Earlier this year, we outlined some proposed tax law changes that were being discussed in Washington D.C. with the Democratic control of the House, Senate, and White House. Last month, the House released a draft of the Build Back Better Act(the “BBB Act”) that contained many of the proposed changes. However, due to the extreme nature of the tax and spending proposals in the BBB Act, moderate Democrats in both the House and Senate have pushed back against it. It remains unclear which provisions will make it into the final legislation or if additional proposals will be added. What remains clear is that the main targets of the tax proposals are high-wealth and high-income taxpayers.
The biggest income tax changes included in the BBB Act are as follows:
- Replacing the flat corporate income tax with a graduated rate structure that provides for a rate of 18% on the first $400,000 of income, 21% on income up to $5 million, and a rate of 26.5% on income greater than $5 million.
- Amending Section 1202 to provide that the special 75% and 100% exclusion rates for gains realized from certain qualified small business stock will not apply to taxpayers with adjusted gross income equal to or exceeding $400,000.
- Increasing the top marginal individual income tax rate to 39.6% for married individuals filing jointly with taxable income over $450,000, heads of households with taxable income over $425,000, and unmarried individuals with taxable income over $400,000
- Increasing the capital gains rate to 25%.
- Applying the net investment income tax (3.8%) to net investment income derived in the ordinary course of a trade or business for taxpayers with greater than $400,000 in taxable income (single filer) or $500,000 (joint filers).
- Adding a new “surcharge” tax equal to 3% of a taxpayer’s modified adjusted gross income in excess of $5 million.
The effective dates of these provisions include the end of 2021, the date of enactment of the law, and the date the draft legislation was introduced (September 13, 2021), depending on the provision.
With regards to estate and gift taxes, at this point, none of the proposals regarding ending the long-standing practice of assets getting a step up in basis at the owner’s death have made it into draft legislation. However, there are a few provisions included in draft legislation that, if enacted, would dramatically change the estate- and gift-tax planning.
First, the draft of the BBB Act terminates the temporary increase in the unified credit against estate and gift taxes, reverting the credit to its 2010 level of $5,000,000 per individual, indexed for inflation. The temporary increase in the unified credit was scheduled to terminate at the end of 2025, but this provision would terminate it at the end of this year. If enacted, this would reduce the lifetime gift-tax exemption amount from $11.7 million in 2021 to around $6 million for 2022.
Second, the current draft legislation would amend Section 2031 to provide that when a taxpayer transfers nonbusiness assets, those assets should not be afforded a valuation discount for transfer tax purposes. This would effectively end the planning technique of using noncontrolling interests in family investment entities to reduce the value of the underlying assets for estate- and gift-tax purposes.
Finally, and perhaps most importantly, the draft legislation fulfills a long-standing desire of Senator Sanders to change the grantor trust rules so assets in a grantor trust would be included in the estate of the taxpayers to whom the trust income is attributed. If enacted, this provision would effectively end the use of all grantor-trust related techniques used by middle- and high-income families alike. Grantors Retained Annuity Trusts (GRATs), Irrevocable Life insurance Trusts (ILITs), and Intentionally Defective Grantor Trusts (IDGTs) would all be included in the taxpayer’s estate. Sales between the taxpayer and the trust would become taxable transactions, and termination of the grantor-trust status would become a taxable gift. These changes would apply to grantor trusts created after the date of enactment, and transfers after the date of enactment to previously created grantor trusts, so planning accomplished before then would still be effective.
As mentioned above, the wrangling between the moderate and progressive Democrats in Congress last week has created some uncertainty with regard to what will be included in the final legislation and when the legislation will be enacted. In general, trust planning prior to the date the law is signed by President Biden will continue to be effective, so acting quickly on any desired planning is advisable.
If you have any questions about how this potential legislation could affect your current estate plan or if you are interested in making any changes to your plan, please contact us. We are happy to help.