Last month, we outlined some of the potential tax law changes circulating Washington D.C. after the recent shift of power in the White House and Senate. Since that update, there have been a couple of additional proposals that give more insight into the potential direction of tax legislation this year.
Last time, we told you about President Biden’s “Made in America Tax Plan” that focused on corporate taxes. The administration has also proposed the “American Families Plan” that is focused on $1.8 trillion of additional spending and extension of some tax credits previously enacted under the American Rescue Plan. It also contains some provisions designed to help pay for additional spending by doing the following:
- Enhance IRS enforcement by requiring financial institutions to report information on account flows so earnings from investments and business activity are subject to reporting (like wages already are).
- Increase IRS enforcement budget and ensure that additional resources go toward enforcement against those with the highest incomes.
- Increase top income tax rate to 39.6%.
- Eliminate capital gains rates for households making over $1 million, meaning that such households will pay a 39.6% tax rate on all income, including long-term capital gains.
- Eliminate the step up in basis at death for gains in excess of $1 million per person.
- End the 1031 tax deferral on real estate gains greater than $500,000.
- Close the carried interest loophole that currently allows some investment fund management compensation to be treated as capital gains instead of ordinary income.
- Close loopholes that create inconsistent application of the 3.8% Medicare tax for those making over $400,000.
As before, the consistent theme of this proposal is to increase taxes on high-income workers and those who earn income from investments. Of particular interest is the proposal to end the long-standing practice of assets getting a step up in basis at the owner’s death. This proposal aligns with another bill recently introduced by Senators Van Hollen, Booker, Warren, Sanders, and Whitehouse: the Sensible Taxation and Equity Promotion (STEP) Act.
The STEP Act aims to prevent the use of trusts to circumvent the general requirement that the gain on appreciated assets is taxed at least once per generation through two core proposals. First, the STEP Act proposes to tax any transfer of property either during lifetime or at death that has a net gain associated with the transfer. At death, as in the American Families Plan discussed above, there is an exclusion of the first $1 million of gain. However, any completed transfer during one’s lifetime (to a trust or any individual other than a spouse) will only allow for the first $100,000 of cumulative gain to be tax-free, with any excess gain being subject to a tax. (Using that $100,000-lifetime exclusion would reduce the exclusion available at death to $900,000.) Accordingly, any transfer to a trust outside of the transferor’s estate would be treated like a sale, and the gain would be taxed. For non-grantor trusts, this would happen immediately. For grantor trusts, this would happen if the property were transferred to someone else or the trust ceased to be treated as a grantor trust. Second, all non-grantor trusts (even ones formed before the bill is enacted) would have to report and pay a tax on the gain on all of their appreciated assets every 21 years. Any trust formed before 2005 would automatically report this gain in 2026.
It is important to note that the taxes on gains imposed by the STEP Act would be in addition to any gift or estate taxes due on the same transfer, but the STEP Act tax would be deductible from the applicable estate or gift tax. While it does not seem likely that the STEP Act will get enacted as is, like the “For the 99.5% Act” that we discussed previously, it gives insight into where the Democrats are looking to increase taxes to finance their many spending priorities. However, unlike the 99.5% Act, this legislation (as drafted) would be retroactive to January 1, 2021.
Finally, the Labor Department released its findings last week, showing that the Consumer Price Index (CPI) rose 4.2% from a year ago, the sharpest rise since 2008. Many commentators seem to think this could put a damper on the Democrat’s spending plans, but that remains to be seen. Even if spending increases do not end up being as robust as what has been proposed, it seems doubtful that the Democrats will miss the opportunity they currently have to push back against the Trump tax cuts and increase taxes on the wealthy.
However, we still do not expect any retroactive legislation this year. We believe there is still time to take advantage of the current historically high estate tax exemption amounts for the remainder of 2021. contact us to see how we can help with your estate plan.