Current proposals suggest tax rates will increase for high income taxpayers. In the spirit of reaching an agreement, initial proposals are a wish list likely to change before being finalized, but our goal is to keep you - as our client - abreast on those proposals as we continue to work with your family to review planning opportunities related to your portfolio and estate. The success of this communication lies not in predicting the final changes, but instead in prompting productive conversations with your team here in advance of tax changes being enacted. To discuss how potential changes may affect your individual case, please reach out to a member of your team.
HIGHLIGHTED PROPOSED CHANGES
- Increase in income tax for high-income individuals (top marginal rate increase from 37% to 39.6%).
- Decrease in the amount of income where the highest marginal tax bracket will apply to align with the pre-TCJA (Tax Cuts and Jobs Act) top bracket adjusted for inflation (for taxable year 2022, the top marginal rate would apply to taxable income over $509,300 for married couples filing jointly and $452,700 for single filers).
- Recent tax credit changes made permanent (Child Tax Credit fully refundable, Earned Income Tax Credit expansion, Child and Dependent Care Tax Credit expansion, Health Insurance Tax Credit).
- Tax capital gains at ordinary income tax rates for filers with AGI over $1 million (currently 37% but would increase to 39.6% under current proposals).
- Gifting of appreciated property would become a capital gains realization event with a $1 million per person exclusion amount.
- The transfer of appreciated property at death would become a capital gains realization event to the estate with a $1 million per person exclusion amount (the exclusion would be portable resulting in a total exclusion of $2 million per couple).
- Deferral of gains from Like-Kind Exchanges (aka 1031 exchanges) would be limited to $500k per person ($1 million per couple).
- Expansion of the 3.8% Net Investment Income Tax (NIIT) to ensure that income from pass through business entities is subject either to Self-Employment Tax or NIIT.
ANITICIPATING CONSEQUENCES & OPPORTUNITIES
One subtle benefit of the proposals is the elongated lower income tax brackets that came with the TCJA are maintained. Higher income taxpayers would see an increase to the new top bracket more quickly. The shift from 35% to 39.6% would occur at $509,300 of taxable income for taxpayers married filing jointly, and $452,700 for single filers. This means the stakes would be raised for income timing strategies related to deferred compensation, options, charitable giving, etc. that could be used to avoid the top bracket.
The greatest immediate impact would be a top capital gains rate of 39.6% (43.4% with the NIIT). Current proposals would only apply this rate to taxpayers whose AGI is above $1 million. Since the test is AGI, perhaps the greatest opportunity is having a multi-year strategy to unwind concentrated or highly appreciated positions would become a greater value add for affected households. Current language in the bill suggests the change in capital gains could be enacted for tax year 2021, however in a scenario where this proposal would be enacted for tax year 2022, the end of this year may be a point of inflection in planning for high income households with large, highly appreciated positions.
The most potential for eventual added tax revenue would be from the proposals related to transfers of appreciated property by death or gift. Currently the gifting of property by an individual or the transfer of property from an estate to a beneficiary would not result in the realization of a capital gain to the individual and/or the estate. This allowed for the possibility of gains being taxed at the lower capital gains rates of the recipient in the case of gifting and allowed for complete avoidance of capital gains tax in the case of transfers at death. Under the proposals these opportunities for tax avoidance for high-net-worth individuals would be dramatically reduced.
The proposals would require recognition of capital gain by an individual who gifts appreciated assets (donor). A lifetime exclusion of $1 million would apply. The basis of the asset in the hands of the recipient of the gift would generally be the FMV of the asset on the date of the gift. However, to the extent no capital gain was recognized at the time of the gift due to the $1 million exclusion, the basis of the asset in the hands of the recipient would be the basis in the asset in the hands of the donor.
The proposals would require recognition of capital gain by an estate for assets transferred at death. An exclusion of $1 million (reduced by any portion of the exemption applied to lifetime gifting) would apply and would be portable in the case of married individuals (i.e. if the first spouse to die would not use their full $1 million exemption their unused portion can be used by the other spouse). The estate would be liable for payment of the tax on such capital gains. The basis of the assets in the hands of the beneficiary(ies) of the estate would be the FMV of the asset on date of death.
The proposals related to the transfer of appreciated assets would become effective for gifts made and/or deaths occurring after December 31, 2021. Therefore, if the proposals are passed there could be potential benefits to the implementation of gifting strategies prior to year-end.
Your TMG team can assist you with the timing of capital gains, reviewing the tax years when you are in a lower capital gains tax bracket (i.e., 0% or 15% rather than 20%), and potentially reducing tax exposure under the current proposals. Even when unable to completely avoid capital gains taxes, recognition in a lower bracket tax year provides a meaningful benefit relative to recognition at the 39.6% tax rate or deferring highly appreciated assets to an heir for recognition. Previously unrealized gains have not passed to heirs in a taxable event, but, based on the proposed changes this would be a planning issue moving forward.
Death and taxes are generally accepted as life’s certainties. Change is often described as the ‘only constant.’ Not surprisingly in tax regulations, time brings change. Income and estate tax planning opportunities change as policies change. In the last decade alone, TMG has helped clients navigate the Affordable Care Act, the Tax Cuts and Jobs Act, the Secure Act, the Cares Act, as well as financial challenges related to a global pandemic. The rules will change over time, but our role in overseeing and coordinating long term strategy items for clients remains the same during periods of change.
Sources
General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, Department of the Treasury, May 2021: https://home.treasury.gov/system/files/131/General-Explanations-FY2022.pdf
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