Preparing for Potential Tax Law Changes

By: Stacey Nickens

The Biden Administration has proposed some changes to estate and tax law that could impact high-net-worth individuals. While these tax code proposals will likely be altered as they pass through Congress, wealthy individuals can still take steps this year to help mitigate tax impacts down the line.

Current Law and Background

The gift and estate tax exemption is currently at an all-time high. Individuals can gift up to $11.7 million in assets, and couples can gift up to $23.4 million, without triggering gift or estate tax. This exemption is already set to decrease to $6 million in 2026. In 2026 and beyond, gifts higher than $6 million will be subject to gift or estate tax, which currently equal about 40% of the gifted assets.

Recipients do not currently have to pay income tax on gifted assets. Additionally, a lifetime gift has a “carryover” basis, such that the gift’s recipient preserves the asset’s unrealized gains. A bequest is treated as having a “step-up” basis, where the asset’s basis becomes current fair market value upon its gifting. This “step-up” wipes out an asset’s unrealized gains upon its bequest.

Proposed Changes

In late May, The U.S. Treasury Department released its Green Book (General Explanation of the Administration’s Fiscal Year 2022 Revenue Proposals). The Green Book advocated for increasing the top income tax rate from 37% to 39.6%. Single filers with incomes above $452,700 and joint filers with incomes above $509,300 could face this higher rate starting in 2022. After 2022, rates would reset around inflation.

The Green Book also proposed ending the favorable tax treatment of long-term capital gains and qualified dividends for taxpayers with adjusted gross income (AGI) above $1 million. Instead, high-net-worth individuals would see their long-term gains and qualified dividends taxed at ordinary income rates. The Green Book suggested that this change could be retroactively effective from April 2021 onward.

The Green Book’s final major proposal involved the treatment of gains on gifts and bequests. Gifts and bequests would become income realization events. Effectively, a gifted asset would be treated as if the donor sold the asset, realized any gain or loss, repurchased the asset, and gifted the repurchased asset. If the gift realized gains upon its faux sale, the donor would pay income taxes on the asset’s “phantom” gain. Most transfers of appreciated property or distributions from trusts would be treated in a similar manner.

Under the current proposal, transfers to charity would not trigger taxable capital gain. Each person would also have a lifetime $1 million “phantom” gain exclusion and would only have to pay taxes on gains realized on transferred assets after those gains exceeded $1 million. Transfers to surviving spouses would not result in the realization of gains. However, these transfers would carryover their original basis and the gains would be realized when the surviving spouse dies or gifts the assets. The Green Book proposed that these changes take effect in 2022.

Mitigating Your Tax Impact

It’s important to keep in mind that these are only proposals. The legislative process will no doubt impact the above suggested changes, but in the interim, wealthy individuals could still consider taking a few precautionary steps.

  • High-net-worth individuals may want to take advantage of the lower 37% income tax rate and pull some income into 2021. For example, wealthy individuals could consider a Roth conversion in 2021 and pay taxes on those funds at the lower 37% tax rate.
  • Wealthy individuals could brainstorm ways to keep their AGI below $1 million in future years. Doing so could protect high-net-worth individuals from facing income tax rates on their capital gains or qualified dividends. After consulting a tax advisor, these individuals could also look into selling appreciated securities and triggering gains in 2021. However, anyone should consult with a professional before using this strategy.
  • High-net-worth individuals could save certain deductions, such as charitable contributions, for future tax years. Doing so could reduce their taxable income in years when tax rates are higher.
  • Gifting in 2021 could make sense for some individuals. Gifting in 2021 could allow the donor to take advantage of historically-high gift tax exemptions and to avoid paying taxes on “phantom” gains.
  • If “phantom” gains become taxable, low-basis assets could trigger high income taxes when gifted at the owner’s death. With that in mind, individuals might consider moving high-basis, rather than low-basis, assets into their taxable estate. High-basis assets would trigger smaller “phantom” gains and an accordingly smaller tax bill.

The Bottom Line

Please make sure to consult a tax and financial planning professional before making major decisions about your assets or estate. These proposed tax code changes could look significantly different after passing through Congress, and it’s important to ensure you’re acting in a manner that meets your current and future needs. I encourage you to reach out to our experienced financial planning team in order to develop a plan that is best for you and your family.