The release of the Build Back Better plan by the House Ways & Means Committee on September 13 represented a step forward towards defining and agreeing upon potential upcoming legislation. Yet, it’s important to remember that this is a fluid situation, with further proposals and new tweaks surfacing almost daily from both the House and the Senate.
Given the potentially rapidly closing window of opportunity to take advantage of certain estate tax savings strategies, it’s important to consider taking action to preserve your wealth, if you think your circumstances warrant it. But as we’ve cautioned in the past, it’s equally critical to avoid panicked reactions to the many preliminary proposals.
Below is an overview of the House Ways & Means Committee’s proposed tax changes that are most likely to affect wealthy taxpayers. We’ve also provided a list of several surprising omissions in this proposal, and inserted some planning suggestions for those people whose situations warrant prompt action.
House Ways & Means Committee Proposals September 13, 2021
Effective Date is January 1, 2022 unless noted otherwise
Change in Tax Rate on Long-Term Capital Gains
The highest marginal income tax rate on long-term capital gains under current law is 20% (28% for “collectibles”). The proposal would increase that rate to 25% for high-income individuals. The Biden administration has also proposed taxing long-term capital gains as ordinary income at a rate of 39.6% for certain high-income individuals. The House Ways and Means proposal would be effective on the date of introduction, which, depending how you interpret the term “date of introduction,” could be as soon as September 13, 2021.
Change in Highest Individual and Fiduciary Income Tax Rate
The highest marginal income tax rate for individual would increase from the current 37% to 39.6% for high- income individuals. The highest marginal fiduciary income tax rate for estates and trusts of 39.6% would apply to taxable income over $12,500.
Change in the Exemption Amount
The estate, gift and generation skipping exemption is currently $11.7 million. The House Ways and Means proposal would reduce that amount to $5 million, and indexed for inflation, effective January 1, 2022. The inflation-adjusted amount would be a shade over $6 million. This means individuals may only have until December 31, 2021 to make full use of their $11.7 million exemption.
Changes in the Grantor Trusts Rules
The proposed changes in the grantor trust rules would drastically affect traditional estate planning. A grantor trust is a trust over which the grantor retains certain powers that cause the income of the trust to be taxed to the grantor while not causing inclusion of the grantor trust assets in the grantor’s taxable estate. The proposal would make two major changes to grantor trusts:
First, grantor trusts created on or after the date of enactment will be included in the grantor’s taxable estate. Existing grantor trusts would be grandfathered. However, gifts made to pre-existing grantor trusts subsequent to the date of enactment would result in the portion of the trust attributable to that post-enactment gift being included in the grantor’s taxable estate.
Second, sales between the grantor and the grantor trust would be treated as income tax realization events. Under current law, sales of appreciated assets by a grantor to a grantor trust are not taxable events for income tax purposes.
This proposal would effectively eliminate the use of grantor trusts in transfer tax planning. As a result, individuals should consider establishing and funding a grantor trust before enactment of the proposal.
The proposal would eliminate valuation discounts for interests in entities holding non-business assets – that is, passive assets like marketable securities that are not being actively used to conduct a trade or do business. This means individuals seeking valuation discounts on gifts of interests in these kinds of entities should complete the gift before enactment of the proposal.
Changes Not in the Proposal but Could Surface Later
The House Ways and Means proposal did not include provisions to:
- Repeal the state and local income tax (SALT) limitation
- Eliminate the step-up in basis at death
- Increase the estate and gift tax rates
- Make transfers of appreciated property during life or at death an income tax realization event
- Establish a minimum term or minimum value for the remainder interest for grantor retained annuity trusts (GRATs)
- Limit the duration of generation skipping trusts for tax purpose
- Implement a “wealth tax” on ultra-high-net-worth individuals
While none of these frequently discussed items made it into the House Ways and Means proposal, discussion of the legislation has a long road ahead and these and other items could be added to the final bill.
As we have noted in prior policy updates, final legislation often looks quite different than what was initially proposed. In fact, the proposed corporate tax rate of 26.5% is less than the 28% President Biden proposed on the campaign trail and we still don’t know where it will settle. While we recognize that higher corporate taxes might negatively impact earnings, there are some positive forces such as record high corporate profit margins, pricing power and increased productivity that can help to offset higher corporate taxes.
Equity markets are very good at discounting the most likely outcome. Judging from the market’s modest reaction to the House’s proposal upon its release, it appears that markets believe further wrangling is likely still in the cards. So, while the legislative calendar may cause a pickup in market volatility near term, it is best to let things settle before making any drastic changes to one’s well-thought-out investment plan.
What to Do
Although we continue to advise that clients plan rather than panic when it comes to tax policy, there are some important planning opportunities that will soon expire. Individuals should consult with their advisors, and estate planning attorneys, CPAs and valuation professionals to see how the proposal affects their personal situation and whether they need to make changes to their tax and estate planning between now and the enactment of any legislation. BNY Mellon Wealth Management will continue to communicate the latest developments on these proposals and stands ready to assist our clients in navigating these proposed changes.