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Tax Legislation Would Make Estate Planning Much Harder

By September 20, 2021November 30th, 2021No Comments

Last week, the House Ways and Means Committee released the first draft of a major tax bill, and it contains sweeping changes that should concern wealthy households.

The proposals are designed to pay for President Biden’s $3.5 trillion Build Back Better Act. And while certain items aren’t as bad as feared—the capital gains rate would increase to 25% rather than an earlier proposal of 39.6%—the House plan would all but eliminate estate planning techniques that wealthy families have long relied on to minimize taxes and transfer wealth. 

The bill cuts in half the lifetime estate/gift tax exemption—currently $23.4 million for a married couple—above which a 40% estate or gift tax is triggered. That change was scheduled to kick in in 2026; it would now occur four years earlier.

Perhaps more importantly for wealthy families, the House proposal comes down hard on the use of trusts in estate planning. Under the draft legislation, grantor trusts will now be included in the grantor’s taxable estate upon their death. Distributions will be considered gifts, and changing the trust to a non-grantor trust will be deemed a gift of the entire trust. In addition, rule changes concerning sales between grantors and grantor trusts mean that these sales will no longer be a viable strategy for excluding assets from one’s estate. 

The House proposal also eliminates valuation discounts for the transfer of “non-business assets.” That kills the strategy of moving passive investment assets (such as publicly-traded stock shares) into an LLC or other corporate entity to claim the lowest defensible valuation. Assets used in active businesses, on the other hand, can continue to be discounted, an apparent concession to owners of family farms and businesses.

Such changes would be big losses for the country’s wealthiest families. But bear in mind that the Senate Finance Committee has yet to release its own proposal. Once House and Senate bills are finalized, they must be reconciled. In other words, the House proposal may not be the final word on what taxes will look like under Biden.

While the House’s plan will be tough for wealthy families to swallow, it could have been worse. Absent from the proposal is a widely anticipated change under which unrealized capital gains on inherited assets would be subject to tax. Other proposals made by the Biden administration have also been tempered in the House proposal. The plan:  

  • Raises the top personal income-tax rate to 39.6% from 37% and lowers the threshold for that bracket to $450,000 for married taxpayers filing jointly from $628,300. 
  • Hikes the capital gains rate to 25% from 20%–well below Biden’s proposed 39.6%. 
  • Levies a 3% surtax on individuals with modified adjusted gross income exceeding $5 million.
  • Prohibits IRA contributions and mandates withdrawals for individuals with more than $10 million of retirement assets. The rule applies to single filers with $400,000 of income and joint filers with $450,000 of income. 
  • Eliminates the so-called backdoor Roth IRA strategy, which lets high-income individuals convert a traditional IRA to a Roth.
  • Precludes Roth conversions during years in which taxable income exceeds $400,000 for single filers and $450,000 for married filing jointly. 

It’s also worth noting that the House bill does not seek to increase the $10,000 limit placed on the deduction of state and local taxes under the Trump administration. It’s possible that a provision will appear in a later version of the legislation—and that other items will be changed as well.

We’re still a long way from a final bill being presented for Biden’s signature. But AdvicePeriod is closely tracking developments in Washington, D.C., and your financial advisor will keep you apprised of the best course of action as the legislation evolves.