September 20, 2021 – On September 13, 2021, the House Ways and Means Committee released a draft legislation that proposes tax increases and tax cuts. It is important to keep in mind that this draft legislation is subject to change as the bill passes through committee markup and as it goes to a vote in Congress.
The proposed tax changes listed below are prioritized by actions that may be taken before the enactment date or year-end. The enactment date is when the bill is signed by the president, and this may be days, weeks, or months away. It may be challenging to implement the suggested planning strategies given the complexity and time frame. Consult your accountant or attorney before acting.
Reduction of estate and lifetime gift exclusion – Effective date 1/1/22.
The basic exclusion will reduce from $11.7mm today to approximately $6mm per individual in 2022.
Planning considerations:
Outright gift to heirs or fund an Irrevocable Trust – Gifting today ensures that the assets are outside of the estate and not subject to the 40% estate tax rate at death. Gifting an amount greater than the $6mm potential exclusion amount and $11.7mm, today’s amount, is beneficial.
Estate tax mitigation strategies of grantor trusts eliminated – Effective date is the enactment date.
Many of the strategies and trust vehicles commonly used for estate tax mitigation purposes may lose effectiveness. This includes GRATs, SLATs, ILITs, IDGTs and all other grantor trusts. Some major implications include: GRAT appreciation passed to a non-spouse will be treated as gift, insurance benefits paid to an ILIT will be included in grantors/deceased’s estate, SLATs and IDGTs will be included in grantor’s estate, sales and substitutions between a grantor and the grantor trust will be treated as realization events.
Grandfather clause – Grantor trusts created before the enactment date will not be subject to the new rules. The proposal stipulates that any additions to the grandfathered trust made after the enactment date will be subject to the new rules.
Planning considerations:
Before the enactment date:
- IDGT – Create and fully fund or complete asset sale.
- SLAT/GRAT – Create and fully fund.
- New and Existing ILITs – Consider creating an ILIT and pre-fund the new or an existing ILIT with future insurance premiums.
IRA investment restriction – Effective for taxable year after 12/31/21.
Investments that require an IRA owner to be an accredited investor will be prohibited. This proposal would be effective for taxable years beginning after December 31, 2021, but with a two-year transition period for investments already held in an IRA as of the date of enactment.
Planning considerations:
If a potential investment requires accreditor status and the duration is expected be longer than 2 years, consider purchasing it outside of the IRA.
Guidance on how to remove existing investments with lock-up periods extending beyond the two-year transition period has yet to be given. Consult with the investment manager.
Restriction on Family LLP discounts – Effective date is the enactment date.
Currently you may gift or transfer minority ownership of a Family LLP at a discount because the partnership interest lacks control or marketability. The discount is available when the Family LLP owns active business interests or passive investments such as stocks, bonds, cash, etc. The proposed tax change would terminate discounting on the portion of the transfer that owns passive investments.
Planning considerations:
Existing Family LLPs – Accelerate transfer of minority stakes that own passive investments.
Family LLP – Consider creating a Family LLP, funding it with passive investments and transferring minority stakes to family members.
Top income tax and capital gains rate increase – Effective 1/1/22 and 9/13/21 respectively.
The top marginal income tax rate will increase from 37% to 39.6% and top capital gains and qualified dividends rate will increase from 20% to 25%. The threshold for when the top rates apply is lowered to $400k for single filers and $450k for married filed jointly.
Planning Considerations:
Convert IRA assets to Roth, take advantage of lower income rates now.
Defer and maximize charitable giving next year. Charitable deductions are worth more in a higher tax rate environment. Donate highly appreciated securities and avoid paying capitals gains tax.
Gift income producing assets such as real estate and highly appreciated securities to family members in a lower tax bracket, this is a form of tax arbitrage.
Accelerate ordinary income realization into this year if possible.
Defer capital losses until 2022 to offset capital gains that would otherwise be taxed at 25%.
It is too late to take advantage of the 20% capital gains rate unless the asset or business were in a binding contract for sale on or before 9/13/21.
Surtax on high income earners and trust income – Effective date 1/1/22.
Married filed jointly and single filers with greater than $5mm in modified adjusted income (MAGI) and trusts with income above $100k will pay an additional 3% tax. Note that capital gains in trusts increase income.
Planning considerations:
Evaluate investments with longer lock-up periods.
Consider installment sales if selling a business.
Evaluate whether opening multiple trusts and funding them with less than a single trust is beneficial. Consult your estate attorney.
Surtax on pass-through entity profits and limitations on QBI deductions – Effective date 1/1/22
The 3.8% surtax, currently known as the net investment income tax, will be expanded to include net income and gain from pass through entities that is not otherwise subject to FICA or SECA tax. Business profits from S corporations, LLCs and LPs will be subject to a 3.8% surtax for taxpayers with MAGI greater than $400k for single filers (S) $500k for married filed jointly (MFJ). Net investment income tax (NIIT) will be applicable regardless of whether the taxpayer materially participates in the business that generated the net income. Qualified business income deductions, also known as Section 199A, will be limited to $400k (S) and $500k (MFJ).
Planning considerations:
Consultant with your accountant to determine an optimal strategy to minimize income taxes.
Qualified small business stock (QSBS) exclusions reduced – Effective date 9/14/2021.
Taxpayers are currently eligible for 75% and 100% exclusions for sales of qualified small business stock (QSBS). The proposal is to eliminate the 75% and 100% exclusion for sales of QSBS that were acquired after 2/17/09 and sold after 9/13/21. The 50% QSBS exclusion would remain.
Planning Considerations:
The 100% exclusion is still available if the sale was in a binding contract on or before 9/13/21 and does not experience any material changes.
The 50% QSBS exclusion remains a valuable tax mitigation tool.
‘Backdoor Roth’ eliminated and Roth conversion restricted – Effective date 1/1/22
Today high-income taxpayers are restricted from contributing directly to a Roth IRA. The ‘back door’ Roth circumvents the direct contribution income threshold and the allows high-income taxpayers to indirectly contribute to the Roth. The proposed legislation eliminates ‘back door’ Roth contributions for all taxpayers.
Pre-tax Roth conversions remain in place for those making less than $400k (S) or $450k (MFJ), measured in Adjustable Taxable Income (ATI). High income taxpayers may make pre-tax Roth conversions if the aggregate value of the taxpayer’s retirement accounts is below $10M. Taxpayers above the income threshold and below the aggregate retirement account threshold will have 10 years to perform Roth conversions.
Planning considerations:
Complete back door Roth conversions before year-end.
Begin Roth conversions this year to take advantage of lower income tax rates.
Consider participating in the employer provided Roth 401(k) if it is available.
Limits on retirement contributions for high earners – Effective date 1/1/22
Taxpayers earning more than $400k (S) or $450k (MFJ) can no longer contribute to traditional IRAs, Roth IRAs, 401(a) plans, 403(a) plans, 403(b) plans, or 457(b) plans. This limitation does not include contributions to employer plans such as 401(k)s, SEPs, SIMPLEs, certain defined benefit plans, rollover IRAs, and accounts acquired by death, divorce, separation from service.
Planning considerations:
Clients who won’t be allowed to contribute to IRAs going forward should contribute before year-end.
Consider adding more to employer plans starting in 2022, if available.
Mega IRAs rules – Effective date 1/1/22
The “Peter Thiel” section of the proposal which mandates required minimum distributions (RMDs) for all taxpayers earning more than $400k (S) or $450k (MFJ) whose total value of applicable retirement plans exceeds $10M. For owners of aggregate applicable retirement accounts worth $10M-$20M, the owner must distribute 50% of excess. For owners of aggregate applicable retirement accounts worth more than $20M, the owner must meet two distribution requirements: (1) distribute the lesser of 100% of the balance over $20M or 100% of the balance in all Roths, and (2) distribute 50% of the excess over $10mm.
Planning considerations:
Clients who are impacted should consult with their CPA to plan for increased income and how to offset it.
Ideas to offset income include itemizing more deductions and increasing charitable gifting.
Disclosures
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