President Joe Biden used the budget vote process to push through his latest COVID-19 relief package, a powerful opportunity that is only available once a year.
Well, the next federal fiscal year starts October 1, 2021, and the budget vote will be available again, which means that Biden and the Democratic Party-controlled Congress will have the opportunity to move forward with their proposed changes to tax laws. Such changes would likely go into effect in 2022, but there is still the possibility that some changes could be made retrospectively to previous dates, which would make things a lot more difficult for clients and consultants alike.
What are the top potential tax changes being discussed which advisors should keep an eye on?
First, reduce the tax exemption for inheritance, gift, and generation changes from $ 11.7 million to $ 5 million, or perhaps even to $ 3.5 million. Such a reduction in the exemption could take place retrospectively. Therefore, it is imperative that customers consider claiming their $ 11.7 million exemption as soon as possible, and that you carefully structure such planning to ensure customers do not experience a high federal gift tax subject to retrospective effect if the exemption is actually applied. It is also possible that the federal estate tax rates will be increased in a graduated order of magnitude from the current 40% to up to 77% for extremely large estates.
Second, to eliminate certain discounting techniques. Discounting the market value of limited partnerships or corporations based on minority interests, lack of marketability, etc. has historically been a very effective method of cutting those assets by up to 30-40% for gift and estate tax purposes. There may also be significant cuts or the elimination of discounting techniques that use deferred escrow gifts, e.g. B. Grantor Retained Annuity Trusts (“GRATS”), Charitable Lead Annuity Trusts (CLATS), Qualified Personal Residence Trusts (QPRTS), and Charitable Remainder Trusts (CRTS).
Third, the taxation of grantor trusts (sometimes referred to as intentionally flawed grantor trusts (IDGTS)) on the grantor’s estate. Currently, such trusts are considered the property of the grantor for income tax purposes, but in the event of death, the IDGT cannot be included as an asset of the grantor’s estate for estate tax purposes.
Fourth, eliminate the increase in the tax base at the time of death. Currently, the taxpayer’s unrealized capital gains at the time of death are not subject to capital gains tax and the beneficiaries of the estate are given a new basis for assets that are at fair market value at the time of death. If the asset is depreciable like real estate, the beneficiaries can make depreciation deductions based on the new reinforced base. We could see an attempt to return to the concept of the «transfer base», where the beneficiaries receive the assets on the same basis that the deceased had. Another suggestion is that the estate tax be abolished in favor of recording all capital gains at the time of death. This is the system currently used in Canada.
Fifth: Limiting the generation exemption to a certain duration of years, possibly every 50 to 90 years, with inheritance tax to be paid by the current income recipients or by the trust itself. This could even be extended to current trusts that exist for more than the 50-90 years. The social policy behind this proposal is to prevent property tax-free building of assets in cross-generational trusts.
Sixth, reducing the annual gift tax exclusion. Currently, a taxpayer can give as many US $ 15,000 tax-free gifts as the taxpayer wishes. Spouses can participate in the gifts, doubling the tax-free gift to $ 30,000 per recipient each year. The proposals under consideration would limit the amount of gift tax exclusion that could be used each year to a total of $ 20,000 to $ 50,000 for all concerned.
Seventh, increase income tax rates for higher income taxpayers. The current rate of 37% is expected to gradually increase to 39.6%. Additionally, for upper-tier taxpayers, the long-term capital gains and qualifying dividends who prefer a 20% tax rate could disappear, and all of those gains and dividends would be taxed as ordinary income.
Eighth, limit the benefit of income tax deductions and, for higher income taxpayers, eliminate up to 80% of their deductions.
Ninth, expansion of Social Security tax of 12.4% currently levied on equalization incomes up to $ 142,800 to all such incomes in excess of $ 400,000.
Tenth: Eliminate tax-free real estate exchanges under IRC Section 1031. Similarly, the benefit of offsetting taxable profits by investing in opportunity zones is expected to be limited.
Eleventh, similar to real estate tax, an annual wealth tax is levied, which requires the payment of a certain percentage of one’s own wealth, but is valued based on the value of all assets.
Twelfth, limit the size to which the IRA or other retirement accounts can grow and / or assess the penalties for accounts that exceed those limits.
Certain clients may be best served by taking immediate action regarding gift and estate tax planning to maximize their beneficiaries’ after-tax access. This planning needs to be done sooner rather than later. Consultants must pay close attention to the development of tax law proposals in Congress and the regulations proposed by the Treasury Department in order to be able to act quickly on behalf of their clients when adverse tax laws and regulations become a reality. Sitting back and watching is not a realistic option. It will not only be necessary to act quickly in this possible window of time in order to use the traditional planning instruments that may be expiring as much as possible, but also to adapt to newly developed strategic tax and financial planning alternatives.
Simon Levin is a board member and Donald A. Kress is senior vice president and chairman of the Trust Administrative Committee, both at Coral Gables Trust Company.