Paying for the Biden Tax Plan: What You Need to Know

We prepared the following summary of previously proposed legislation prior to changes to such proposals on October 28. Please be aware that changes in the laws are expected at any time and it’s important to contact your estate attorney to see how such changes may affect you and how best to plan for them.

On September 13, 2021, the House Ways and Means Committee released a proposed tax bill (Proposed Legislation) as part of the Biden administration’s tax plan

It seems like there have been almost daily proposed change to the Proposed Legislation; this post highlights potential changes to the way trusts and estates could be taxed.

Gift, Estate and Generation Skipping Transfer Tax Exemption 

The Tax Cuts and Jobs Act (the “TCJA”), which took effect in 2018 and is set to sunset on December 31, 2025, significantly increased the gift/estate tax exemption and generation-skipping transfer tax exemption amounts (currently all $11.7 million). 

The Proposed Legislation would reduce these exemptions to approximately $6 million, effective January 1, 2022. 

Capital Gains Tax Rate Changes

The Proposed Legislation would increase the top capital gains tax rate from 20% to 25% for certain taxpayers.  

This increase could be effective for all capital gains after September 13, 2021 (the date the Proposed Legislation was introduced).

However, as of now, there is an exception for gains arising from a transaction that was closed in a written, binding contract in existence as of September 13, 2021.

Income Tax Changes

The Proposed Legislation increases the top individual tax rates starting January 1, 2022, from 37% to 39.6%. 

The Proposed Legislation also includes a 3% of modified adjusted gross income surtax on certain income in excess of:

• $100,000 for any trust or estate
• $2.5 million for a marrieds filing separately
• $5 million for every other taxpayer. 

It would also extend the reach of the net investment income tax by subjecting individuals with modified adjusted gross income in excess of $400,000 (for single taxpayers) or $500,000 (marrieds filing jointly) to the net investment income tax of 3.8%.

Finally, it would also cap the TCJA’s Section 199A Deduction for individuals of 20% of income for qualifying business income and effectively eliminate the deduction for trusts and estates.

Grantor Trusts  

One of the most useful estate planning vehicles for high-net-worth individuals and families has been the intentionally defective grantor trust (IDGTs). 

These trusts are structured in such a way that the grantor is treated as the owner for income tax purposes, but not for transfer tax purposes.  

As a result, the grantor is permitted to pay the income taxes for such a trust each year without such payment counting as an additional taxable gift to the trust, thereby allowing the trust to effectively  grow income tax free while reducing the estate of the grantor/income tax payer.

Because these IDGTs are treated as an alter ego for the grantor/creator of the trust for income tax purposes, gifts or sales of assets to these trusts from their creators to the trusts are treated as gifts or sales from one person (the grantor) to the same person and, as a result, there is no gain to report associated with either such transfer. 

Very importantly, under current law, a properly structured IDGT is not subject to estate tax upon the grantor’s death. 

The Proposed Legislation includes certain significant proposed changes, including (but not limited to) the following, which would all be effective as of the date of enactment of the new legislation:

Distributions from a grantor trust to anyone other than the: 

1. grantor
2. the grantor’s spouse
3. or, to a discharge of debt will be treated as a taxable gift

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;

If grantor trust status is toggled off during a grantor’s lifetime, a taxable gift of the assets in the trust will be deemed to have been made by the grantor;

Capital gain will have to be recognized on the sale of an asset between a grantor trust and its deemed owner.

Elimination of Valuation Discounts 

Under current law, an interest in a family partnership or limited liability company that is not publicly traded and in which the owner lacks voting control may be discounted from its underlying value to reflect its lack of marketability and control.  

These discounts can be substantial, and are often disputed by the IRS; but, they are legal and permissible. 

An amendment to Code section 2031 could change this.

Changes to IRAs

The Proposed Legislation adds new Code section 409B which would prohibit contributions by certain taxpayers to an IRA when his or her combined account balance in all applicable retirement plans exceeded $10 million at the end of the preceding calendar year.  

This limitation would apply to individuals with taxable income over $400,000 ($450,000 for marrieds filing jointly). 

The Proposed Legislation would also require distributions from large retirement plans held by individuals with taxable income over $400,000 ($450,000 for marrieds filing jointly) and would modify Code section 4974 by adding new required minimum distributions based on threshold amounts regardless of the age of the owner.  

In any year when an individual’s combined account balance in all applicable retirement plans exceeds $10 million, a minimum distribution of 50% of the excess over $10 million would have to be taken. 

This increases if there’s an a combined balance in excess of $20 Million. 

The Proposed Legislation also modifies the rules regarding conversions of traditional IRAs to Roths.  

Under current law, an individual with taxable income in excess of the threshold amount is permitted to make a contribution to a traditional IRA and subsequently convert the traditional IRA to a Roth IRA.  

The Proposed Legislation would eliminate this “backdoor conversion” for individuals with taxable income over $400,000 ($450,000 for marrieds filing jointly).

Our Message 

If you have established an irrevocable trust, you are an individual with a $6+ Million estate, a married couple with a $12+ million estate or any of the above-described proposals or any other proposals in the Proposed Legislation may apply to you, please contact your attorney and CPA to discuss how best to proceed immediately.