Ways and Means Committee Proposes New Legislation
The House Ways and Means Committee recently released a draft of the tax portion of the proposed reconciliation bill.
Some of the proposals affecting individual taxpayers, estates and trusts are described below.
Termination of Temporary Increase in Gift and Estate Tax Exclusion Amount
The gift and estate tax exclusion amount is presently $11.7 million (indexed for inflation). Under current law, it is scheduled to revert to about half that amount (indexed for inflation from 2021) in 2026.
The proposal would end the temporary increased exclusion amount beginning in 2022. If the proposed law is enacted, the exclusion amount would revert to about $6 million on January 1, 2022 (indexed for inflation after that).
Individuals with remaining gift tax exemption should consider making taxable gifts to use their remaining exemption before year-end (or earlier, as explained below, if they want to make gifts to grantor trusts). To make use of some of the “disappearing” exemption, individuals will have to make gifts that would raise their aggregate lifetime gifts above $6 million.
Estate Tax Inclusion of Grantor Trusts and Taxation of Transactions with Grantor Trusts
The proposed grantor trust provisions are designed to tax the creation of new grantor trusts and sales of assets to and from: (i) grantor trusts created after enactment; and (ii) grantor trusts created before enactment which receive contributions of property after enactment. The main proposed changes to current law are as follows:
- For any grantor trust created after the law is enacted:
- the trust assets will be includible in the grantor’s estate for estate tax purposes if the trust remains a grantor trust until the death of the grantor;
- any distribution from the grantor trust to a beneficiary (other than the grantor or the grantor’s spouse) will be deemed a taxable gift by the grantor at the time of the distribution; and
- if the trust becomes a non-grantor trust during the grantor’s lifetime, the grantor will be deemed to have made a gift of the trust assets at that time.
- Grantor trusts created before enactment to which no future contributions are made are excluded from the proposed new gift and estate tax provisions. However, if any post‑enactment contributions are made to a grantor trust that was created before enactment, the proportionate share of the trust assets attributable to the additional contributions would be subject to the proposed rules described above.
- In order to avoid double gift and estate taxation, the proposal contains a provision that should compensate the grantor (or her or his estate) for any gift tax exemption used in connection with post-enactment contributions to grantor trusts, which essentially means that only the appreciation on such contributions will be subject to additional gift or estate tax.
- In the case of a grantor trust created after enactment, sales of assets between the grantor and the grantor trust will be treated as taxable sales. If post-enactment contributions are made to a grantor trust that was created before enactment, such sales will be taxable to the extent of the proportionate share of the trust attributable to those contributions.
- The current proposal does not define “contribution,” making it difficult to understand the implications of certain types of post-enactment transfers to existing grantor trusts.
Individuals who are considering creating grantor trusts should do so and fund these trusts as soon as possible to ensure that assets in these trusts will not be includible in their estate if the provisions of the proposal are enacted.
Individuals with existing grantor trusts who may want to make additional contributions to those trusts (whether by gift or other means) should consider doing so as soon as possible to ensure the contributions take place before any new rules are enacted.
Valuation Rules for Nonbusiness Assets
Interests in entities are often valued at a discount for gift and estate tax purposes, even if the entity only holds investment assets.
Under the proposal, no discount would be allowed with respect to passive nonbusiness assets.
Individuals who are considering making gifts of assets that are eligible for valuation discounts should make such gifts as soon as possible before any new legislation that might limit the use of valuation discounts is enacted.
Restoration of 39.6% Top Individual Income Tax Rate
The top individual income tax rate had been 39.6% from 1993 through 2017, and was scheduled to return in 2026.
The proposal would restore the 39.6% rate beginning in 2022 for unmarried individuals with income over $400,000 and married individuals filing jointly with income over $450,000.
Increase in Top Capital Gains Tax Rate to 25%
The proposal would increase the top tax rate on qualified dividends and long-term capital gains from 20% to 25% beginning September 13, 2021. There would be a transition rule that would apply the current 20% rate for transactions that are currently in progress (i.e., gains realized after September 13, 2021, pursuant to a binding contract executed before that date). The new 25% rate would apply to individual taxpayers in the 39.6% income tax bracket.
Expansion of 3.8% Net Investment Income Tax
There currently is a 3.8% net investment income tax on investment income to the extent a taxpayer’s income exceeds $200,000 (for unmarried individuals) or $250,000 (for married individuals filing jointly). However, income from pass-through businesses such as S corporations and partnerships is sometimes not subject to this tax for certain owners.
The proposal would extend this tax to pass-through business income of unmarried individuals with income over $400,000 and married individuals filing jointly with income over $500,000 beginning in 2022. There would be a phase-in for unmarried individuals with income between $400,000 and $500,000 and for married individuals filing jointly with income between $500,000 and $600,000.
Limitation on Section 199A Deduction for Qualified Business Income
Section 199A currently allows a deduction for 20% of qualified business income (i.e., income from pass-through entities), subject to limitations for certain service income for high income taxpayers.
The proposal would limit the deduction to $400,000 for unmarried individuals, $500,000 for married individuals filing jointly, or $10,000 for estates and trusts, beginning in 2022.
Surcharge on High Income Taxpayers
For individuals, there would be a surcharge of 3% on modified adjusted gross income above $5 million beginning in 2022. This surcharge also would apply to trusts with modified adjusted gross income above $100,000. This would effectively create a new 42.6% income tax bracket.
For this purpose, “modified adjusted gross income” means adjusted gross income less a deduction for interest expense.
Qualified Small Business Stock
There currently is a 50%, 75% or 100% exclusion for up to $10 million in gain (or gain up to ten times aggregate basis) attributable to dispositions of qualified small business stock (“QSBS”).
The 50% exclusion applies to gain on QSBS acquired after August 10, 1993, and before February 18, 2009, the 75% exclusion applies to gain on QSBS acquired on or after February 18, 2009, and before September 28, 2010, and the 100% exclusion applies to gain on QSBS acquired on or after September 28, 2010. In each case, the exclusion applies only to QSBS held for at least five years.
The proposal would limit the exclusion to 50% of the gain attributable to dispositions of QSBS after September 13, 2021, for individual taxpayers with adjusted gross income over $400,000 and for all trusts, regardless of adjusted gross income.
While the provisions described above are only proposed legislation, individuals who may be affected by the proposals should contact a member of our Trusts & Estates department listed or a member of our Tax department as soon as possible to discuss whether any immediate action is appropriate.