By Charles R. Kennedy, CPA, MBA
Vice President & Director of Tax Services

Tax proposals put forth during presidential campaigns often are watered down significantly by the time they get to the legislative stage, and those favored by President Joe Biden are no exception. That being said, the tax overhaul proposal that recently came out of the House Ways and Means Committee would have significant impacts on estate and gift taxes.

Given Congress’ penchant for late December passage of major tax legislation – the massive Tax Cuts and Jobs Act (TCJA) was passed on December 20, 2017 and took effect 12 days later – high net worth individuals should evaluate their estate plans before the end of this year to guard against negative tax consequences, in the event the proposed tax changes become law.

Major elements of the Democratic tax plan currently being considered in the House include:

• Effective January 1, 2022, the federal gift or estate tax exemption would be reduced to $6 million, from the current level of $11.7 million for a single filer taxpayer. The current higher exemptions, enacted as part of the TCJA, are scheduled to sunset in 2026; the Democratic proposal would accelerate that reduction to 2022.
• The federal generation-skipping transfer tax (GST), which is currently assessed at a flat rate of 40%, would mirror the reduction in the exemption amount.
• Limitation on the use of grantor trusts, which are trusts in which the grantor is the “owner” of the trust for tax purposes. This provision would include in the taxpayer’s gross estate any grantor trust established after the date the law is enacted, thereby making the trust assets subject to federal estate tax upon the grantor’s death. Existing grantor trusts would be grandfathered, but contributions made after enactment would be subject to the new rules.
• A surcharge on high-income individuals, trusts and estates. This provision would impose a tax equal to 3% of the portion of a taxpayer’s modified adjusted gross income over $5 million ($2.5 million for a married individual filing separately). This provision would become effective on January 1, 2022.
• An increase in the highest capital gains tax rate to 25% from the current 20%. It’s important to note the effective date of this provision would be retroactive as the legislation is currently written, though retroactivity could be negotiated away before passage.
• The proposed law would prohibit individual taxpayers with taxable income over $400,000 (and married taxpayers with joint income over $450,000) from converting traditional Individual Retirement Accounts (IRAs) to Roth IRAs. This provision would become effective January 1, 2032. However, effective January 1, 2022, it would also prohibit all taxpayers, regardless of income, from converting after-tax IRA contributions to Roth.

Many taxpayers and advisors are relieved that the Democrats’ plan is silent on the issue of stepped-up basis. President Biden’s campaign tax plan called for elimination of stepped-up basis, which would have subjected inherited assets to immediate taxation for many estates.

High net worth individuals who could potentially be affected by these changes and other provisions of the proposed tax legislation should consider transferring assets before the end of the year in a number of ways, including:

• Establish a trust. Doing this before the enactment of any tax proposals would ensure that a grantor trust continues to be subject to the current favorable tax treatment, rather than the limited treatment under the proposed law.
• Gift assets to family members. Gifting assets now would enable you to take advantage of the higher gift and estate tax exemptions currently in place.
• Make charitable gifts. Consider a more formal charitable giving strategy based on assets held. Donating low-basis assets is still a viable tool. It allows for a deduction at fair market value while eliminating an asset from the estate.

If you would like to have a conversation about preparing for changes in tax laws, please contact us as soon as possible.