Anxiously Awaiting the New Tax Rules

LegislationTax

Oct 7

Written By Mike Mulcahy, CFA® CPWA® CTFA

On September 13, 2021, the House Ways and Means Committee released its tax plan. This is from the Committee and must still go before the entire House, and the Senate has yet to develop its own proposal. Still, the current Committee language does much to solidify the Administration’s position on estate taxes and estate planning strategies. (We wrote about President Biden and Senator Sanders’ proposals earlier this year.)

The current bill would be less damaging to taxable estates than those proposals but definitely makes thoughtful estate planning more important for many. We anxiously await the final bills and rules and anticipate decisions before year-end.

Here are some of the most pertinent proposals from the House Ways and Means Committee.

1. Estate Tax Exemptions would be lowered to $5 million per person.

The current exemptions for estate, gift, and generation-skipping transfers sit at $11.7 million per person (or $23.4 million for married couples). While this was set to be cut in half at the end of 2025, the proposal would essentially accelerate that timeline and reduce the threshold a bit more to around $5 million per person indexed for inflation The effective date would be after December 31, 2021.

On the positive side, there are some protections for farming or other business ownerships that protect these entities from disruptions due to estate taxes.

2. Grantor Trusts could be included in Grantor’s estate.

This is a significant change as many estate planning techniques might be included in the Grantor’s taxable estate if the Grantor remains the deemed owner for trust income tax purposes at the time of death. This includes Grantor Retained Annuity Trusts (GRATs), Intentionally Defective Grantor Trusts (IDGTs), Insurance Trusts, and Spousal Limited Access Trusts (SLATs) that are a grantor structure.

Any gifts to existing Trusts after the effective date of the new rule would be includable in the Grantor’s taxable estate.
Sales to the above Trusts with installment notes could be deemed as a transfer by gift, or potentially create a taxable gain for the Grantor.

The timeline is on or after the date of the enactment of the Build Back Better Act. Again, making planning today more imperative.

3. Elimination of some valuation discounts.

Another popular technique for estate planning is the discount for minority ownership and/or lack of marketability for ownership in certain assets like property and family limited partnerships. This bill would eliminate some of these discounts through a new two-step valuation process. This would affect asset transfers made after the date of enactment of the Act.

4. Income Tax Rates to be increased.

The proposal is to increase the top marginal individual income tax rate to 39.6% from 37.0% for single individuals earning over $400,000 and to married couples filing jointly earning over $450,000. The new rate becomes effective January 1, 2022.

5. Capital Gains Rates to be increased.

Capital gains rates would increase to 25% from 20%. And, a 3% surcharge would be imposed on the income of very high-income earners ($5 million or more) and trusts (over $100,000).

The Net Investment Income Tax of 3.8% remains and continues to be applied to married tax filers with AGI over $500,000 ($400,000 for single.)

So, top rate on capital gains could be as high as 25% + 3% + 3.8% = 31.8%.

What is Not Included in the Plan? (Some “Good News”)

There appears to be no change in the estate tax rate, which is 40% today. (Earlier versions had an increase to 45% or more.)

There is no change to the Generation-Skipping Transfer Tax (GSTT). And, the gift tax and estate tax exemptions remain unified.

No changes in the annual gift tax exclusion are being proposed. (Earlier versions had major changes.)

Bottom Line

If you are planning on utilizing many of the current tools, immediate action may be necessary to form and fully fund any trusts being created. However, we still don’t know for certain if this proposal will ever become and remain law. This makes drafting new trust documents challenging. We will stay vigilant and attentive as final legislation is shaped.

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Mike Mulcahy, CFA® CPWA® CTFA

With the founding of Kings Path Partners, Mike brings a diverse set of professional and personal experiences into the wealth services business. His professional roles and community experiences give him a unique and real perspective into the needs of families, entrepreneurs, and business executives. Previous roles include president of a $6B investment management firm; management consultant with McKinsey & Company; VP of corporate finance & strategy with Compaq/HP; and managing director of an entrepreneurial web-based business. He is also an active venture investor with a focus on impact investing and social enterprises.

Mike earned an MBA from the Harvard Graduate School of Business and completed an Executive Program in Portfolio Management at the University of Chicago. He graduated summa cum laude with a Bachelor of Science in Economics with a minor in Chemistry from Texas A&M University. He holds designations as a Certified Private Wealth Adviser®, Chartered Financial Analyst®, and Certified Trust and Fiduciary Advisor (CTFA). He is a member of the Investments & Wealth Institute® and the CFA Society of Houston.

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