It is said that two things are certain in life: death and taxes. True, but incomplete. What is missing from this short list is a third inevitable occurrence – tax law changes. We now have a new and pressing series of proposed tax law changes with the “Build Back Better Act” (the “Act”) that is winding its way through the legislative process in Washington D.C. There will likely be many changes to current proposals before and if they become law. LP's Trust & Estates Group offer a few thoughts for you to consider (and take action as appropriate) on proposed changes in the estate, gift, and generation-skipping transfer taxes, income taxes, and the taxation of retirement accounts.

The proposed effective dates of the separate provisions of the Act vary – the date of introduction (September 13, 2021), the date of enactment of the Act, after December 31, 2021, or later. We will not know the actual effective date of any provision of the Act until (and if) an actual bill is passed. What is done is done, but we can plan for what is to come. And no matter what the law or the changes in the law, undone planning is a burden we can resolve when we take action.

Gift and estate planning. There are several proposed modifications to the current estate, gift, and generation-skipping transfer taxes and associated planning strategies with grantor trusts and there are at least three reasons to consider making gifts well before the end of the year.

• Early Sunset. Since 2017, we have enjoyed historically high gift, estate, and generation-skipping transfer tax exclusions ($11,700,000 in 2021), knowing that these exclusions are scheduled to sunset at the end of 2025. The Act would move the sunset date to the end of this year, reverting to a $5,000,000 exclusion, adjusted for inflation, after December 31, 2021.
• Valuation Discounts. Valuation discounts are a means of leveraging the gift and estate tax exclusion and are commonly used with gifts of interests in entities such as limited liability companies and limited partnerships, outright or in trust. The Act would limit the use of valuation discounts to active trades or businesses and would generally not be available for nonbusiness assets, meaning passive assets held for the production of income, with limited exceptions for assets used in hedging transactions and working capital. The new rules would look through entities to underlying investments. This change would be effective after the date of enactment of the Act (not the end of the year), which could be any time before the end of the year.
• Irrevocable Grantor Trusts. Irrevocable trusts of which the grantor is treated as the owner for income tax purposes, commonly referred to as grantor trusts, and transactions with grantor trusts are used in gift planning to reduce one’s taxable estate at death – Grantor Retained Annuity Trusts, Spousal Lifetime Access Trusts, Irrevocable Life Insurance Trusts, and sales to grantor trusts. The Act would add two entirely new provisions to the Internal Revenue Code that would cause:
  • grantor trusts, whether revocable or irrevocable, to be brought back into the decedent’s estate at death;
  • sales between an irrevocable grantor trust and the grantor to be treated as sales to third parties (triggering gain on appreciated property);
  • exchanges of property between a grantor or an irrevocable grantor trust to trigger gain on appreciated property;
  • distributions from a grantor trust to anyone other than the grantor or the grantor’s spouse to be treated as gifts; and
  • a grantor trust’s ceasing to be a grantor trust to be treated as a gift by the grantor.

In short, the Act would eliminate most, if not all, of the gift planning currently done with irrevocable grantor trusts after the date the Act is enacted (but should not negatively impact existing irrevocable grantor trusts unless future contributions are made to them).

Income tax planning. Next, let’s consider income tax. Income tax is the primary source of Federal revenue. Increases in income taxes are “quick hits,” and they are recurring sources of revenue. Income tax changes affecting individuals and business owners in the Act include the following (effective after December 31, 2021, unless otherwise noted):

• Individual Capital Gain Tax Rate Increase and Wash Sale Rules Expanded. The Act would increase the long-term capital gain tax rate and qualified dividend tax rate from 20% to 25%. This change as proposed would be effective for transactions that have not closed and were not under a binding contract as of the date the legislation was “introduced.” The Act would also expand the wash sale rules, which preclude the sale of stock and other securities at a loss, followed by the purchase of a substantially identical stock. This rule would be expanded to include digital assets, commodities, and currencies.

• Individual Income Tax Rate and Surcharge. The Act would bring back the marginal ordinary income tax rate of 39.6% for married taxpayers filing jointly with taxable income over $450,000, for unmarried individuals with taxable income over $400,000, and for trusts with taxable income over $12,500. The Act would also impose an entirely new surcharge of 3% of modified adjusted gross income in excess of $2,500,000 for married individuals filing separately, $100,000 for trusts and estates, and $5,000,000 for all other taxpayers.

• Net Investment Income Tax. The Act expands the application of the 3.8% net investment income tax, which is a relatively new tax, to include income from a trade or business income of individuals, trusts, and estates. The change would affect married joint return filers with modified adjusted gross income over $500,000, married individuals filing separately with modified adjusted gross income over $250,000, and others with modified adjusted gross income income over $400,000.
• Business Related Income Taxes. Numerous proposed changes would impact business owners, which we will discuss in greater detail in a future article. A few changes of particular note include:
  • Increase in the marginal corporate income tax rate to 26.5%;
  • Limitation on the Section 199A deduction for qualified business income to $500,000 for married joint return filers, $250,000 for married individuals filing separately, $10,000 for trust and estates, and $400,000 for other taxpayers; and
  • Limitation on the capital gain exclusion for qualified small business stock (C-corporations), with a 50% exclusion being available for all taxpayers, but higher exclusions only being available for taxpayers with adjusted gross income of less than $400,000.

Retirement planning. Finally, the proposed changes under the Act affecting traditional and Roth individual retirement accounts and defined contribution accounts such as 401(k) accounts (“retirement accounts”). The changes related to retirement accounts would affect individuals with large retirement account balances and individuals with private equity, hedge, and closely held business assets in their retirement accounts. The proposed changes are numerous and quite technical. We highlight just a few of particular significance:

• Prohibition on contributions to large individual retirement accounts. The Act would prohibit additional contributions to individual retirement accounts for individuals with combined retirement account balances at the end of the prior year in excess of $10 million, but only for high-income taxpayers, including married couples filing jointly with adjusted taxable income over $450,000 and single or married individuals filing separately with taxable income over $400,000.
• Required distributions from large retirement accounts. In addition to the limitation on additional contributions to large retirement accounts, the Act would require increased required minimum distributions from retirement accounts if combined retirement account balances at the end of the prior year exceeded $10 million, with additional distributions requirements if the combined amount exceeded $20 million, but again, only for high-income taxpayers.
• Limitations on investments in retirement accounts. The Act would also preclude investment in private placement private equity and hedge investments in individual retirement accounts and require disinvestment of existing investments. In addition, the Act would preclude individual retirement account investment in a company in which the account owner is an officer or in a business in which the account owner has more than a 10% interest in a private company.

The retirement account-related provisions would generally be effective for tax years beginning after December 31, 2021, with 2-year transition periods for account level reductions and investment changes.

While the Act as proposed is broad and far-reaching, there are a number of notable “omissions” from the Act. The Act would not do away with the basis adjustment to fair market value for assets owned at death, no gain on appreciated assets would be triggered by death, and the Act would not further limit the current scope of tax-favored 1031 like-kind exchanges. All good-news from a wealth planning perspective.

There will be a flurry of activity in the days, weeks, and months ahead. We will not have certainty with respect to the many proposed changes any time soon. To delay planning until there is certainty and finality is not to plan at all, as tax laws change continuously. The time to plan for tomorrow is today.

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