As you may have heard, the Treasury Department has released detailed information about the Biden Administration’s tax proposals, some provisions of which, if enacted, could be effective this year. Below is a summary of some of the potential changes accompanied by planning points.
Income tax rate increase from 37% to 39.6% top rate
- Proposed effective date for years beginning after December 31, 2021
For individuals with income over $1 million, qualified dividends and capital gains would be taxed at ordinary rates
- The rate on gains and qualified dividends would increase from 23.8% to 43.4% (proposed ordinary top rate of 39.6%+3.8% net investment income tax).
- The new rate would only apply to the excess over $1 million of income.
- Proposed effective date is for gains recognized after April 28, 2021.
- Given the retroactive date, there is not much planning that can be done except for possible postponement of gains or harvesting losses prior to year end.
Transfers of appreciated property by gift or on death would be treated as if sold
- Eliminates income tax free step-up in basis on death and subjects all property to a capital gains tax.
- Transfers during lifetime of appreciated assets would be considered a deemed sale and subject to capital gains tax.
- There is a proposed $1 million exemption for the gains which would be available to each person, or $2 million per married couple.
- Forced capital gain recognition for property held in trusts, partnerships and other non-corporate entities every 90 years if there has not been a gain recognition event during that time. The first forced recognition of gain would be December 31, 2030.
- Each of these proposals have an effective date for transfers or deaths after December 31, 2021 (except where noted for the forced gain recognition on assets every 90 years).
Planning to avoid capital gains on gifts
As long as grantor trusts are still recognized, sales of appreciated or appreciating assets to “defective” grantor trusts can be made as opposed to gifts.
- A transfer of appreciated or appreciating assets would be made via a sale to a trust in exchange for a note.
- Current low interest rates make this plan very attractive.
- No gain recognition because it is a sale to a grantor trust.
- Grantor gets back same value plus interest on sale.
- Although estate is not decreased, it is frozen as to the transferred assets which are now replaced with cash/note.
- Notes must be paid or sale may be reclassified as a gift.
- Cash is needed to make the payments or there could be a “give back” of the property to the grantor to satisfy the note nullifying part of the sale.
Charitable Remainder Annuity Trusts (CRATs)
- Leverages a remainder gift to beneficiary while benefitting a charity for a period of years.
- Under proposed legislation, there would still be gain recognition on the transfer by gift, but only on the calculated remainder to the non-charity beneficiary.
- As long as assets grow at a rate higher than the interest rate, beneficiaries will benefit from the strategy.
For more information on the Biden administration’s tax proposals, see our previous tax alert. At this time, it remains unclear what future tax laws will provide. We will continue to monitor future legislation and will alert you to any changes.
We encourage you to connect with your Baker Tilly adviser regarding how any of the above may affect your tax situation.