October 25, 2021
By: Tim Moll , Lyzz Smith , and Hunter Traynor, Rembolt Ludtke LLP
If you have paid any attention to the news lately, you have likely heard talk of the legislative gymnastics at play in Washington D.C. Legislators have been in an ongoing stalemate over four major legislative items: stopgap funding, the debt ceiling, a bipartisan infrastructure package, and the Democrats’ $3.5 trillion reconciliation bill. The last of those items includes significant tax changes that would impact estate planning, family businesses, corporations, and more. The situation is fast-evolving and proposals could change, but this article summarizes some of the most likely changes.
In September, the House Ways and Means Committee released their proposed changes (the “Proposal”) which were then sent to the Senate for approval. Two moderate Democratic senators then stalled negotiations, urging less government spending. Despite this stall, the changes described below appear to be congressional Democrats’ top tax priorities.
Estate and Gift Tax :
The current estate and gift tax exemption is $11.7 million per person. This means you can transfer assets worth $11.7 million during life or at death before incurring federal estate tax. Currently, this exemption is set to revert to $5 million (indexed for inflation) in 2026. Under the Proposal, this exemption would revert in 2022 rather than 2026. So, starting on January 1, 2022, the estate and gift tax exemption would be approximately $6 million instead of $11.7 million. In addition, the Proposal eliminates the favorable tax status of Intentionally Defective Grantor Trusts, limits the use of Grantor Retained Annuity Trusts, and restricts the use of valuation discounts on transfers of nonbusiness assets. These final changes could take effect as early as the enactment date of the Proposal. On the positive side, the Proposal does include some changes which would expand the availability of special use valuation for real estate used in farming or a family business.
Tax Rates :
Under the Proposal, the corporate tax rate would no longer be a flat 21%. Rather, the first $400,000 of corporate taxable income would be taxed at 18%, the next $4.6 million would be taxed at 21%, and earnings over $5 million would be taxed at 26.5%. For corporations with earnings under $400,000, this change would represent a small decrease in the applicable tax rate. For individuals, the Proposal would increase the top rate from 37% to 39.6% beginning at $450,000 for married couples and $400,000 for single filers. That said, if your taxable income is over $500,000 for married couples ($400,000 for singles), then the extra 3.8% net investment income tax would apply to all of your business income above those thresholds, resulting in a higher effective rate. Also, taxpayers with annual income over $5 million would pay an additional 3% surtax. The top capital gains rate would increase from 20% to 25%. However, taxpayers would also owe the 3.8% net investment income tax, so it would effectively be a top rate of 28.8%. These changes would all be effective for tax years beginning after January 1, 2022.
Business Deductions/Losses :
The Section 199A qualified business income deduction would be limited to $400,000 for singles, $500,000 for married couples, and $10,000 for trusts and estates. Currently, a taxpayer can only deduct up to $500,000 of business losses (indexed to inflation) to offset wages or other income in any year, and the excess is carried forward as a net operating loss. Under the Proposal, this limitation will be made permanent.
Retirement Plan Changes :
The Proposal would prohibit annual contributions to retirements plans if a taxpayer’s total retirement plan balances exceed $10 million. In addition, taxpayers with retirement plan balances in excess of $10 million would be required to take accelerated required distributions to reduce the balance to $10 million. The Proposal would also eliminate so-called “back door” Roth conversions where a taxpayer makes a taxable contribution to a traditional IRA and then converts to a Roth. The Proposal also further restricts the use of IRA funds for investments in which the IRA owner has an interest.
What’s Not in the Proposal :
President Biden had originally proposed a number of additional changes which are NOT included in the Proposal. The Proposal does not include any changes to the step-up in basis rules applicable at death, does not impose a transfer tax on the transfer of appreciated assets by gift or at death, does not impose self-employment tax on earnings over $400,000, and does not make any changes to the rules for like kind exchanges of real estate.
All of the above items are just proposals at this point. Nothing has been enacted into law and there are ongoing negotiations about all aspects of the Proposal. Nonetheless, it is important for you to be prepared if any of these changes could adversely impact you. It may be necessary to take some precautionary steps now. Please contact us if you have questions or concerns or would like to talk through some planning options. We will continue to closely monitor these developments and will post updates to our website www.remboltlawfirm.com.
