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Current as of: May 2021

Proposals call for significant increases on taxes paid by high-net-worth individuals.

The prospects for significant tax policy changes have grown considerably now that the White House and both chambers of Congress are under single-party control. President Biden has made it clear that he wants to overhaul our tax system to make the wealthy pay more taxes. In addition to plans emanating from the White House, Democrats like Senator Bernie Sanders are advancing their own tax proposals to fund new programs.

The tax debate is now beginning to take shape, and it’s important to understand how changes in tax policy may affect income and wealth transfer taxes. To that end, we’ve prepared the following summary of the various proposals and how they differ from current tax laws.

Individual Tax Proposals

Area

Current Law

Proposed

Individual Tax Rate

  • Top marginal rate is 37%.
  • Increase top marginal tax rate to 39.6% for income over $400,000.

Capital Gains

  • Preferential rate for capital gains and qualified dividends of 0, 15, or 20% depending on income level.
  • Remove tax rate preference for capital gains and qualified dividends for income over $1 million by taxing them at ordinary rates.
  • Eliminate the basis step-up at death. Implement carry-over basis at death or impose deemed recognition event at death.

Deductions

  • No limitation on overall itemized deductions.
  • PEASE limitation repealed after TCJA. PEASE reduced itemized deductions by 3% of AGI over a certain threshold, max reduction up to 80% of itemized deductions.
  • State and Local Taxes (SALT) deduction limited to $10,000.
  • Qualified Business Income (Section 199A) Deduction phaseout if taxable income above threshold depending on filing status. If Specified Service Trade or Business (SSTB) additional Wage & Property limitations apply.
  • Limit total itemized deductions to the reduction in tax liability does not exceed a benefit of 28%.
  • Restore 3% PEASE limitation for incomes above $400,000.
  • Return of the SALT deduction (no limitation).
  • Phase out the 20% Qualified Business Income deduction for income over $400,000 (regardless if SSBT).

Social Security Tax

  • 12.4% employer/employee rate applies only up to earnings of $142,800.
  • Expand to apply to income over $400,000.

Retirement

  • Pre-tax contributions allowed for contributions to workplace retirement plans and deductions for contributions to traditional IRAs (subject to income limitations).
  • Replace the deduction for worker contributions to traditional IRAs and defined contribution pensions with a refundable flat tax credit of 26%.

Estate & Gift

  • TCJA doubled the basic Estate & Gift Exclusion Amount & GST exemption. Currently $11,700,000 in 2021. Current top estate tax rate is 40%.
  • Decrease Transfer Tax exemption to $3,500,000.
  • Raise top tax rate to 45%.

Bernie Sanders’ Proposal (99.5 Percent Act) - March 25, 2021

Area

Current Law

Proposed

Estate & Gift

  • TCJA doubled the basic Exclusion Amount & GST exemption. Currently $11,700,000 in 2021. Gift tax has same exclusion amount.
  • Current estate top tax rate of 40%.
  • Estate & GST exemption of $3.5 million indexed for inflation. Gift Tax Exemption of $1 million not indexed for inflation.
  • Rate ranges from 45% (between $3.5 million - $10 million) to 65% (over $1 billion).

Grantor Trusts

  • Assets of grantor trust not included in gross estate at death. Enables use of Intentionally Defective Grantor Trusts taxed to grantor for income tax purposes, but not included in grantor's estate at death.
  • No step-up in basis for property in a grantor trust.
  • Assets in grantor trust are included in taxable gross estate. Distributions from grantor trust during life are taxable gifts and when grantor trust status is turned off, then deemed gift occurs.

Valuation Discounts

  • Appraisals take into account adjustments for lack of marketability, minority & other discounts.
  • "Non-business assets" no valuation discount. Will be an exception for working capital. Lack of Marketability & Minority discounts limited if family members have control or majority ownership.

GRATs

  • Currently can fund a GRAT without using gift tax exception ("zeroed-out GRAT"). No minimum term limit.
  • Minimum 10-year term. Maximum term of life expectancy plus 10 years. Remainder interest not less than greater of 25% of FMV of trust or $500,000.

GST Changes

  • Allocation of GST exemption to dynasty trusts could exempt trust assets from transfer tax for generations.
  • Cap trusts that are GST exempt to a 50-year term. Pre-existing trust deemed "terminated" 50 years after passage of the Act. Effectively requiring distributions at the end of the term to be subject to GST tax.

Annual Gift Exclusion

  • $15,000 per donee. Unlimited annual gifting.
  • $15,000 limit per donee. $30,000 limit per donor. (Beginning January 1, 2022)
  • $30,000 per donor limit applies to only certain transfers (transfer into a trust, transfer an interest in certain family entities, an asset subject to prohibition on sale or an asset that cannot be immediately liquidated).
  • Gifting limit could impact ILITs.

Sensible Taxation and Equity Promotion Act (STEP Act) March 29, 2021 – Close the Stepped-up Basis Loophole

Area

Current Law

Proposed

Inherited Assets

  • Inherited assets receive a basis step-up allowed at death.
  • Unrealized appreciation not subject to capital gains income tax.
  • Taxes unrealized capital gain when heirs inherit.
  • Exclude up to $1 million in unrealized gain.
  • Could be exclusion amount for residence and retirement accounts.
  • Exempt - gifts to charity, spouse, tangible personal property.
  • Similar Grantor trust rule changes as the Sanders Act.
  • Eliminates carryover basis for gifts.
  • Tax on unrealized gain can be paid over 15 years (in case of illiquid assets like a farm or business).
  • Capital gain tax would be a deduction against the estate tax.
  • Non-grantor trusts deemed realization every 21 years on unrealized gain.
  • Changes would be retroactive to January 1, 2021.

Higher income and wealth transfer taxes will clearly be at the center of the tax debate over the next several months. That said, the prospects for sweeping changes in this environment are less certain. Lawmakers will be loath to run the risk of derailing the economic recovery with a large tax hike at this time. And while Democrats control the White House and Congress, their razor-thin majority in the Senate will make it a challenge to push forward with their more ambitious plans.

Still, it’s quite possible that some of the proposals will be taken up as part of a compromise between the two parties. We will continue to monitor developments on the tax front and keep you up to date on how your wealth strategy may be impacted.

For more information, please contact your Key Private Bank Advisor.

Publish Date: May 4, 2021.

Any opinions, projections, or recommendations contained herein are subject to change without notice and are not intended as individual investment advice.

This material is presented for informational purposes only and should not be construed as individual tax or financial advice.

KeyBank does not provide legal advice.

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