The Tax Cuts Jobs Acts was voted into law in 2017. It had been the most significant tax cut since 2001 when former President George Bush unveiled his tax plan. In 2010, former President Barak Obama allowed many of the cuts expire. Once again with a new president, we are faced with another new proposal. Does it feel like a game of "King of the Mountain?"
We have included the chart below that highlights the proposed changes, as well as unpacking the proposed elimination of the Federal Estate Tax extension, which is particularly impactful to our clients.
Federal Estate Tax Exemption
The current Federal Estate Tax exemption is $11.7MM or $23.4MM per married couple. According to the terms of the TCJA, if the federal estate tax extension is allowed to expire in 2025, the exclusion reverts to what it was prior to passage of the 2017 law: $5 million. Impending legislation suggests this may happen a lot sooner.
In order to lock in the higher estate tax rate, individuals with estates over $5MM (married couples over $10MM) would want to reduce their taxable estate by gifting or donating assets that exceed the $5MM threshold.
Individuals have the ability to accelerate gifting programs now, while the new, higher exemption is still the law of the land. Though related strategies such as grantor-retained annuity trusts (GRATS) and other grantor trusts may come under scrutiny as part of changes in tax law, these are viable means for high net worth individuals to facilitate and accelerate gifting under the currently more favorable climate, especially since the IRS has indicated they are not inclined to institute “clawback” provisions.
For example, a married couple whose estate is currently worth $20MM may consider certain strategies to move $5MM worth of assets out of their name and into those of their heirs this year, thus reducing the tax their estate will pay from $400,000 to $200,000 (at a 40% estate tax rate).
For those with strong philanthropic leanings, consider how charitable lead annuity trusts (CLATs) can fit into your plans, especially now, while interest rates remain at historically low rates. The use of donor-advised funds (DAFs) in connection with charitable giving strategies is also a sound strategy.
It’s a good time to review all your estate planning documents, including wills, trusts, and beneficiary designations for life insurance, annuities, and retirement plans. For those with a high percentage of illiquid assets and estates of $3.5 million or more, consider employing life insurance or other means to ensure adequate liquidity at death for paying any taxes or other transfer expenses that may come due.
Also, there has never been a better time to talk about Roth conversions. Paying taxes at current “discounted” rates may make more sense than continuing to defer and risking much higher tax burdens later. Especially with the loss of the “stretch IRA” as part of the TCJA, eliminating RMDs and converting future potential income from taxable to non-taxed can be valuable, not only for the current owner, but for potential inheritors, as well.
Please see below some of the preliminary proposed changes under consideration.
CURRENT TAX LAW
PRESIDENT BIDEN TAX PROPOSAL
Individual Tax Rate
The 2017 Tax Cuts & Jobs Act (TCJA) reduced the top rate from 39.6% to 37%.
Reverts the top rate to 39.6% for households with taxable income over $400,000.
Long Term Capital Gain (LTCG) and Qualified Dividend Tax Rate
LTCG and qualified dividends are taxed at the top rate of 20%, plus a 3.8% net investment income tax (NIIT) imposed under the Affordable Care Act (ACA).
Raises the top LTCG and qualified dividend tax rate to match the top ordinary income rate of 39.6% for taxpayers with income over $1 million.
Social Security (SS) tax is split evenly between employers and employees. Currently a 12.4% SS tax is imposed on wages up to $142,800. No SS tax is imposed on wages above $142,800.
1. 12.4% SS tax for wages up to $142,800; 2. No SS tax for wages between $142,801 - $400,000; 3. 12.4% SS tax for wages above $400,000. Note: The above parameters apply to the SS tax component of self-employment tax as well.
The 2017 TCJA increased the exemption amount to $11.7 million for 2021. It will revert back to $5 million (to be adjusted for inflation) after 2025. The current estate tax rate is 40%. Assets passed to heirs at death get a basis step-up to fair market value.
Reduces the estate tax exemption amount to $3.5 million, increases estate tax to 45%, and eliminates basis step-up at death. Alternatively, death may become a taxable event by subjecting unrealized capital gains to income tax at death.
The 2017 TCJA capped the State and Local Tax (SALT) and real estate tax deduction to $10,000. It also suspends (through 2025) the 3% limitation on total itemized deductions for high-income taxpayers.
Ends the $10,000 SALT and real estate tax cap, restores the 3% itemized deduction limitation for high-income taxpayers with income above $400,000, caps the tax benefits of itemized deductions to 28% of value (taxpayers in the tax brackets with a tax rate higher than 28% will face limited itemized deductions).
Section 199A Qualified Business Income (QBI) Deduction
The 2017 TCJA allowed a 20% QBI deduction. For higher income taxpayers, the deduction is subject to limitations based on wages and unadjusted basis in depreciable assets.
No change to the QBI deduction for taxpayers with taxable income under $400,000, while phasing the deduction out completely for those with income over $400,000.
A qualified “like-kind” exchange of real property allows the tax deferral of gains.
Eliminates Section 1031 like-kind exchanges for investors with annual income greater than $400,000.
Corporate Income Tax Rate
The 2017 TCJA reduced the corporate tax rate from 35% to 21%.
Raises the corporate tax rate from 21% to 28%.
Corporate Alternative Minimum Tax (AMT)
The 2017 TCJA eliminated the federal AMT for corporations.
Reinstates the corporate AMT in a different form. A 15% minimum tax is imposed on “book” profits of $100 million or higher, still allowing for net operating loss (NOL) and foreign tax credits.
Global Intangible Low Tax Income (GILTI)
10.5% minimum tax is imposed for qualified foreign affiliates of U.S. companies on income earned from intangible assets.
Doubles the minimum tax rate on GILTI from 10.5% to 21%.