As we move through the remainder of 2021, the focus on tax policy to help fund the Biden administration’s initiatives is sharpening. There are numerous tax proposals circulating that may dramatically impact taxpayers soon. Whether any of these proposals pass and in what form remains unclear. Although sweeping tax reform is unlikely, what is taking shape may be targeted increases, including an acceleration of changes to the current law that went into effect in 2017, well ahead of the sunset of certain provisions at the end of 2025. A few of the major proposals circulating follow.
Highlights of proposed changes
Under President Biden’s plan, the estate tax exemption amount would be reduced to $3.5 million per person, the gift tax exemption reduced to $1 million per person, and the top estate tax rate would be raised to 45%. Further, the President proposed eliminating the basis adjustment for assets at death. Other major provisions of his plan call for expanding tax increases when income exceeds $400,000; restoring the highest marginal income tax rate to 39.6%; expanding Social Security tax to 12.4% (split evenly by the employee/employer), capping itemized deductions to 28%; and restoring the Pease limitations. The President may eliminate the preferential rate for long-term capital gains currently at 20% and qualified dividends on income over $1 million to 39.6%. He would repeal the 20% qualified business income deduction for taxpayers with greater than $400,000 in income. Originally proposed as part of the President’s tax plan, the possible increase in the federal corporate tax rate from 21% to 28% was included in his recently announced infrastructure bill.
Closing stepped-up basis on unrealized capital gains
Another proposal, the Sensible Taxation and Equity Promotion (STEP) Act, sponsored by several Democratic senators including Chris Van Hollen, Bernie Sanders, and Elizabeth Warren, seeks to close the step-up in basis on unrealized capital gains at death. The bill would allow for all individuals to exclude $1 million in unrealized gains. Under this legislation, taxpayers could pay the tax in installments over 15 years for gains that apply to an illiquid asset such as a business.
“For the 99.5% Act” changes
Senator Bernie Sanders’ recent proposal, called “For the 99.5% Act,” recommends the same reduction to the estate and gift tax exemption as in the President’s plan but would install a progressive estate tax rate. For example, estates between $10 million and $50 million would be taxed at 50%. The highest rate under Senator Sanders’ plan calls for a 65% tax on estates over $1 billion. However, his proposal goes much further and seeks to impose a 50-year term for new and existing long-term trusts. Trusts lasting longer than 50 years could be subject to generation-skipping transfer taxes for distributions to a skip person. In addition, the proposal includes limitations on annual exclusion gifts for certain transfers, minimizes valuation discounts for transfers to family entities, and treats trusts owned by the grantor for income tax purposes (as opposed to estate tax purposes) as part of the grantor’s taxable estate at death. Certain proposed provisions of this legislation would take effect immediately after the enactment date while others would be delayed until January 1, 2022.
Wealth tax proposal
Another approach to raising revenue is a “wealth tax” recently proposed by Senator Warren and co-sponsored by Senator Sanders. The Ultra-Millionaire Tax Act of 2021, as it is referred to, would have a household pay a two percent tax on every dollar of net worth in excess of the $50 million threshold, and a one percent surtax (i.e., three percent total) on every dollar of net worth above $1 billion. The legislation would provide funding to the IRS for enforcement and require a minimum audit rate of 30%.
We can expect more proposals to be put forth by both parties in the coming weeks, and it is far from certain what the final form of legislation might look like. What we do know is that the likelihood of changes being made to the law as it stands today is gaining momentum. With that said, the time to act may be now.
Considerations for high-net-worth taxpayers
Taxpayers with taxable estates over the current gift, estate, and generation-skipping transfer tax exemption limits available today may want to consider revisiting their planning to determine if they can take advantage of opportunities under the current tax law. For those who might be exposed to estate tax under the current proposals, it is important to take a critical look at estate and financial plans to see whether tax mitigation strategies should be pursued. For those with existing irrevocable trusts, it may be the ideal time to determine whether they can be further leveraged with additional gifts of any remaining exemption, selling assets to them for long-term notes, and looking at where assets should be located to capture future appreciation. For business owners who may be contemplating a sale of their businesses or investors who have an appreciated portfolio, it may be time to accelerate the sale of the assets to take advantage of preferential capital gains laws which are far lower than the current proposals.
The year is already one-quarter complete and year end will be here quickly. Now is the time to talk to your advisory team to review your plan and make any changes before change occurs.
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