On September 13, 2021, the House Ways and Means Committee released a proposed tax bill (House proposal) as part of the Biden administration’s “Build Back Better Act.” The segments of the proposed bill discussed below highlight important changes to the way trusts, estates, and individuals could be taxed. However, it is important to note that this proposed legislation is likely to change (perhaps substantively) before it is finally passed into law.
Gift and Estate Tax Exemption. Under the TCJA signed into law in 2017, the gift, estate, and GST tax exemptions were scheduled to decrease from $11.7 million per person (currently in 2021) to $5 million per person (plus adjustments for inflation) on January 1, 2026. The House proposal accelerates the decreased exemption to take effect January 1, 2022.
Capital Gains Tax Rate Changes. The House proposal increases the top long-term capital gains rate from 20% to 25%, and lowers the threshold for the top capital gains tax bracket. The adjusted capital gains rates and brackets are proposed to be effective retroactively as of September 13, 2021. However, the House proposal also includes a transition rule for any written binding contracts entered into before the September 13 cutoff date.
Income Tax Changes. The House proposal increases the top individual tax rates starting January 1, 2022, from 37% to 39.6%. The House proposal also includes a new surcharge beginning in 2022 for high income individuals, estates, and trusts. The surcharge is equal to 3% of modified adjusted gross income on certain income in excess of: $100,000 for any trust or estate, $2.5 million for a married individual filing separately, and $5 million for every other taxpayer.
Additionally, starting in 2022, the House proposal will extend the reach of the Net Investment Income Tax (NIIT) by subjecting individuals with modified adjusted gross income in excess of $400,000 (unmarried individuals) or $500,000 (married individuals filing jointly) to the NIIT of 3.8%. If a taxpayer’s modified adjusted gross income exceeds the above thresholds, then the NIIT would be applied to the lesser of the net investment income or the amount by which the modified adjusted gross income exceeds the income thresholds.
The House proposal also impacts the Section 199A Deduction that was introduced in the TCJA, which provided a deduction of 20% of income for qualifying business income. This deduction will now be capped for individuals, and practically eliminated for trusts and estates.
Tax Treatment of Grantor Trusts. Major changes to the tax treatment of grantor trusts could be introduced with the passage of this House proposal. In particular, the following changes would be instituted:
- When the deemed owner of a grantor trust dies, the assets in the grantor trust are treated as part of the deemed owner’s gross estate.
- Any distribution from a grantor trust to anyone other than the: a) grantor; b) the grantor’s spouse; or c) to a discharge of debt; will be treated as a taxable gift.
- If a grantor trust ceases to be treated as a grantor trust during the grantor’s life, the assets held in the grantor trust will be treated as a taxable gift made by the grantor.
- Sales between a grantor trust and its deemed owner are treated as a sale between the deemed owner and a third party. Consequently, capital gain must be recognized on the sale of an asset between a grantor trust and its deemed owner. However, capital losses will not be recognized.
- These provisions would apply to grantor trusts created on or after the date of enactment. Existing irrevocable trusts would be grandfathered in, but any additional contributions made to a grandfathered trust after the date of enactment would be subject to the new legislation.
Valuation of Non-Business Assets. According to the House proposal, family entities funded with marketable securities can no longer be appraised at their lowest defensible valuation (resulting in a valuation discount). That approach is reserved only for operating businesses moving forward. Instead, when an interest in an entity is transferred, it must be valued in two steps. First, any “non-business assets” owned by the entity are valued as if they were transferred by the transferor directly; and second, the interest in the entity that is being transferred is valued using the traditional “willing buyer-willing seller analysis,” but the value of the non-business assets are ignored. This new valuation rule applies to transfers made after the Act is enacted.
Qualified Small Business Stock. For taxpayers other than corporations, Section 1202 excludes a significant portion of gain recognized on certain sales or exchanges of Qualified Small Business Stock (QSBS) held for more than five years. Originally drafted to exclude 50% of such gain, the statute was subsequently expanded to exclude 100% of the gain on qualifying sales or transfers of QSBS acquired after September 27, 2010. Under the House proposal, this 100% exclusion rate will not apply to taxpayers with adjusted gross income equal to or greater than $400,000, limiting them instead to the 50% exclusion. As is the case for the proposed capital gains rate, the proposed changes are effective retroactively as of September 13, 2021, and the transition rule above also applies.
As noted, this proposed legislation is still subject to change, however, it appears likely that reforms to estate, gift, and income tax laws will be enacted in the near future. These reforms are unlikely to be more favorable than the current laws. If you have any questions about how these reforms might impact you, or what wealth transfer strategies are available under current law, please reach out to your Duggan Bertsch advisor or contact any member of our Estate Planning Team.