Changes in tax legislation and unintended consequences
The Biden administration has released the Green Paper, which details what they want in changes to the way income, and especially capital gains, is taxed. Here is a brief summary of the proposed changes:
- The top marginal personal income tax rate drops from 37% to 39.6%.
- The top personal income tax bracket starts at $ 452,700, up from $ 523,601.
- Capital gains are taxed as ordinary income for taxpayers with incomes greater than $ 1 million.
- Deferred interest is taxed as ordinary income for taxpayers with income over $ 400,000.
- Any transfer of ownership (including gifts and on death) will be treated as a sale of the property and capital gains will be taxed, with gains over $ 1 million taxed at the new rate of 39.6% (plus l 3.8% net investment income tax).
There is an exclusion for transfers to a spouse or to a charity.
The tax on illiquid assets can be paid over 15 years.
Tax on a family business is deferred as long as the family operates it.
Transfers to trusts and partnerships trigger capital gains tax.
Trusts that have been in existence for more than 90 years will be taxed,
There will be no discount for fractional interest in an asset.
There is an inheritance tax deduction for capital gains tax paid.
- S-Corp shareholders, holders of interests in partnerships and other taxpayers who receive passed on business income greater than $ 400,000 will have to pay either tax on net investment income (3.8 %) for passive investors in the company, i.e. the tax under the Law on Contributions to Self-Employed Workers (12.4%) if they materially participate in the company.
- Similar exchanges against real estate are limited to $ 1 million per year.
The date of entry into force of these changes is December 31, 2021, but there is talk of making the law retroactive to “the date of announcement” of April 28, 2021.
These proposed changes represent a fundamental change for more than a century of tax law. The change will superimpose an increased capital gains tax on top of any gift, inheritance or generational leap transfer tax due and eliminate the base increase in estates. Estate assets (which are not used to pay capital gains tax and exceed $ 3.5 million) pay both capital gains and estate tax.
There is also a proposed annual reporting requirement for trusts, not only a balance sheet and income statement, but also accounting for the activities and transactions of the trust during the year, if the trust has assets greater than $ 1 million or revenues over $ 20,000.
What is missing from the Green Paper, which has been alluded to, is the proposal to make donation taxes retroactive to January 1, 2021, the elimination of annuity trusts retained by grantors and other transfer techniques. ‘split interest.
So look for an accelerated shift in planning from gift and estate tax planning to income tax planning. This has been going on since 2012, but he will dominate. Holding assets that are appreciated until death in order to obtain a stronger base will no longer be a viable strategy. Small businesses and professional businesses are changing the way they manage their income with more funding from retirement accounts rather than investing in company equity, and fewer owners of their place of business, doing so increase commercial rents. Installment sales will become more popular, especially when the annual installment payment keeps the seller below the annual tax level of $ 1 million. The use of qualified opportunity zone funds, charitable master trusts, charitable residual trusts and other alternative strategies will flourish.
All of this means that planning will have to be done years, if not decades, before possible transactions involving businesses involving illiquid assets, such as farmland, even if there is a 15-year period to pay the tax. , a huge brake on the profitability of these companies.
Also, given the postponement of recognition of capital gains for family businesses, look for family members who are forced into a “material participation” in the business, and a sharp decline in M&A operations involving private enterprises, in order to avoid triggering capital gains tax. Far from breaking the concentrations of wealth, it will force a greater concentration of wealth, but on a family basis.
Even if these proposals do not materialize, automatic tax changes are on the horizon. Indeed, the tax changes made in 2017 under President Trump last only 10 years, that is, the laws return in 2026, in just five years. The proposal will have the useful effect of focusing the client’s immediate attention on tax planning that they would otherwise delay until too late.