House Ways & Means Committee tax proposals’ impact on estates, gifts and trusts
On September 13, the House Ways & Means Committee released its first draft of the proposed tax changes to be incorporated into the Build Back Better Act budget reconciliation bill to fund Biden’s $3.5 trillion in spending priorities.
While the draft — referred to as “Subtitle I - Responsibly Funding Our Priorities” — provides some insight on where negotiations currently stand, this is only the first step in creating the final legislation that will eventually be voted upon by Congress and sent to Biden for signature. Given the current political environment, the final tax law changes will likely look very different than this draft text.
The following is a summary of key estate, gift, and trust tax revenue provisions included in the draft:
Top ordinary income tax rate
- Increase the top marginal income tax rate from 37% to 39.6%, imposed on taxable income over $12,500
Top capital gain tax rate
- Increase top capital gains rate from 20% to 25%
- Generally effective for tax years ending after September 13, 2021
- Transition rule provides that 20% rate would still apply to gains recognized prior to September 13, 2021, and gains recognized after September 13, 2021, if pursuant to a written binding contract in effect on September 13, 2021, and not materially modified thereafter
New surcharge tax
- Impose a 3% surcharge on trusts with adjusted gross income greater than $100,000
Net investment income tax (NIIT)
Currently, NIIT does not apply to income derived in the ordinary course of a trade or business or income attributable to the disposition of property used outside of a passive activity.
- This provision would impose the 3.8% NIIT on all flow-through business income that is not already subject to NIIT, FICA, or self-employment income tax, regardless of whether the trust or estate is active or passive in the flow-through entity
- Perhaps most significantly, NIIT would now be imposed on active S corporation K-1 income
Sec. 199A
- Limit the Sec. 199A qualified business income deduction (20% of pass-through income) to a maximum of $10,000 for trusts and estates
Lifetime exemption
- Accelerate the scheduled expiration of the current $11.7 million estate and gift tax exemption per taxpayer from January 1, 2026 to December 31, 2021
- Exemption would revert to the $5 million exemption per taxpayer allowed in 2010, adjusted for inflation to roughly $6 million
Grantor trusts
- Under new Sec. 1062, sales by a grantor to a grantor trust that is not revocable would no longer be disregarded for income tax purposes
- Under new Sec. 2901, assets contributed to a grantor trust would be included in the grantor’s estate
- Distributions from a grantor trust (other than to the grantor or the grantor’s spouse) would be treated as gifts made by the grantor
- This provision would apply to:
- Trusts created on or after September 13, 2021
- Any portion of a trust established before September 13, 2021 that is attributable to a contribution made on or after September 13, 2021
- These, and other proposed changes to grantor trusts, would significantly impact the value of many common estate planning tools and require immediate updating of many taxpayers’ current estate plans
Valuation discounts
- Eliminate the use of valuation discounts under Sec. 2031 (e.g., discounts for minority interests, lack of marketability, etc.) on gifts of interests in closely held businesses, to the extent such interests include nonbusiness assets
- Nonbusiness assets for this purpose are passive assets that are held for the production of income and not used in the active conduct of a trade or business
- Exceptions are provided for assets used in hedging transactions or as working capital of a business
- A look-through rule provides that when a passive asset consists of a 10% or greater interest in another entity, this rule is applied by treating the holder as holding its ratable share of the assets of that other entity directly
- Would include real estate investments to the extent the transferor does not participate in the real estate activity more than 750 hours per year
- Applies to transfers after the date of the enactment of this Act
Real property used in farming or other trades or business
- Sec. 2032A allows the estate of a decedent who owns real property used in a farm or other business to value that property for estate tax purposes based on its actual use rather than its fair market value
- This provision would expand the maximum reduction allowed under Sec. 2032A for qualified real property from $750,000 to $11,700,000
Additional comments
- The elimination of the step-up in basis that occurs at death was not included in this draft, nor was the recognition of taxable gain on appreciated assets held at death
What’s next?
Some of these changes were expected, while others come as a surprise. Unless noted, the changes would be effective for tax years beginning after December 31, 2021, allowing taxpayers minimal time to implement planning opportunities to minimize their impact.
Wipfli will continue to monitor progress with respect to the Build Back Better Act and issue guidance as further details are provided on provisions that could impact businesses and their owners. But don’t wait until these proposals have become law to start thinking about how they will impact you, your business, and your future deals. If you have questions or would like additional information, please contact us. We are here to help.
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