James Lange, CPA, is a principal and financial adviser with Lange Financial Group LLC in Pittsburgh and author of The IRA and Retirement Plan Owner’s Guide to Beating the New Death Tax. He joins us to discuss the factors leading to a higher tax environment and what CPAs can do to get their clients ready.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

Podcast Transcript

The role of the CPA personal financial planner is not always to react to changes that take place, but also to see them come before they take place and prepare their clients for a new environment. One such instance would be preparing clients for a higher tax landscape. In today's podcast, James Lange, CPA, attorney, principal and financial adviser with Lange Financial Group LLC in Pittsburgh, and author of several books, including the new The IRA and Retirement Plan Owner's Guide to Beating the New Death Tax will explore the factors leading to a higher tax environment, and what CPA personal financial planners can do to get their clients ready.

What are the factors combining right now to create a higher tax environment in the immediate future?

[Lange] We have a couple of things going on. Obviously, a new president who has openly stated he wants to raise taxes. We have a Democratic-controlled Senate and House, and I believe that they are interested in raising taxes. We have record deficits. And I think a lot of people, even by an informal poll, thinks that taxes are going up. Then finally, even if the Democrats and President Biden fail in every attempt at legislation and tax raises, we have the sunset provisions of the 2017 Tax Cuts and Jobs Act. Now, this is really important because basically what that said was, we had a pretty serious tax cut, including income tax rates in 2017. And in order to get that through, and to pass the budgetary constraints, it had to expire. Meaning the tax rates go up at a certain point in the future.

Well, that point in the future is 2026. I'm not going to go through all the numbers, but I'll just say that, assuming that nothing is passed, that law is triggered. We have a major tax increase in the year 2026. That doesn't even include the severity of the tax rates, particularly for IRA owners. So that's a little background of, if you will, setting up the problem that IRA and retirement plan owners, as well as all tax-paying entities have. But I think it's going to be a worse than ever.

Let's go over some of the tips CPAs can give clients to prepare for a higher tax environment. One of them is go from taxable to tax-free. Certainly makes sense, but what are some of the transitions that can be made to allow this to happen?

[Lange] The one other thing I'm going to say before I answer that question directly is one of the things that I believe that CPAs should be very cognizant of ... and by the way, one of the purposes of this talk and my writing is to make the CPA the hero to the client, not necessarily the financial advisor or the attorney … but CPAs, I think many of us, or probably most all of us, know about the SECURE Act and the new 10-year income tax acceleration on IRAs at death, subject to some exceptions. Basically, the old stretch IRA is gone. And when our clients die with a significant IRA, and leave it to a non-spousal heir or an heir that doesn't qualify for the exceptions, the beneficiary is going to have to withdraw that IRA within 10 years of the IRA owner's death and face a very significant tax on that.

So we have the increased taxes, we have what could be a massive income tax acceleration, and we could talk more about minimum required distributions, etc. But let me then go back to your question. Which is we are in this, what I would call, taxable environment. For that, at least to the things that we can control, one of the important things about the taxable environment is many of our clients are sitting with very significant IRAs. When I say IRAs, I'm including 401(k)s and 403(b)s and SEPs and Keoghs, and other types of qualified plans. Unless we're going to leave it to charity, all this money will at some point be subject to income tax.

We're fearing higher tax rates. So here the IRA owner, again, the client of many of us CPAs ... and by the way, this is relevant for CPAs themselves who are dutiful savers and have significant money in their IRAs and retirement plans. We're sitting on an income tax time bomb. That's the taxable environment that we are in. What is a good way to reduce the impact of taxes in the long run, which is to aim for some type of a transition. We can never do it completely, but to some extent, from the taxable environment to the tax-free environment. That's what I'm kind of aiming for. If your question is, well, what are some of the ways that you can do that, I'd be happy to answer that. But I just wanted to, let's say, clarify the circumstances of the question.

The basic idea is, if possible, are there specific ways that clients can be moving from the taxable landscape, as you say, to the tax-free? What are the concrete ways that they can do that?

[Lange] Well, first I'm going to talk about the most obvious one that should come to the minds of most of our listeners, which is to make a series of Roth IRA conversions. I think against what we have learned since we were kids, which was “tax deferral, tax deferral, tax deferral,” now we're talking about, and my adage, if you will, is pay taxes later, except for the Roth. What we're talking about is paying taxes now, preferably using money from outside the IRA, to pay for the tax for the Roth IRA conversion. Then the result of that is a Roth IRA, which, as we know, grows income tax free for the rest of our life, the rest of our spouse's life, and then even under the new law, for 10 years after both we and our spouse die. As a bonus, no minimum required distributions of the Roth IRA for our self or our spouse. That's the first obvious one. Would you like me to go into some of the less obvious ones?

I wouldn't mind one or two, just to give people an idea of what's available.

[Lange] Well, one of the things is, and I talked about the Tax Cuts and Jobs Act of 2017, there's also going to be a reduction, or at least part of the law says there'll be a reduction, in the estate tax exclusion. So many of our clients are facing not only an income tax problem, but also an estate tax problem. One of the ways that we can get money from the taxable environment to the tax-free environment for income tax is we can add getting the money out of our estates.

For one very easy example that probably most of our clients have to some extent is, for example, a 529 plan. You're taking an IRA, you're paying taxes on it, or part of it. You're taking the proceeds after that. You're putting it into a 529 plan, most likely for a grandchild. That 529 plan, assuming it's eventually withdrawn for education purposes, comes out tax free. It's really a lot like a Roth in that you're paying tax now, you get tax growth. You withdraw the money tax-free down the line, but it's outside of your estate. By the way, the 529, you can take back if you ever need it, although I've never seen anybody do that.

Another thing would be a gift that would be invested in a tax-free vehicle. Here's some money, child, grandchild. Put this money in your own Roth IRA, in your own Roth 401(k). Of course, the life insurance is another way of doing it, assuming it's handled correctly. It's outside your estate. The difference between what you pay in premiums and the death benefit, as the insurance people like to say, when the policy matures, is all tax-free. These are all ways of going from the taxable to the tax-free environments. When we run the numbers, which we do extensively, and we compare, let's say, the status quo versus a variety of these strategies, and usually some combination of them, and we run numbers for two generations, it almost always works out better than the status quo of doing nothing.

You mentioned gifting there for a moment, and we can dive into that a little more if there's more to give: What steps are available to be taken in the form of gifting to alleviate a tax hike?

[Lange] Well, I'm a big fan of gifting. I would say the biggest mistake that my clients have made, and I've been doing this over 35 years, and this might not be all that rare for a CPA, let's assume that the client gets the investments right. Let's assume that the client gets the Roth IRA conversions right. Let's assume that the client even gets their estate planning right. Usually, they don't get all three of those right. But even if they do, with the CPA's, and maybe the attorney's or the advisor's, help, the area that I find is one of the biggest areas of mistake is they don't gift often enough and aggressively enough.

What happens to a lot of clients, so they were in kind of Depression-era mentality mode for so many years. Accumulate, accumulate, accumulate. Now they have millions of dollars. Maybe they're giving $15,000 a year away, but their estates are growing and growing and growing. Then, ultimately they die, maybe when their kids are in their 60s. So, when their kids are in their 60s, they inherit a lot of money, often subject to a lot of taxes, when a much better strategy would have been aggressive gifting to reduce taxes. Then, also, there’s the benefit of getting money to your kids when they need it. I don't know your particular situation. My guess is you're financially secure. And if somebody gave you $100,000 or more or less, it probably wouldn't change your life very much. But what about 20 years ago?

It would have been, “Wow.” And I guess I'm speaking to CPAs who have clients who are maybe at the grandfather's stage, and their kids are adults by this time. Their kids, they face their own pressures. Even if they have a good job, they have their own financial problems. They're worried about their own college expenses for their kids. They're worried about they want to have money for life insurance. They want to have money for a nice home, maybe. Whatever it is. They're feeling financial heat. More aggressive gifting would make an enormous qualitative difference in their life.

For most of the clients that I'm talking about, they're not going to go out to dinner one more time, they're not going to take one more or one less vacation than if they are more generous to their children. I don't think we have time, but I could contrast two families, one of which who was not generous to their child, died when their child was in their 60s, and had a pretty bad result; the other one who gifted aggressively, and the difference in the child's life and that of their grandchildren was just dramatically different.

What is the first thing a CPA should be doing to prepare their clients for this new environment? How important is it to be doing frequent reviews of their plan?

[Lange] Well, one of the things that I like to do is, it's hard to solve a problem if the client doesn't know they have a problem. One of the things that I like to do is to show people the status quo. For example, you can start with a simple projection. Here's if you do nothing, and use whatever rate of return the client wants, but let's say 5 or 6%, and you're spending at your current level plus inflation. Look what happens to your minimum required distribution. Look what happens after one of you die, and then you have this much higher single tax rates. Look at the enormous taxes that your kids are going to have to pay when they inherit this giant IRA. Think about how hard you've worked, and how much money that you've earned is going to go to the government.

I hate to say it, but scare them. The idea is if somebody doesn't think they have a problem, then why should they do anything? Okay, so you show them that problem. They see, oh, gee, that's not good. What can I do about it? Then you say, okay, I start with Roth conversions, because frankly, that's an easier sale, if you will, than making a gift. Then, I'd look at gifts. For very wealthy clients, I talk about exclusion-invasive gifts. What if you gave a million dollars to your kids tomorrow, how would that compare with not? More times than not, I bring that up. That's probably a terrific strategy because not only are you getting the million dollars out of your estate, but you're getting the growth on that million dollars that would occur if you didn't make the gifts out of your estate. Saving both income taxes and more likely estate, and even if you're not in the federal estate tax situation, many of our clients live in states where there's an inheritance, or an estate tax, or a pickup tax, or whatever.

Once again, the book is the IRA and Retirement Plan Owner's Guide to Beating the New Death Tax. Jim, I wonder if there's any particular place where our audience can go to get the book?

[Lange] Well, of course, at Amazon. I didn't discuss this with you to ask if it's okay, but we are more than happy to send out books. You can tell I'm a proselytizer of ideas, and it costs me a nominal amount of money to send out a book. You could certainly go on Amazon. You can get the digital version, I think, for a buck. The hard copy, I think, is $25. Or they could just go to admin@paytaxeslater, and say, "Hey, I'd love a copy of the book." And then maybe I'll even throw in something else that I haven't thought of for anybody that does that. But I love the idea that the CPA is going to be the hero. Some CPAs, like myself, have also gone into money management. But whether you do or not, I want the CPA to be seen as the quarterback. Maybe the adviser might be talking about investments, but for whatever it's worth, this type of information is extremely valuable to clients. I want to cement the relationship between the CPA and the client.