President Biden was able to use the budget reconciliation process to realize the latest COVID-19 relief package. This process is only available once every fiscal year, so lawmakers have to be careful when they use it and what they use it for.
The next fiscal year will start on October 1, 2021, and this opens up the budget reconciliation process for its next use. Many political experts believe that Biden and the Democratic Party will want to use this for major tax reform. Numerous tax changes have been proposed, which we may see implemented by the end of this year. Some new tax laws—if passed—may not go into effect until 2022 or later. Some may actually be retroactive to the beginning of the tax year, which could cause complications for some people and their tax advisors.
Here are 12 of the key tax changes being proposed, and how they may affect you:
1. Reduction of Federal Estate, Gift and Generation-Skipping Tax Exemption
Currently, this tax exemption is set at $11.7 million (for 2021), but it is set to sunset automatically in 2025 per the Tax Cuts and Jobs Act of 2017. However, proposed tax changes could see it reduced even sooner than that, back to the previous maximum amount of $5 million or maybe even as low as $3.5 million (or lower). If you are in a position to use this exemption, you should take advantage of it while it is available.
2. Elimination of Certain Discounting Techniques
For gift and estate tax purposes, many business owners have used discounting strategies to reduce asset values by as much as 30-40%, or more. Examples include Grantor Retained Annuity Trusts (GRATS), Charitable Lead Annuity Trusts (CLATS), Qualified Personal Residence Trusts (QPRTS), and Charitable Remainder Trusts (CRTS). These discounts could be eliminated or altered, which would impact how some business assets are sold or transferred as part of an estate plan.
3. Taxation of IDGTS
Intentionally defective grantor trusts are already subject to income taxes during the lifetime of the grantor, but proposed tax changes could make IDGTS subject to estate taxes for the grantor’s estate, as well.
4. Elimination of the Step-Up Basis
A taxpayer’s unrealized capital gains are not subject to capital gains tax at the time of death. In addition, beneficiaries receive a new basis in those assets based on the market value at the decedent’s time of death. This is known as the adjusted basis, or “step-up” basis when there is an increase in value. We may see a shift back to the old “carryover basis,” where the asset values are not adjusted and unrealized capital gains are subject to capital gains tax as part of the estate.
5. Generation-Skipping Exemption Limitation
The generation-skipping tax (GST) exemption could be limited to a time frame of 50-90 years to prevent tax-free build-up of assets in generation-skipping trusts that can often span multiple generations. This would cause a time limitation for dynastic planning.
6. Reduction of Gift Tax Annual Exclusion
Tax changes could reduce the annual gift tax exclusion from $15,000 per individual (or $30,000 for spouses), to a lower maximum amount.
7. Higher Income Taxes
It is known that President Biden would like to raise the taxes for taxpayers with higher incomes. The current 37% rate might be increased to 39.6% on a graduate scale.
8. Reduction of Income Tax Deduction
Proposed tax changes could cap the benefit derived from income tax deductions, especially for upper-income taxpayers who might currently deduct various losses and expenses.
9. Expanding Social Security Tax
The Social Security tax rate could be increased, again with a focus on high-income earners in the $400,000-plus range.
10. Elimination of IRC Section 1031 Exchanges
Tax-free real estate exchanges under this Internal Revenue Code section could be eliminated, and there be reduced opportunity to offset capital gains through investment in “Opportunity Zones.”
11. Introduction of Annual Wealth Tax
One new proposal is the introduction of an annual wealth tax, with an annual tax liability of 1% of the person’s wealth—based on the assessed value of all assets.
12. Restrictions on IRA Growth
Restrictions could be imposed on IRAs and other retirement accounts, limiting how much they can grow or assessing penalties if they exceed set limits.
Of course, we cannot know which (if any) of these changes might happen. However, it is important to realize that significant tax changes are likely coming. It is important to start planning now for changes coming in the near future. While still possible, you may be able to take advantage of current tax laws that can benefit you, while updating your estate plan and tax plan to better prepare you and your family in light of changes that may be implemented.
For help with your estate plan and tax planning needs, contact me today.
