a crucial planning consideration, Berger said.
Abbie Everist, a senior manager in RSM’s Washington National Tax practice, noted the importance for grantors to make sure “transactions are very well thought out and documentation is done appropriately and timely to meet all requirements.”
Estate planning can be a stressful time, so having a clear and articulate plan can help put everyone at ease and stay focused. A strong plan builds off the family’s estate-planning philosophy and includes legal, estate and investment considerations. To facilitate the planning process, Berger suggested bringing everyone together, including the advisory team, before executing on the estate planning transaction.
There are many advanced estate planning techniques available, but most important is to start at the top, said RSM Senior Manager Alex Milano.
“Planning for yourself is, obviously, a crucial first step to any transaction and successful estate planning,” Milano said. “You should be working with your advisors to understand what you and your significant other need to maintain your lifestyle and your retirement goals.”
For more helpful tips, check out: Multigenerational wealth planning: A guide to do’s and don’ts.
Planning considerations for a down market
Current market volatility and uncertainty present opportunities for taxpayers to derive value from transferring assets while minimizing their tax obligations and those of their estate. To that end, comprehensive wealth planning can help taxpayers act quickly to leverage fluctuating asset values, said Jamie Sanders, a partner in RSM’s private client services practice.
“Really think about what charitable planning you can do to decrease the tax ramifications of that sudden increase in income, or what you can do quickly when assets are depressed to utilize those losses or sell that depressed asset to an entity, individual or trust outside of your estate,” Sanders said.
Sanders and Max Youngquist, a senior manager in RSM’s family office practice, presented 11 wealth planning ideas for an inflationary and volatile market. They included harvesting losses, a term that describes selling assets at losses to help offset current or future gains; taking advantage of historically low interest rates that are used in connection with family loans and sales to intentionally defective grantor trusts; and gifting assets to maximize the benefit of the lifetime estate and gift tax exemption, which is scheduled to be halved at the end of 2025.
Residency considerations in a multifaceted tax planning dynamic
The interconnectedness of business, individual and fiduciary tax planning underscores the importance of paying close attention to the variety and complexity of state tax laws, especially given pandemic-induced shifts toward remote working and personal mobility of the workforce.
Individual taxpayers that factor residency considerations into their planning can avoid unintended outcomes by being mindful of two types of residency—domicile and statutory—and the requirements for each in applicable states.
For a residency claim to withstand a taxing authority’s scrutiny, it’s important for a taxpayer not only to maintain relevant documentation but also to establish a lifestyle reflective of domicile residency in that jurisdiction, said Eric Manus, RSM state and local tax partner.
Manus suggests a holistic approach to building a narrative that accurately depicts domicile residency in the new state of residence while showing abandonment of domicile in the former state. That includes considerations other than tax, such as how a move would affect family members and the social and lifestyle aspects of everyday life. Assessing those factors can help an individual determine whether relocating is truly in their best interest.
Similarly, business and individual tax planning is most effective when a taxpayer understands the numerous ramifications of relocating. For example, a partner in a pass-through entity who is considering a move should look at whether they have state-sourced income and whether moving would change their tax position more substantially in the near or long terms than other ways they might save money, Manus said.
Another prominent relocation consideration relates to pass-through entity tax regimes. States have different rules, including whether they offer a resident credit for taxes paid. To learn more, read: Pass-through entity elections are here to stay: What you need to know.
