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Current as of: October 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

Current Law

Previously Proposed

House Ways and Means Committee tax proposal
September 13, 2021

Individual Tax Rate

  • Top marginal rate is 37%.
  • 3.8% surtax on net investment income over applicable threshold.
  • Increase top marginal tax rate to 39.6% for income over $400,000.
  • Top marginal rate of 39.6% (return to pre-TCJA top rate) starting at taxable income of $450,000 (MFJ) and $400,000 (Single)
  • Expand 3.8% net investment income surtax to apply to investment income derived in the ordinary course of business starting at taxable income of $500,000 (MFJ) and $400,000 (Single)
  • 3% surtax for ultra-high earners with MAGI exceeding $5 million (threshold applies to both joint and single).
  • Expansion of Net Investment Income Tax (3.8%Medicare surtax) to S corporation owners if modified adjusted gross income (MAGI) exceeds $500,000 (MFJ) and $400,000 (single) subject to phase-in range.

Capital Gains

  • Preferential rate for capital gains and qualified dividends of 0, 15, or 20% depending on income level.
  • Section 1202 exclusion for qualified small business stock (QSBS) can be 50%, 75%, or 100% depending on when QSBS stock was originally issued.
  • 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.
  • Increase top capital gains tax rate to 25% when taxable income exceeds $450,000 (MFJ) and $400,000 (Single) effective immediately (date of proposals). There may be an exception for sales under a binding contract with certain requirements.
  • Current statutory rate would apply to gains and losses prior to September 13, 2021.
  • Limit Section 1202 exclusion for QSBS to 50% for taxpayers with adjusted gross income of more than $400,000 for sales or exchanges after September 13, 2021. Exception for sale already under a binding contract on September 13, 2021.

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 so the reduction in tax liability does not exceed a benefit of 28%.
  • Restore 3% PEASE limitation.
  • Return of the SALT deduction (no limitation).
  • Phase out the 20% Qualified Business Income deduction for income over $400,000 (regardless if SSBT).
  • Qualified Business income deduction maximum allowable amount capped at $500,000 (MFJ) and $400,000 (Single) regardless of income or SSTB.
  • Does not currently include a repeal of the $10,000 limit on the state and local tax deduction (may be ultimately included or in other legislation).

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 Exclusion Amount & GST exemption. Currently $11,700,000 in 2021. Current top estate tax rate is 40%.
  • Decrease Federal Estate exemption to $3,500,000. Gift exemption of $1,000,000.
  • Raise top tax rate to 45%.
  • Federal exemption reduced to 5 million (inflation adjusted) effective January 1, 2022.
  • No change in estate tax rate.
  • Gift tax exemption reduced to $5 million (inflation adjusted) (same as estate exemption amount).

Wash Sales

  • Current wash sale rules apply to shares of stock or securities.
  • Expansion of wash sale rules to cryptocurrencies (and other digital assets), commodities, and foreign currencies.

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

Current Law

Previously Proposed

House Ways and Means Committee tax proposal
September 13, 2021

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 $3.500,000 million indexed for inflation. Gift Tax Exemption of $1,000,000 million not indexed for inflation.
  • Rate ranges from 45% (between $3.5M - $10M) to 65% (over $1B).
  • See Above

Grantor Trusts

  • Assets of grantor trust not included in gross estate at death. Enables use of Intentionally Defective Grantor Trusts (IDGTs) taxed to grantor for income tax purposes, but not included in grantor's estate at death.
  • Sales between grantor and IDGT do not cause recognition of capital gain.
  • 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.
  • No provision that would eliminate step-up in basis for property in a grantor trust.
  • Asset of IDGTs to be included in grantor's estate at death (impacting many ILITs as well).
  • Sales between the grantor and IDGT will be treated as a third-party sale with gain recognition at the time of sale (effectively eliminating the sale to an IDGT strategy of selling highly appreciating assets in exchange for low-interest rate, no-growth promissory notes.)
  • Transfers out of IDGTs will be treated as taxable gifts.
  • Trusts prior to enactment date will be grandfathered. However, additions to exist IDGTs would be subject to new rules.

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.
  • Minority discounts limited if family members have control or majority ownership.
  • Non-business assets no valuation discounts. Business assets still eligible for discounts.
  • Exception for reasonable amount of cash for working capital, derivatives held for legitimate business purpose, or real estate that is part of an active real estate business in which the transferor materially participates.

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.
  • Upon funding, income tax on excess of FMV of assets over basis and excess value remaining at the end of GRAT term may be considered a gift when distributed.

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.
  • No Deemed termination of GST exempt trust that would subject distribution 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, including transfers into trusts..
  • Gifting limit could impact ILITs.
  • No change to annual gift limit in proposal.

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

Current Law

Previously Proposed

House Ways and Means Committee tax proposal
September 13, 2021

Overview

  • 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 $1M 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.
  • Nongrantor trusts deemed realization every 21 years on unrealized gain.
  • Changes would be retroactive to January 1, 2021.
  • No capital gains tax at death included in proposal.
  • No deemed realization for gifting appreciated assets to nongrantor trusts included in proposal.

Retirement Provisions - Securing a Strong Retirement Act of 2021 (aka SECURE 2.0 Act)

Current Law

Previously Proposed

House Ways and Means Committee tax proposal
September 13, 2021

Required Minimum Distributions

  • SECURE Act increased RMD age from 70 1/2 to age 72 after December 31, 2019.
  • Penalty imposed upon the participant for failing to make a mandatory withdrawal is 50% on any missed RMDs.
  • Increase age to begin RMDs to age 75 over time, Age 72 starting on Jan. 1, 2022, then 74 on Jan1, 2029 and them to age 75 of Jan. 1, 2032
  • Reduced penalty to 25%. If a failure is in an IRA, penalty is reduced to 10% if the error is corrected in a timely manner.
  • Regardless of age - New RMD of 50% of the combined balance over $10 million (and 100% of combined balances over $20 million) for those with both income over $450,000 (MFJ) of $400,000 (Single) and combined retirement account balances over $10 million (mega-sized retirement accounts).
  • New ordering rules for RMDs of high-income earners and mega-sized retirement accounts requiring Roth funds used first to satisfy RMD.

Employer Auto-Enrollment

  • To encourage employers to adopt an automatic enrollment feature for a 401(k) plan, 403(b) plan or SIMPLE IRA plan, the SECURE Act created a new tax credit for employers that established new planes that included automatic enrollment or converted an existing plan to an automatic enrollment design.
  • Require newly established 401(k), 403(b) and SIMPLE plans to automatically enroll eligible workers at a savings rate of 3% of their salary. That contribution increases, unless participant opts out, by 1 percentage point each year until it reaches 10%. Exception for businesses with fewer than 10 employees, which opened fewer than 3 years ago and retirement plans for churches and government agencies. The requirement will not apply to existing 401(k), 403(b) or SIMPLE plans.

Permit Small Financial Incentives for Contribution to a Retirement Account

  • Employers are currently prohibited from providing financial incentives to encourage workers to contribute to retirement plans
  • Allow employers to provide small financial incentives to lure employees to save for retirement. (Example: gift cards)

Bigger Employer Sponsored Plan Catch Up Contributions

  • Currently, age 50 catch-up of $6,500 for 401(k) and 403(b) plans. For a SIMPLE IRA, the catch-up is $3,000.
  • Workers age 62, 63 or 64 would be able to contribute a catch-up amount of $10,000 to a 401(k) or 403(b) and participants in SIMPLE IRAs could contribute an additional $5,000. Existing catch-up for over age 50 would remain. Catch-up amounts would be indexed for inflation beginning in 2023.

IRAs

  • Allowed to make contributions to Traditional IRAs irrespective of how much they have already saved into retirement accounts.
  • Currently, age 50 catch-up of $1,000, not indexed for COLA.
  • Age 50 catch-up limit would be indexed for inflation starting in 2022.
  • Prohibition on new Traditional or Roth IRA contributions if individual is both a high-income earner and has more than $10 million in aggregated retirement account balances. (This provision appear to apply to other retirement plans such as tax qualified defined contributions plans).

Additional Employer Matching Funds

  • Employers cannot currently match employee student loan repayments with a contribution to an employee's 401(k) plan, 403(b) plan, SIMPLE IRA or governmental 457(b) plan.
  • Allow employers to make matching contributions to workers' retirement accounts based on workers' own student loan repayments. Effectively allowing the employee to still save for retirement at a time when they might not otherwise be saving for retirement due to student loan debt.

Old Retirement Accounts

  • Currently, it is difficult to find and receive benefits from a company that has moved, changed its name, or merged with a different company. Plans also have difficulty finding former employees that have changed their name or address.
  • Create a National online lost-and-found database for retiement plans, run by the Pension Benefit Guarantee Corporation.
ROTH Accounts
  • 401(k)s, 403(b)s and 457(b)s can accept Roth contributions. Simplified Employee Pension (SEP) plans and SIMPLE IRAs may not be designated as Roth.
  • No income limitation on Roth IRA conversions irrespective of income limitation on Roth IRA contributions. If employee exceeds income limitation, can make nondeductible contribution to Traditional IRA and then convert to Roth IRA (so called ''backdoor' Roth IRA strategy).
  • Expanded Roth contributions to SIMPLE and SEP IRAs.
  • Prohibit Roth conversion of after-tax accounts for both IRAs and employer sponsored retirement account (eliminating "backdoor" and "mega-backdoor" Roth conversions strategies).
  • Prohibits Roth conversions for those above applicable thresholds after 2032 (10-year window for Roth conversions to continue).
Part-Time Workers Retirement Plan Eligibility
  • SECURE Act allowed long-term part-time employees who work at least 500 hours a year for 3-consecutive years to contribute to a retirement plan.
  • Allows long-term, part-time workers to defer earlier by reducing the 3-year rule to 2-years.
403(b) Plan Investment Options
  • Currently, 403(b) plans can only invest in annuity contracts and mutual funds.
  • Would allow 403(b) custodial accounts to invest in collective investment trusts if certain conditions are met.
Tax Credits for Small Business
  • Currently, small businesses with up to 50 workers, can receive a tax credit for three years to offset start-up costs for setting up retirement plans. The credit equals 50% of administrative costs, up to an annual maximum of $5,000.
  • Tax-credit for joining a multi-employer plan if the plan has been around for less than three years.
  • The Act would increase the credit to 100% of expenses for employers with up to 50 employees. Additional credit for defined contribution plans equal to the amount contributed by the employer on behalf of employees, up to $1,000 per employee. The full credit would be available to employers with 50 or fewer employees, phase out for employers with between 51 and 100 employees. Full tax credit in the first and second years, 75% of the credit in the third year, 50% of the credit in the fourth year, and 25% of the credit in the fifth year. No credit for employer contributions after the fifth year
  • Small businesses could also receive a tax credit for joining a multi-employer plan, no matter how long the plan has existed.
Saver's Credit
  • Current individual tax credit available for contributions made to retirement plans or IRAs, based upon individual income level. Max credit of $1,000 per person.
  • Simplify the Saver's Credit with a single tax credit rate equal to 50% of the contribution amount. Increase the maximum credit to $1,500 per person and make credit available to taxpayers with higher income. Th credit would be adjusted for inflation each year.
QLAC (Qualified Longevity Annuity Contracts)
  • Currently, QLAC premium cannot exceed the lesser of (a) 25% of aggregated Traditional IRA account values as of 12/31 of the prior year or (b) $135,000.
  • Remove the 25% cap. Possibility of seeing an increase in the QLAC premium limit to $200,000.
Qualified Charitable Distributions (QCDs)
  • Taxpayers over 70 1/2 can give up to $100,000 to charity directly from their IRA without including that distribution as taxable income.
  • Expand the QCD provision to also include distributions from qualified retirement plans.

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: October 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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