Are You Prepared If The Tax Laws Change?
You have likely heard by now that President Biden has offered various suggestions and proposals to make changes to the tax code. This communication will not only discuss some of the proposals that are on the table, it will discuss why you should consider talking to your estate planning and tax professionals sooner, rather than later, if these proposals are likely to impact you.
Much of the tax law revisions are derived from a desire to increase tax revenue. This should not come as a surprise considering the unprecedented spending since the emergence of COVID-19 in March, 2020 and the proposed additional spending on the horizon. The U.S. national debt was $23.3 trillion dollars as of February, 2020. Since then, Congress passed several COVID relief bills, including the CARES Act ($2.2 trillion), COVID-19 Economic Relief Bill ($900 billion), FY 2021 Omnibus Appropriations Bill ($1.4 trillion) to fund pandemic aid and federal agency operations, and the American Rescue Plan ($1.9 trillion). One year later, the national debt has ballooned to nearly $28 trillion.1
In addition to the above-mentioned spending on COVID relief, President Biden has proposed “once in a generation investments” of $2.3 trillion for the American Jobs Plan and $1.8 trillion for the American Families Plan. It has been suggested that an increase in tax revenue will pay for the infrastructure improvements as well as the social and economic initiatives outlined in these proposals. It is worth mentioning there is opposition from some within the President’s own party, specifically Senators Joe Manchin and Kyrsten Sinema, in a Senate divided down party lines with a one vote margin. Some view the President’s proposals as reaching for the sky in the hope of compromise. Others suggest opposition to the President’s proposals will mount as labor shortages persist, inflation expectations rise, and sectors of the economy reach pre-pandemic levels. In short, it is still too early to know which, if any, of the President’s proposals are likely to become a reality. Negotiations are already underway in the hopes of a bi-partisan agreement.
What we do know is estate planning professionals, accountants, and valuation experts have seen a flood of activity from those who are seeking to take advantage of the current tax environment. A number of these professionals have recently shared they anticipate an inability to meet the demand if folks wait until the fourth quarter of the year to revise their estate plans, gift a portion of their family business, or make other strategic tax mitigation decisions.
We will continue to monitor the proposed tax law changes and will update this communication when there is more clarity. In the interim, it is encouraged that you speak with an estate attorney sooner rather than later if you believe you would be impacted by a reduction in the estate and gift tax exemptions. We have heard estate planning departments of law firms are already becoming very busy and waiting until the end of the year may not allow sufficient time for new estate documents to be prepared. Transactions involving a family business will likely require coordination with tax and appraisal professionals. Appraisers have already been in high demand and valuations can take up to several months with the prolific acquisition activity in the market today.
A few of the more notable proposals under consideration are summarized below:
Increase In The Corporate Tax Rate:
In addition to the intent to repeal portions of the 2017 Tax Cut and Jobs Act (TCJA), it has been proposed the corporate income tax rate be increased from 21% to 28% and that a new 15% minimum tax be imposed on the book income of large corporations with over $100 million of book income. According to the Tax Foundation, an increase in the corporate tax rate to 28% would raise the U.S. federal-state combined tax rate to 32.34%, said to be the highest among most countries with democratic free market economies. There are a number of Senate Democrats who believe 28% is too high and would support an increase to 25%.
Increase In The Individual Income Tax Rate:
The federal tax brackets for 2021 are as follows with a top individual income tax rate of 37%.
Tax Rate Taxable Income Taxable Income
(Single) (Married Filing Joint)
|10%||Up to $9,950||Up to $19,900|
|12%||$9,951 to $40,525||$19,901 to $81,050|
|22%||$40,526 to $86,375||$81,501 to $172,750|
|24%||$86,376 to $164,925||$172,751 to $329,850|
|32%||$164,926 to $209,425||$329,851 to $418,850|
|35%||$209,426 to $523,600||$418,851 to $628,300|
|37%||Over $523,600||Over $628,300|
President Biden’s proposed individual income tax rate of 39.6% would apply to individuals with income above $452,700 and married couples with income above $509,300. Essentially this would be a reversion to the top individual income tax rate in place prior to the TCJA. The income that will trigger the highest tax bracket under President Biden’s proposal is lower than the income required to trigger the current top tax bracket. It has been suggested there is likely to be a readjustment of all the tax brackets for 2022 if President Biden’s plan is adopted.
In addition to an adjustment of the tax rates, the Wall Street Journal reported that part of the funding for the American Families Plan would come from a heightened reporting requirement for banks to identify and disclose unreported income. Specifically, banks and peer to peer payment services (Venmo, CashApp, etc.) would be required to report annual account inflows and outflows to the Internal Revenue Service.
Increase In The Long Term Capital Gains Tax Rate:
Long term capital gains apply to an asset that has been held more than one year before it has been disposed of. Assets held for a shorter period of time are generally taxed at ordinary income tax rates. The current federal tax rate on long term capital gains is calculated as follows based on taxable income:
Tax Rate Taxable Income Taxable Income
(Single) (Married Filing Joint)
|0%||Up to $40,400||Up to $80,800|
|15%||$40,401 to $445,850||$80,801 to $501,600|
|20%||Over $445,850||Over $501,600|
|+ 3.8%||Over $200,000||Over $250,000|
In 2021, the maximum long term capital gains rate is 20% plus 3.8% Net Investment Income Tax (NIIT) for a total of 23.8%. Under President Biden’s proposal, the top long term capital gains rate would nearly double to 39.6% plus the 3.8% NIIT for a total of 43.4%. The top rate would apply to those individuals or married couples earning in excess of $1,000,000 of taxable income. Essentially, long term capital gains of those with taxable income of $1,000,000 or more will be taxed at ordinary income tax rates. It has been reported that discussions have been ongoing behind closed doors to negotiate the top long term capital gains rate and the taxable income that would trigger it.
Elimination of Step-up In Basis:
Under current law, when a person dies and leaves property to an heir, the basis of that property is increased to its fair market value. This is referred to as a step-up in basis. When the heir sells the property, the capital gain will be calculated based on the step-up in basis. This operates to reduce the capital gains tax collected on inherited property. President Biden has proposed the step-up in basis be eliminated on the transfer of inherited property.
Decrease In Estate and Gift Tax Exemption:
The TCJA significantly increased the federal estate and lifetime gift tax exemption. For 2021, the estate and lifetime gift tax exemption is unified at $11.7 million per individual or $23.4 million per married couple. The current tax rate on estate assets in excess of the exemption is a flat 40% rate. This increased estate and gift tax exemption is scheduled to expire on December 31, 2025. At that time, the estate and lifetime gift tax exemption would revert back to the pre-TCJA exemption, plus an adjustment for inflation. In 2017, the estate and gift tax exemption was $5.49 million per individual or $10.98 million per married couple. In November, 2019 the IRS issued guidance that it will not claw back gifts made under the increased exemption when the TCJA sunsets on December 31, 2025.
President Biden seeks to reduce the estate and gift tax exemption prior to the December 31, 2025 sunset. There are reports the estate tax exemption could drop to as low as $3.5 million per individual and $7 million per married couple with a top tax rate of 45% on estate assets in excess of the exemption. While this would be a significant change, it is worthy to consider the federal estate tax exemption in 2001 was a mere $675,000 with a top estate tax rate of 55%. An estate tax exemption of $3.5 million per individual would be a reversion to 2009 levels. President Biden has also suggested the estate and gift tax exemptions should no longer be unified. Rather, it has been proposed the gift tax exemption should be $1,000,000; an amount significantly lower than the current unified exemption.
The proposed reduction in the estate and gift tax exemption has resulted in an increase in estate planning activity. For example, owners of a closely held family business may seek to take advantage of the current unified exemption by gifting shares of the business to the next generation or to an irrevocable trust. There is the possibility that a modification of the estate and gift tax exemption could be retroactive to January 1, 2021 if passed this year. However, a retroactive effective date is generally considered to be unlikely.
As discussed above, there is much speculation about which of the President’s proposals could actually be adopted. There is significant opposition from republicans and a few democrats in the Senate. There has been talk that the President may try to push his proposals through in a second reconciliation bill which only requires 50 votes in the Senate with the concurrence of the Vice President. It was generally believed the recently enacted $1.9 trillion-dollar American Rescue Plan would be the only legislation that could be passed through a reconciliation bill in the current fiscal year which ends September 30, 2021. However, on April 5, 2021, the Senate Parliamentarian, Elizabeth MacDonough, ruled a second reconciliation bill could be passed by the Senate in the current fiscal year.
As we continue to monitor the debate of the President’s proposals, we encourage you to consider whether the proposals would impact your current and future plans. If so, it may be worthwhile to schedule a consultation with a legal and tax professional to discuss recommendations that may apply to your situation. A member of our Wealth Management team would be happy to discuss your specific situation and help guide you in the right direction.
EBS is not an accounting or law firm. The foregoing is a general summary and is not intended to apply to all persons and situations. You should contact your tax or legal professional for advice. Please contact a member of the Wealth Management Group to discuss your specific situation.
Data provided has been obtained by third party sources. This data, while believed to be reliable, has not been independently verified by EBS.