With the passage of the Biden Administration’s COVID-19 relief bill, the focus in Washington, D.C., has shifted to Administration plans for investment in infrastructure and related items and significant tax changes to help pay for that investment. The tax changes are expected to be substantial and far-reaching, and to include corporate, individual and capital gains tax rate increases; international tax changes; and estate and gift tax changes.
Expected Timing of Biden Administration Tax Changes
Congressional committees in the House and Senate are already working on tax and budget proposals that will become part of a second budget reconciliation bill. President Biden’s fiscal year 2022 budget is being released this month. The House and then the Senate will craft and approve a budget resolution to serve as the vehicle for the reconciliation process. Most expect committee action to begin in early May, with ultimate enactment in the fall. Only 51 votes are needed to pass budget reconciliation legislation in the Senate. The effective dates of the newly enacted provisions generally are expected to be Jan. 1, 2022, but certain provisions may have proposed effective dates as early as the date of enactment.
What does all of this have to do with estate planning? Depending on a taxpayer’s specific circumstances, significant tax savings may be achieved by those who anticipate the expected changes and take steps now to take advantage of existing tax provisions and rates. This alert addresses only a fraction of the tax changes expected to be enacted by this fall, with a focus on those changes most relevant to 2021 individual and estate planning opportunities.
Expected Capital Gains and Dividend Tax Rate Increases for High-Income Individuals
Capital gains and dividend tax rates are expected to increase for certain higher-income taxpayers from their current level of 23.8 percent (a 20 percent tax rate plus the 3.8 percent tax on net investment income) to as high as 43.4 percent (the expected higher ordinary income tax rate of 39.6 percent plus the 3.8 percent tax on net investment income). Higher rates are expected to apply to taxpayers with adjusted gross income in excess of $1 million, although that threshold could be as low as income in excess of $400,000. This expected change would tax higher-income individual taxpayers on their long-term capital gains and qualified dividends at the same rate as short-term capital gains and ordinary dividends.
Expected Changes to Existing Timeline for Certain Tax Cuts and Jobs Act Provisions
Many of the provisions of the 2017 Tax Cuts and Jobs Act (TCJA) that currently are scheduled to change or expire in the coming years will be addressed in the budget reconciliation package this fall and, as a result, may change or expire earlier than previously provided.
Securing a Strong Retirement Act Provisions
Many of the items contained in the Ways & Means Committee bipartisan Securing a Strong Retirement Act (e.g., automatic enrollment in company 401(k) plans, increasing the Saver’s Credit, increasing minimum distribution age to 75, allowing student loan pay-downs and employer matching in lieu of 401(k) contributions, increasing allowed contributions by individuals 60 and older) are expected to be included in the fall 2021 budget reconciliation bill or otherwise enacted in 2021.
Expected Individual Income Tax Rate Increases and Changes
For individuals earning more than $400,000, the top marginal income tax rate is expected to return from its current level of 37 percent to the pre-2018 level of 39.6 percent. The Section 199A pass-through deduction, which allows certain pass-through business owners to deduct up to 20 percent of their qualified business income (leading to a current-law marginal rate of 29.6 percent), may be repealed or may become unavailable to taxpayers with income in excess of $400,000.
The $10,000 cap on state and local tax deductions may be repealed and replaced with limitations on itemized deductions (i.e., phaseouts, a 28 percent cap on the value of itemized deductions, etc.) for taxpayers earning in excess of $400,000.
Expected Estate and Gift Tax Increases and Changes
The estate tax and lifetime gift tax exemption (which was temporarily doubled until 2025) is currently $11.7 million per person ($23.4 million for married couples). In addition, there is a $15,000 per donee gift tax exclusion ($30,000 if spouses agree). The current estate tax rate on amounts in excess of the exemption amounts is a flat 40 percent, and the tax basis in inherited assets is “stepped up” to the fair market value upon the death of the decedent. The Biden Administration is expected to seek an increase in the estate tax rate to 45 percent and to reduce the exemption amounts to their pre-TCJA level ($5.3 million per person, $10.6 million for married couples), and some have proposed an even higher tax rate and a lower exemption amount. The tax basis of inherited assets is expected to carry over rather than step up. There is even a proposal in both the House and the Senate to tax capital gains when a gift is made and when a person dies. The portability of exemption amounts between spouses is expected to continue, but many of the planning techniques presently utilized by taxpayers may be curtailed or eliminated entirely.
Expected Additional Clarifications, Details and Changes
As the Administration and congressional committees continue to work on tax and budget proposals, clarifications and details regarding the various proposals will emerge. Some of the initial proposals may be abandoned and revised, or additional proposals may emerge. As soon as the new Administration issues its so-called Green Book, BakerHostetler will prepare additional analysis.