AIPIS 118 – Reducing Your Capital Gains & State Taxes with Ashlea Ebeling, Attorney and Associate Editor at Forbes

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Welcome to the AIPIS show for accredited income property investment specialists and those who desire to be. This is your host Jason Hartman where we we talk about increasing your income, your productivity and just generally having a better life while serving your clients better with America's most historically proven asset class income property. We have a great interview for you today and we will be back with that in less than 60 seconds. It's my pleasure to welcome Ashley Ebeling to the show. She is a associate editor with Forbes magazine and Forbes.com and she wrote an interesting piece recently about the New York estate tax and how we should be aware of a 164%, yes, you heard that right. Marginal tax rate and profiles different states around the country and their tax situation and a whole bunch of interesting things. So it's a pleasure to have her on today. Ashley, welcome. How are you?

I'm just fine. Thanks for having me on the show.

Well, it's good to have you. So first let's dive into this article and, and just, I mean this is insane. I cannot believe it. How do we get to more than 100% tax? As if 100% weren't bad enough.

So New York estate tax has this provision called a cliff and people are trying to change it. It's obviously a problem. But one thing is New York made sweeping changes to its estate tax law just this year and they doubled the amount that's exempt. So if you had over $1 million before, you would owe estate tax on that amount and they've doubled it now to 2,062,500. But the cliff problem, if you die with just 5% more than that new 2 million dollar number, you face this cliff and that's where that crazy marginal tax rate would come in. And I can give an example. So Sharon Klein did, she kind of gave me an exact example because the New York State Department of Taxation, they did a summary memorandum on the new law, but they neglected to spell out the effect of this cliff. So her example was a taxable estate of 2,062,500 would pay no tax. But if you had $2.1 million, you would have a tax liability of 49,000. So that's more than the 37,000 increase in the value of estate. So just your state's gone up by 37,000, but your taxes would go up by 49,000. So that's the effect of the cliff.

Boy, this is crazy. Yeah, that's really crazy.

So what the lesson is, people need to know about state estate taxes. The federal estate tax law, that's been changed. So there's a big, big exemption. The Federal exemption of 5 million per person Indexed for inflation is now permanent and that's indexed for inflation. So next year the exemption will be 5.43 million. So obviously, most people don't really have to worry about federal estate taxes at all. In the meantime, the state estate taxes can be as low. Well, on inheritance taxes, it starts at the first dollar. And states with estate taxes, New Jersey is the lowest exemption with $675,000. So people with a nice house, they're in estate tax territory, right?

Right, they certainly are. So what do you think that, what change do you think will come to this law?

Well, the New York. There are people trying to change that cliff. So it would be more of a. It would be more gradual. So that's a possibility that, that could get tweaked in the next legislative session. And the good news in New York is that the law that's been put in place is eventually it's going to match the federal exemption. So BY, in just two years, by 2017, the New York state exemption will match the federal exemption. So for most people, it's not going to be an issue.

Very interesting. So when one looks at a state to consider a move, they need to consider what life stage they're in. If they're in their career stage and they're earning a lot of money, you obviously want to state with no or very low income tax if you're retired, as my mom retired many years ago and she, you know, I told her she should move to Texas and she said, no way. The property taxes are too high and she didn't care as much about income tax. You know, Texas has no state income tax. So, you know, it really depends. It's like where to live during your career years, where to retire and then where to die. And where to retire and die may be two different things. Right.

They're very different, really. You know, it's going to depend on each family specific situation. But you're Right. That you have to look at all the whole tax picture. So you look at income taxes, sales taxes, property taxes, estate taxes, gift taxes. And it's a little crazy that there's that much to look at, but it makes a huge difference. And then for retirees, they're state pension tax breaks that come into play. So that's another that goes under the category of income taxes. But you have to see whether your state taxes Social Security or whether it doesn't. My mom just moved from Virginia to Connecticut, so now her Social Security is being taxed where it wasn't in Virginia.

Wow. Okay. So you're in Connecticut, I believe.

Right, Right.

And that's the only state with a gift tax.

That's right. Minnesota had one. Tennessee got rid of theirs. I think it was 2012. And then Minnesota put one in in 2013. And then last year they. Then they. Earlier this year, they got rid of it again. So gift taxes are a bit controversial, but the idea with gift taxes is they don't. The states don't want people giving big amounts to their heirs in a way to avoid the estate tax. So Connecticut, for example, has a $2 million limit that you can't give more than that without having to pay a tax that would go up to 12%.

So do we see a lot of people in these states where you have the high estate tax, especially New York, what do they do to get around it? Do they use a charitable remainder trust or what is the vehicle they're using? Or do they just try and spend all their money before they.

That's obviously a simple way to do it.

I'm spend.

Might not be too thrilled with it. There are probably four big ways that people avoid or get around the state of state taxes. The one would be moving, so you could be in New York and then also have a home in Florida, and you would make Florida your residence. But you have to really do it. You have to be there more than 183 days a year. You have to change bank accounts, driver's licenses. There are all kinds of residency rules to make sure New York doesn't pull the state back into their territory. So moving is a big one. And I say everyone says Florida all the time, but there are seven of these no income tax states. And the second big move that people do is setting up a traditional credit shelter or bypass trust when the first spouse dies. And that puts the money that goes into that trust would then be exempt from estate tax. But the tricky thing is the federal level. You don't have to worry about that because there's something called portability. And if you have all this so someone who has $5 million at the federal level, they can send the money over to their spouse and then it's, it's protected even without a trust. But at the state level, there's still more of a need for trusts for estate planning.

Very interesting. Anything more you want to say about different taxes in different jurisdictions? Because I want to just touch on some of the other stuff that you're following and writing about.

Well, I guess if we look at the, at the, at the, it's for the state estate taxes. It's actually 19 states plus the District of Columbia that, that have these taxes and why you need to keep track of it. I have an interactive map that we keep on forbes.com called where not to Die. And every year it's updated. There were eight states that are ushering in changes for 2015. So that's one place to look. The Tax foundation has great maps on tax climate, on income tax taxes in all the different states. So that's another place I'd send people to look.

And I've seen some very complex charts as you were talking about the comparisons a few minutes ago. I've seen some very complex charts in terms of all 50 states or maybe 51 with District of Columbia, 52 with Puerto Rico, which has got some very desirable income tax and capital gains tax opportunities right now. It's just a really complicated matrix of all of these different issues that one needs to consider.

Well, when you're speaking of capital gains tax, that's another thing that people completely don't think about. And that can be taxed. Like in California, it's the same. I think it's up to 10.3 is the top rate there for the income tax. So if you're selling real estate, it's really important that you look that you know that when you're going into it with the capital gains rates are going to be not just a federal rate, which has been increased now, but to 20% for high income earners. Plus there's another net investment income tax and there's the state capital gains tax. So you have to add all of those together to really know what your tax rate is going to be.

So I'm looking at the where not to die map now. I found that while you were speaking just a moment ago. And it looks like, I guess the right red states are those the undesirable ones?

Those are the estate tax states. The blue states are also undesirable in their inheritance tax states. And again, that's something a lot of people don't know the difference. In New Jersey and Maryland, they have both estate and inheritance taxes. The inheritance taxes are a little different because it's who gets the money, who pays the tax, whether or not you pay the tax. So Pennsylvania is a good example. It used to be that spouses paid Pennsylvania inheritance tax at a 6% rate. And then people complained about that because generally for estate taxes, spouses don't pay estate taxes at all. You can give anything when you die to your spouse and it's estate tax free. So this inheritance tax, so they were paying 6% in Pennsylvania, they cut it to 3% in 1994, and then the next year they cut it to zero to make it similar to other states. But there's still in Pennsylvania, if you have an estate going to children, grandchildren or parents, it's a 4.5% tax. And if it goes to a brother or Sister, it's a 12% tax. If it goes to a nephew or niece, it's a 15% tax. So new Jersey has a similar lot of that too. And there's, you know, there are people trying to change it there too, where they think it's not fair that it's. If you're single and you're giving your state to your sister, you're taxed. But if you're, you know, if you're, you have children and you're giving it to them, you're not taxed.

Yeah, very interesting. And we should mention that the red and blue on this map are not political red and blues. So.

No, but, but it does follow like the north, the north east has this big chunk of estate tax dates. Washington has the highest rate. Washington state has the Highest rate at 20%.

Wow. Wow. Yeah, that's something else.

And then the interesting thing is there is precedent for repeal. If you looked at this map a few years ago, it had a lot more estate tax states. North Carolina and Indiana repealed their taxes in 2013, and Kansas, Ohio and Oklahoma all repealed theirs in 2010.

Very interesting. And it is interesting that it follows the political map to some extent. And that doesn't surprise me. But tell us about some of the other stories you're working on. I know you cover some real estate stuff and I'm kind of looking at your portfolio here on Forbes.com.

Yeah, I love. One of my favorite topics is philanthropy. And you mentioned charitable remainder trust. So that's something. That's another great move tax move for people who are charitably inclined And I had a nice example of a son who inherited a vacation house from his family and then they put it in a charitable remainder trust. And then it's a way to give real estate to charity that works.

What do you think about the Roth IRA versus the traditional?

Well, we're at Forbes, huge fans of the Roth IRA for people, but again, it's a tax play. So if you're going to be in a higher tax bracket in retirement, it's a total no brainer, you definitely should do it. But some people who should be doing it, who aren't thinking about it, they're actually in a low tax bracket now and they're young. So they should be putting money in a Roth because they don't get any advantage of the pre tax deduction that you would for a regular traditional ira.

So just to explain for the listeners who don't know, you know, a Roth basically says pay the tax now, but let it grow tax free. And so you, you can take it out. And ostensibly the idea is the tax rate will be much higher later in the future as the country is more and more fiscally insolvent and looking for money. And then you'll just have that money that's compounded for you over the years tax free because you pay the tax early. My fear and why I maybe I'm just being too paranoid, but the reason I am not a big Roth proponent is that I just think the government is going to become more and more hungry in years to come and they might just change the law. I mean, what's to stop them from doing that?

Some people do have that fear. And I can't say that it's implausible that it could never happen, but I think there would be like such an outcry that it wouldn't happen. And then another point, you've got those two buckets, you automatically, if you're at a workplace plan, any like employer money that goes into a plan and earnings that's all pre tax. So some people like doing some Roth, some pre tax to hedge their bets. And whether you actually take money and pay taxes on it to do a Roth conversion, which you can do to try to get more money into a Roth, that that's. That I would be more hesitant about the way for what you're saying.

Yeah, yeah. I think that these retirement plans are going to become the low hanging fruit in a. Hopefully not, but very likely. Unfortunately, I think desperately desperate future where the government will say, you know, they want to nationalize them or you know, it's Just so easy to attack the retirement plans.

Well, there are, there are already proposals out there in the administration to say that you can only put a certain amount in your retirement plans. And after that point, then once it's, I think it was about $2 million, once it's at a certain balance, there are different numbers depending on the different proposals that then you wouldn't be able to add anymore. So when you see the proposals out there, there's a reason to be somewhat scared.

It seems like the guard against that might be to have a retirement plan, whether it be a Roth or traditional. That's one issue that we already discussed. But have it be self directed. Because if it's self directed and the assets aren't just with big brokerage firms and really simple electronic transactions, that is not going to be the low hanging fruit for the government. The self directed plans, if you've got, you own some notes or mortgages, you own some real estate, self directed plans.

Are great for people who you have to really research what you're putting in with them and make sure you're not worried about the self direction dealing rules. But there definitely is a place for those for folks. I think if the government puts in limits though, they're going to apply across the board whether it's self directed or through a regular brokerage. And then theoretically, if you have the Roth money in there, you have more money in. If they're just putting limits on and they're not making a difference between Roth and pre tax, then you can, you can basically have a bigger retirement pot.

That's Roth money, you know, Very interesting. Okay, any, any other stories you're working on or have recently covered that you want to talk about? Just thought I'd open it up for you.

Just the. Well, I guess the kind of biggest one I just finished that got a lot of attention was about the upcoming 2015 tax filing season. I don't want to think about that yet because it's the fourth quarter, but the IRS commissioner is warning that it's going to be like the worst season ever. And Congress is now back in lame duck session and they have 50 plus tax extenders that expired tax laws that expired at the end of last year. They still haven't decided what they're doing with. So there's a lot of tax news that's going to be happening by year end that people should pay attention to because what happens on those bills is going to affect your taxes that you're paying when you write your check in April or if you're Getting a refund, you'll get less of a refund, Ashley.

So when you say it's going to be a really difficult season, what do they mean by that? Law changes, audit risk. What?

So law changes because with these tax extenders, whether some of them, and it's everything from taking the deduction for sales taxes to teachers buying $250 worth of supplies, to a $4,000 college tax break, commuter tax benefits. I mean, it's just, it's a big list. So chances are one of the things on that list will affect you. And if they don't, if Congress doesn't get around to figuring out what they're going to do with those laws by early December, then the IRS commissioner said that'll delay the whole processing of returns. They might have to delay the start of the tax season and then that would potentially delay refunds. Wow.

Yeah. What a mess. You know, I remember I was talking to Steve Forbes and then he gave a speech to our group and he just, you know, as a proponent of flat tax, he is so right. You know, he just said, let's just drive a stake through this old system and start fresh. Because this is so overly complex. I mean, I can't believe it. Ashley. You know, I am scared to death to sign my tax returns every year. There is no possible way I can understand the hundreds and hundreds of pages that I'm putting my name on every year. I mean, I don't even think one highly qualified CPA can understand all of.

Well, there are always people say three people get three different answers if they file your taxes for you, which unfortunately is right. And if you call the IRS hotline, you might get two different answers if you call two times. And then good luck calling because they're predicting 34 minute wait times for the 53% of the people that actually hang on until they get a live person there. So I wish I had better news on that, but that's kind of the way it is and do the right thing and try and understand the tax laws and get the right kind of advice. Another one of the reasons they also said about the delay is because they're putting, they're going to have on the website, on the IRS website a list of tax preparers. And obviously if you go to a CPA or enrolled agent, there are, they're high standards, fiduciary standards they have to hold to. But there's been the problem with unregulated tax preparers. So we always have to warn people about that. And they are going to put up. The IRS is going to start putting up on their website a database of qualified tax preparers.

Yeah, very, very interesting. We will see how it all turns out. Ashley, give out whatever website you'd like. Is it just Forbes.com or something specific?

Forbes.com, the Where not to die you can type in if you're interested to learn more about state taxes. And my name is Ashley A S H L E A so that's an easy way to find my articles too. And I'd love you to follow me on Forbes or Twitter.

Fantastic. What is your Twitter?

Just ashleyebline.

Okay, fantastic. Well, thank you so much for joining us Ashley. A very informative thank you.

Thanks for having me. Take care.

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