2021 is proving to be a monumental year in terms of significant tax changes at the state and federal levels. We began the year with Proposition 19, which significantly pared down the parent-child property tax reassessment exclusion for transfers of real property from parents to children. We are ending the year with a flurry of activity concerning federal tax laws.
Here we are in the Fall of 2021, and there is a tax bill in Congress. Here are some of the items
on the negotiating table that impacts our clients.
Capital Gains Tax
The current proposal does not change the adjusted basis rule and no forced “realization” event at death.
- The only change is increasing the long-term capital gains rate from 20% to 25%.
- The President proposed eliminating the preferential long-term capital gains rate, increasing the capital gains tax rate from 20% to 39.6%.
- If Congress modified the adjusted basis rule, every heir or beneficiary would face a massive tax nightmare as they would pay capital gains tax simply because they inherited a capital asset, even if they did not sell the inherited asset. In addition, it could be impossible to determine a capital asset’s tax basis.
For now, we are confident that the only change to capital gain taxes would be an increase in the rate. Therefore, we do not expect a change to the adjusted basis rule .
Unified Credit against Estate and Gift Taxes
The Unified Credit, the credit amount against taxable gifts and a deceased taxpayer’s gross estate, is currently $11.7M. The Unified Credit is indexed to inflation and will increase through 2025. In 2026, it will return to its 2010 base of $5M and receive an inflation adjustment from 2010 through 2026.
The current proposal sunsets the unified credit in 2022 rather than waiting until 2026. Congress estimates the unified credit will be approximately $6.1M on
January 1, 2022. Thus, over the next 60 days, serious consideration should be given to making roughly $5.7M in gifts as those will carry no estate or gift tax consequences. In short, think of this as a short window of opportunity to transfer some wealth with no estate or gift tax consequences.
Advanced Estate Planning Techniques
As many of you know, we talk quite a bit about creating entities to own assets and then giving away entity interests to family members to create valuation discounts. However, the current proposal eliminates valuation discounts for all passive assets (e.g., rental real estate). In addition, another advanced estate planning technique on the chopping block is the use of grantor trusts. Grantor trusts are used to avoid the high tax rates trusts pay plus maximize the value of gifts by having the trust’s income taxes personally paid by the grantor rather than trust assets. If the current proposal becomes law, these two provisions will become effective immediately upon passage, yet all pre-passage transactions will be valid.
The flat tax rate for C-Corporations is currently 21%, which was a compromise amount based on the tax legislation passed in 2017. The current proposal proposes a progressive tax rate based on the company’s net income:
Net Income (Rate)
- Up to $400,000 (18%)
- Up to $5,000,000 (21%)
- Over $5,000,000 (26%)
In addition to the new rates, a concept has emerged for a minimum corporate tax of 15% based on a formula different from the one used to calculate net taxable income.
Individual Income Tax Rates
There are numerous subparts to the increase in income tax rates.
- First, the top rate will increase to 39.6% for married individuals with $450,000 or more in taxable income and unmarried individuals with taxable income over $400,000.
- The income amounts within the 32% and 35% brackets will likely face an increase as well.
- There is also the expansion of the 3.8%. net investment income tax (“Obama Care Tax”), which is colloquially called “NIIT.” Currently, NIIT applies only to passive income (such as interest, dividends, and gain on the sale of stock). The current proposal has NIIT covering mainly all income for single filers with taxable income of $400,000 or married filers with taxable income of $500,000.
- Also, taxpayers who have adjusted gross income more than $5,000,000 face a 3% surcharge tax. As the debate continues in Congress, expect a good deal of chatter regarding tax rate surcharges on income for “the wealth.”
Wealth Tax on Unrealized Gains
Over the past week, Congress has discussed about taxing some of the wealthiest Americans on unrealized gains (e.g. capital assets that have appreciated value but have not been sold or transferred).
A good example of an unrealized capital gain is Elon Musk and his Tesla stock. He probably has a basis of $0 in each share, yet a share of Tesla is selling for $1,114.00. I think it is doubtful that Congress passes a law that collects tax on unrealized capital gains.
What We’re Closely Monitoring
Congress is in session the next three weeks, and President Biden returns from Europe later this week. The earliest a bill can be signed is likely on Friday, but that would require round-the-clock negotiations, bill writing, and votes. For our clients, the timeline as to when a bill can become law is critical concerning the valuation discounts and grantor trust proposals discussed above. Upon becoming law, those tax benefits are no longer legal.
For now, we assume there will be a tax increase but remains curious to see the final legislation. We are closely monitoring the legislative process and will issue more updates as more information becomes available. In the meantime, if your estate has a value of $6M or more ($12M for married individuals), we should discuss whether a gift of the excess value makes economic sense. We expect the free $5.7M transfer window to pre-maturely close on January 1, 2022, rather than January 1, 2026.