President Biden has proposed a $6 trillion 2021-2022 Federal budget which includes his proposed infrastructure and American Families Plan. This is by far the largest Federal budget in history. In order to pay for it, the President has proposed Federal corporate and individual and estate tax changes which allegedly impacts only big business and wealthy individuals and families but may affect others both directly and indirectly. While it can be expected that Congress will change many of the proposals and
the substance and timing of these changes is uncertain, the major proposals being considered would significantly alter the tax landscape and how certain Americans should approach tax planning. For corporations, the principal change is to increase the tax rate from 21% currently to 28% and to provide a minimum 15% tax on “book income”. This article will focus on the proposed changes for individuals and families.
The individual income tax proposed change is to increase the top marginal rate from 37% to 39.6% for individuals and head of households earning in excess of $452,700 and married couples filing jointly earning in excess of $509,300. For those with income in excess of $1 million, it is proposed that the capital gains tax on assets held for more than one year and the tax on qualified dividends be increased from a potential high rate of 23.8% currently to 39.6% which means 43.4% when the 3.8% tax on investment income which is part of the Affordable Care Act is included.
For estates the significant proposed changes include reducing the unified credit and the exemption for generation skipping transfers (GST) from $11.7 million currently ($23.4 million for married couples) to $3.5 million ($7 million for married couples). The current credit was scheduled to be cut in half in 2026 anyway. It is also proposed to eliminate the “stepped up basis” at death for assets with gains in excess of $1 million. Heirs would inherit their transferor’s basis and therefore incur a higher capital gains rate upon sale. The estate tax rate itself would increase to 45% from 40% for assets in excess of $3.5 million and increase to 50% for assets above $10 million, 55% for assets above $50 million and 65% for assets above $1 billion. The exemption for lifetime gifts would revert to $1 million.
For individuals and families affected by the above proposed tax increases, it is important that they consider taking actions in 2021 which may mitigate the effect of the significant proposed changes. For business owners contemplating retirement or sales of their business, accelerating the timing of those transactions could be crucial. Otherwise, business owners should consider “installment” sales to spread the impact of future tax increases over many years and possibly keep the income level in any one year below the above thresholds. Individual taxpayers might wish to defer certain tax deductible expenditures such as charitable contributions and accelerate deferred compensation to the current year. Taxpayers may benefit from converting traditional IRA’s to Roth IRA’s in 2021 rather than waiting. Owners of real estate that has appreciated in value should consider 1031 exchanges in 2021 before the proposed limit of $500,000 in the proposed tax changes takes effect.
In 2021 a taxpayer can gift $15,000 to an unlimited number of people each year with no gift tax consequences, no tax filing requirements and no impact on the taxpayer’s lifetime exemption. The amount is doubled for married individuals. In addition, such taxpayer can pay medical and certain educational expenses of each recipient. Under the proposed tax changes, the limit would be reduced to $10,000 and there will be a $20,000 limit for all gifts made in trust or involving family entities, restricted property or certain illiquid assets. These limits may affect irrevocable life insurance trusts (ILITs) and taxpayers should consider pre-funding future premiums in 2021 even if the amounts affect the taxpayer’s lifetime exemption and trigger a gift tax filing requirement.
Currently, the value of gifts of interests in family-owned entities, such as limited partnerships and limited liability companies, can be discounted for tax purposes under certain circumstances. These discounts are based on the lack of marketability and lack of control of minority interests and can range from 5% to 40% of the pro rata value of the entity. The potential new rules would take away these discounts for any non-business holdings of an entity. While active businesses could still be discounted, cash, marketable securities and certain other assets would be valued at their direct fair market value despite being held within a separate entity. For families owning entities with non-business assets, now may be the time to complete gifts of minority interests in the entities.
Currently taxpayers may utilize certain Grantor trusts to remove assets from their estates while retaining a current interest in the income generated and reporting that income on their personal income tax returns. So long as the taxpayer’s interest in the income ceases prior to their death, the assets will not be included in the taxpayer’s estate for Federal estate tax purposes and any appreciation in the value of the assets will pass to the taxpayer’s heirs free of Federal estate tax. Under the 2021 tax proposals these trusts must last for a minimum of 10 years and a minimum of 25% of the amount transferred must be treated as a current gift..
The information contained above has been prepared by the Law Offices of Lawrence Pohly for general informational purposes and is not intended to constitute a legal opinion or provide legal advice, which is provided only to clients of the Firm who have a retainer relationship with the Firm. The Law Offices of Lawrence Pohly disclaims all liability to any person who relies to their detriment on the information contained herein. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication (including any attachments), unless otherwise specifically stated, was not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any matters addressed herein.