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The discussion below focuses on those elements of the House plan that are likely to have the greatest impact on individual investors, if enacted.
Key income tax proposals:
- The top corporate income tax rate would increase from 21% to 26.5%, effective in 2022.
- Under current law, 100% of up to $10 million of gain from the sale of qualified small business stock (QSBS) may be excluded from gross income. The House proposal would slice that exclusion to 50% for most QSBS shareholders, effective immediately.
- The top marginal income tax rate would increase from 37% to 39.6%, effective in 2022, for married couples filing jointly with taxable income of more than $450,000, individuals with taxable income of more than $400,000, and trusts and estates with taxable income of more than $12,500. An additional 3% surcharge would apply to modified adjusted gross income of more than $5 million for married couples filing jointly, $2.5 million for individuals, and $100,000 for an estate or trust, effective in 2022. Including the new 39.6% rate, the new 3% surcharge, and the current 3.8% surtax on net investment income, the highest marginal federal rate would climb to 46.4% under the House proposal.
- The long-term capital gain tax rate would increase from 20% to 25%, effective immediately, for married couples filing jointly with taxable income of more than $450,000, individuals with taxable income of more than $400,000, and trusts and estates with taxable income of more than $12,500. Including the new 25% rate, the new 3% surcharge, and the current 3.8% surtax on net investment income, the highest marginal long-term capital gain tax rate would rise to 31.8% under the House proposal.
- Under current law, the 3.8% surtax on net investment income applies only to passive income. The House proposal would add active trade or business income, effective in 2022, for married couples filing jointly with more than $500,000 of taxable income, and individuals having more than $400,000 of taxable income.
Key transfer tax and related proposals:
- Under current law, the gift and estate tax exclusion sits at $11.7 million per person; the House proposal would halve that amount to about $6 million (inflation-adjusted), effective in 2022—accelerating a reduction that is set to occur in 2026.
- Assets held in grantor trusts will be included in the grantor’s estate for estate tax purposes. Any distribution from such a trust during the grantor’s life would be treated as a gift for gift tax purposes. Any sale of assets to such a trust will be treated as a sale to a third party, and thus subject to income tax on any gain. Each provision would apply to (i) trusts created on or after the date of enactment (i.e., when the President signs the legislation), and (ii) to any portion of a trust established before the date of enactment which is attributable to a contribution made on or after the date of enactment.
- Transfer tax valuation discounts for nonbusiness assets would be disallowed, effective for transfers after the date of enactment.
Key individual retirement account (IRA) and qualified plan proposals:
- No additional contributions may be made to Roth or traditional IRAs if total IRA and defined contribution plan balances (“combined balance”) exceed $10 million. Accelerated distributions would be required for combined balances exceeding $10 million. Each provision would take effect in 2022.
- An IRA holding any private placement security (e.g., an investment that is available only to qualified purchasers or accredited investors) would forfeit IRA status, effective in 2022, subject to a two-year transition period for IRAs already holding such investments.
Not included in the House proposal:
- Repeal of the “step-up” in basis at death
- Deemed recognition of capital gain at death
- Repeal of the current $10,000 limit on the deductibility of state and local taxes (SALT)
- Limitations on Section 1031 exchanges
The House proposal represents the first real indication of how Congress may fund the $3.5 trillion American Families Plan. Assuming Democrats find common ground, at least some of the proposed tax law changes are likely to stick. In that spirit, certain tax planning opportunities emerge:
- Investors who have been considering large gifts of up to the $11.7 million basic exclusion amount—especially gifts that would involve a valuation discount for nonbusiness assets—should finalize those transfers prior to the end of 2021. Transfers to irrevocable (“intentionally defective”) trusts may have an even shorter timeframe, as restrictions on grantor trusts would become effective as of the date the President signs the legislation. Attorneys and appraisers are already extremely busy so prompt attention to pending transfers is essential.
- Owners of QSBS should consider using multiple layers of exclusions (commonly referred to as “stacking”) to maximize the avoidance of gain under a reduced 50% exclusion.
- Consider early withdrawals from IRAs and qualified plans, and exercising nonqualified stock options at lower marginal rates today to avoid a “force-out” of assets at higher rates beginning next year.
- Qualified purchasers and accredited investors should consider investing in certain alternatives through low-cost, “private placement” life insurance (PPLI) policies, as new investments through an IRA may become prohibited. If structured properly, investment growth within such a policy should avoid current income taxation. The proposed 5% increase in the long-term capital gain tax rate, and the 3% surcharge for those expecting more than $5 million in income, make investing through PPLI even more appealing.
We will continue to monitor the progress of any tax legislation and keep you informed. As always, we are eager to work with your tax professionals to answer any questions and develop a plan that fits your individual circumstances.
For illustrative purposes only; and does not constitute an endorsement of any particular wealth transfer strategy. Bernstein does not provide legal or tax advice. Consult with competent professionals in these areas before making any decisions.
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