In 2020, we provided a three-part newsletter series on “The Perfect Storm for Advanced Estate Planning.” The convergence of three significant variables made that time an incredible opportunity for more advanced estate planning. The three variables included historically low interest rates, relatively low and/or volatile asset values, and an expectation of higher taxation on the horizon.
Then, in November 2020, we provided an unofficial part 4 to the Perfect Storm newsletter series on “How to Best Use the Temporarily Doubled Exemptions from the Wealth Transfer Taxes.” As we stated then, of the three significant variables of the Perfect Storm, the most important to clients had proven to be the risk that the exemptions from the wealth transfer taxes (including the gift, estate and generation skipping transfer taxes) would likely be cut in half as soon as January 1, 2022. As a result, the November 2020 newsletter set out the options for using the temporary portion of the wealth transfer tax exemptions before they evaporated.
Now, even more radical Federal tax law changes are being proposed by both President Biden and various members of Congress. The purpose of this unofficial part 5 to the Perfect Storm Newsletter series is to provide a listing of the most significant tax law changes being proposed from an estate planner’s perspective and a discussion of what you should consider doing NOW to combat these proposed changes. As they say, the only constant in life is change. So, lets get prepared.
I. Federal Tax Law Proposals
The Federal tax law proposals of most interest include: (i) President Biden’s “Made in America Tax Plan”; (ii) Senator Sanders’ “For The 99.5% Act”; (iii) the “Sensible Taxation and Equity Promotion Act of 2021” (STEP Act) introduced by Senators Van Hollen, Booker, Sanders, Whitehouse, and Warren; and the Treasury Department’s explanations of the Biden administration’s fiscal year 2022 revenue proposals (commonly known as the “Green Book”). When I first heard about these various proposals, I did not take them seriously. I figured President Biden would try to undo much of the 2017 Tax Act, but this did not seem too concerning since these provisions had not been around long and they were already set to expire in any case as of January 1, 2026. In addition, I did not think that the newer, much more radical proposals, had much chance of enactment. However, when I started digging deeper, I learned that many very bright and experienced professionals were taking these proposals very seriously, and I needed to start doing the same. My goal with this newsletter is to give you the basic understanding you need so you can decide if you should seek individualized guidance to help minimize the negative impact of these proposed changes.
II. The Basis for Change
While some of the spending proposals have other purposes, I believe the primary driver as to the tax law proposals is to help reverse wealth inequality and to help prevent the concentration of wealth in the hands of the relatively few. In other words, I believe public policy is driving most of the revenue raising proposals rather than the simple need to raise tax revenues.
If you want to learn more about why the Democrats feel the urge to act so forcefully about these issues, read the recent book written by Chuck Collins, entitled “The Wealth Hoarders.”
The bottom line is that the Democrats have control of both houses of Congress and the Presidency at least until the next Congressional elections to be held on November 8, 2022. These elections will involve all 435 seats in the US House of Representatives and 34 of the 100 seats in the US Senate. The Democrats understand that no guarantee exists that they will retain control over both houses of Congress after these elections. As a result, the Democrats will try to push through whatever legislation they deem important before this next set of elections.
The Democrats will, however, still need to negotiate with themselves, which is not as easy as it seems. In order to enact any desired legislation, the Democrats will likely need every single Senate Democrat vote. This means that a single Senate Democrat can torpedo any Democrat proposals. It is my understanding that the US Senate has at least 2 moderate Democrats who favor bipartisanship and who will not simply agree to any tax increase they find excessive or to any spending proposal that might significantly increase US government debt. It is for this reason that I believe any tax law changes that get enacted will be tempered somewhat from the current proposals.
As for a possible effective date for such tax law changes, it should be noted that most tax laws become effective on January 1st of the year AFTER the year in which the laws were enacted. As a result, the most likely effective date for most (but not necessarily all) of the proposed tax law changes is January 1, 2022, and the second most likely effective date is January 1, 2023. Of course, some changes may have an effective date beginning with the date of enactment or an earlier date.
III. Specific Federal Tax Law Proposals
The proposed tax law changes are numerous, so I will try to touch on the ones I find most important to estate planners.
A. Estate Planning Related Taxes (Gift, Estate, & GST taxes and related income taxes)
- The Basic Exclusion Amount (BEA) is the name of the exemption from the unified gift and estate taxes. The BEA is currently $10 million (indexed for inflation) and is set to return to $5 million indexed for inflation on January 1, 2026. The current proposal is to reduce the BEA to either $5 million (indexed for inflation) or $3.5 million (without indexing). Proposals also exist to decouple the gift and estate taxes so that the gift tax exemption amount is reduced to $1 million. Presumably, but not necessarily, the GST tax exemption amount would end up as the same figure Congress decides to use for the estate tax exemption.
- Step-up in income tax basis at death is on the chopping block. Proposals eliminate the step-up benefit at death, but some amount of basis ($1 million for an individual and $2 million for a married couple) may be given to allocate to appreciated assets at death. At least one proposal simply caries over the decedent’s tax basis in assets to the beneficiaries. Other proposals change death into an income taxable event, so that any capital gain is recognized at death (with some exceptions for transfers to a spouse or to charity, and some relief given for closely held business interests). The common belief is that the more radical taxation at death proposal is really a negotiation ploy added to make other options that would result in ending the step up in income tax basis at death appear more attractive by comparison. In any case, these proposals are a very big deal.
- Gifts as income taxable events. Biden is proposing that gifts made during life and transfers at death should be treated as income taxable events, along with the ability to allocate basis and exceptions as discussed in the preceding paragraph. This proposal is an even bigger deal, as it fundamentally changes how our tax laws work.
- Contributions to and distributions from various types of business entities and trusts will be treated as income taxable events. This proposal makes me speechless! These changes would not only change how our tax laws work, but it may also act as a massive wet blanket on our economy as it strikes at how business entities have historically been funded and used.
- Income taxation on previously untaxed appreciation. President Biden is proposing that any untaxed gain in assets owned in trusts should be subject to income tax (presumably based on a deemed sale theory) every 90 years of a trust’s existence, with the clock starting on January 1, 1940, so that the first deemed sale events are to take place for the oldest trusts in 2030.
- Further proposals attempt to eliminate almost everything estate planners do for their clients today to help them reduce their future wealth transfer taxes and maximize asset protection via trusts. While paragraphs b – e above fundamentally change how our tax laws have historically worked, these provisions set out to stop all the beneficial types of planning done today under our existing laws. These changes will effectively: (i) end the wealth transfer tax benefits and flexibility provided by a grantor trust (this is a very big deal as grantor trusts are the swiss army knife used in most estate planning strategies today); (ii) may prevent trusts from providing asset protection and control benefits for as long as state law would otherwise provide (possibly as short as 50 years); and (iii) statutorily based strategies, like Grantor Retained Annuity Trusts (GRATs), would no longer be viable.
B. Personal Income Tax Related (but generally not applicable to families with an annual income below $400,000)
- Increase top rate on ordinary income from 37% to 39.6%.
- The top long-term capital gain rate is to be the same as the top ordinary income tax rate for those with income for the year above $1 million.
- Itemized deductions would go back to being limited.
- Eliminate Section 1031 like-kind exchanges, which are used to defer gain on sales of interests in real property, to the extent the taxable income for the year exceeds $1 million for a married couple ($500,000 for an individual).
- Require payment of the Social Security employment taxes (12.4% total tax with employer and employee paying one-half each or self- employed individuals paying the full increase) on compensation (or self-employment) income above $400,000.
- S corporation (and LLC / partnership) employee owners would be prohibited from differentiating between compensation and profits to avoid application of social security taxes (or self-employment taxes) on profits.
- Carried interests (really profits interests in partnership taxed entities) received in return for services rendered (or to be rendered) would be taxed as compensation income rather than as capital gain for partners who have taxable income for the tax year greater than $400,000.
C. Corporate Income Tax Related
- Increase top income tax rate from 21% to 28%.
- Create a 15% Alternative Minimum Tax on book (accounting) income of larger corporations.
- Change laws as to taxing foreign income of US multi-national corporations to try to prevent shifting of income to low tax foreign jurisdictions, including working with other countries to create a worldwide minimum tax.
D. Improve Tax Compliance
- Provide significantly more funding to the Internal Revenue Service (IRS). The IRS has been strangled financially for too long, and as a result, it is no longer able to ensure proper voluntary tax compliance or provide a decent level of customer (taxpayer) service. Lack of enforcement of existing tax laws means that there is a tax gap between the revenue the government should be receiving under those laws and what it actually receives; this gap has become extremely large.
- More third-party information reporting will be required to increase tax compliance.
- More funds will be provided to help bring IRS technology into the current century so that more can be done automatically and with the assistance of artificial intelligence (AI).
- The combination of the above will permit the IRS personnel to spend more of their time on significant areas of tax compliance and tax evasion.
IV. What Should You Consider Doing Now?
Now that you can see that potentially significant tax changes are on their way, the questions are who should act, when should you act and what should be done?
A. Who should act?
As discussed in our prior Perfect Storm newsletters, you clearly need to act to take advantage of the temporary portion of the BEA and GST tax exemptions if you are likely to have an estate tax liability and you will be comfortable gifting the necessary assets in some manner to accomplish this objective. We have found that couples with at least $30 million (or individuals with at least $20 million) in wealth should fully undertake this planning. For couples with between $10 million to somewhat less than $30 million (or individuals with between $10 million to somewhat below $20 million) in wealth, significant planning should be considered, but you may not take full advantage of your temporary BEA and GST tax exemption amounts.
Of course, most couples and individuals have wealth well below these levels. What should they consider doing? The answer is that they may want to act now to take advantage of planning that may end up getting shut down with new legislation, such as gifting to a grantor trust. The hope is that any such planning will end up getting grandfathered, which could be a potentially significant benefit over the long haul. In addition, those that will need to gift to an existing trust to pay life insurance premiums or otherwise in the future should consider making large gifts to that trust now so that the assets will be available to cover part or all such future obligations and the need to make future gifts will be reduced or eliminated.
B. When should you act?
This answer to this question is simple: now! While the effective date of any such changes may end up being sometime after January 1, 2022, it is not worth taking this risk.
C. What should be done?
- As for taxable gifting strategies to partially or fully use the temporary portion of your wealth transfer tax exemptions, please see our unofficial part 4 to the Perfect Storm Newsletter series on “How to Best Use the Temporarily Doubled Exemptions from the Wealth Transfer Taxes.”
- For those that do not have sufficient wealth to comfortably gift enough to partially or fully use the temporary portion of your wealth transfer tax exemptions, you should consider making additional gifts to an existing grantor trust (to cover any future obligations to pay life insurance premiums or otherwise, or just to have more assets in a potentially grandfathered grantor trust) or you should create a new grantor trust in which to transfer taxable gifts of some amount. The hope is that any new trust and the transfers made to it before the effective date of any such change in the tax law should end up being grandfathered and subject to existing tax law, at least to some extent.
- Use strategies that the proposed tax law changes seek to end. For example, sell assets to a grantor trust or create and fund a longer term, zeroed out GRAT. Lots of options exist since the current proposals intend to shut down most or all currently acceptable estate and tax planning strategies.
- What type of trust should be used for current gifting purposes? The answer is a grantor trust with maximum flexibility built into its terms so that the technically legal gifts feel practically like not much was given away. Grantor trusts are invisible for income tax purposes, so you can transact with your trust without it having any income tax effects. These types of trusts have different names, which include Family Gifting Trusts (FGTs), Spousal Limited Access Trusts (SLATs), Irrevocable Life Insurance Trusts (ILITs), Domestic Asset Protection Trusts (DAPTs), and Hybrid DAPTs (FGTs that can later turn into DAPTs). Each of these trusts is set up somewhat differently, with some more flexible than others.
D. Consider planning to reduce risk of a retroactive effective date.
Some of the current tax law proposals state that they will become effective, at least to some extent, retroactively to January 1, 2021 or to some other date on or before the date of enactment or the following January 1st. As a result, a risk exists that a transaction that does not cause a tax liability could end up causing one after the fact. While not likely based on prior Congressional history, retroactive taxation remains a potential risk that needs to be considered. While no perfect strategies exist to avoid this risk altogether, one or more alternatives do exist that should significantly reduce any such risk.
Bottom line: The proposed tax law changes should be taken seriously and the time to act is now if you are at risk of owing estate taxes based on an exempt amount as low as $3.5 million (single person) or $7 million (married couple). Even if you are not comfortable making significant taxable gifts now, you may still want to make gifts to a flexible grantor trust now to hopefully achieve grandfathered status, which could provide significant benefits down the road. Finally, for those with obligations in existing irrevocable trusts (such as those that own life insurance policies), the time is now to gift the amount that may be needed to partially or fully fund these future obligations.
If you would like to learn more about this important and timely topic, please call our offices at (678) 720-0750 or e-mail us at firstname.lastname@example.org to schedule an estate planning consultation to discuss your particular situation.
 These 2 moderate Senate Democrats include Joe Manchin of West VA and Kyrsten Sinema of Arizona. It is my understanding that their ideology would fit well within the group known as the “Blue Dog Coalition” that is in the House of Representatives.
 The reason for limiting the gift tax exemption to $1 million is to limit planning opportunities to reduce potential estate taxes at death. It is not clear if this figure will be indexed for inflation.
 The step-up in income tax basis is really a change in the tax basis of assets (up or down) to their date of death value (or the alternative valuation date value in some situations).
At this point, the 3.8% Net Investment Income Tax (NIIT) would still apply, so the highest capital gain rate would go from 23.8% (20% + 3.8% NIIT) to 43.4% (39.6% to 3.8% NIIT).
 This could be a significant tax increase on those earning incomes above the $400,000 threshold. Currently, Social Security taxes are only paid on income up to a certain amount (which is $142,800 for 2021).