Introduction
Last year I discussed President Joe Biden’s Proposed Tax Policy For Individuals, Charles J. Allen discussed the tax plans of the democratic presidential candidates, and Josh Sage discussed some of Biden’s potential changes. We are now a few months into President Biden’s tenure and the first ripples of tax reform can be felt by those with an ear to the ground. Two new pieces of legislation have been proposed, the For the 99.5 Percent Act and the Sensible Taxation and Equity Promotion Act of 2021 (“STEP Act”). President Biden is also scheduled to reveal details on the second package in his Build Back Better plan, including an array of tax hikes on wealthy households, in an April 28 speech before a joint session of Congress according to the White House.[1]
For the 99.5 Percent Act Summary
The For the 99.5 Percent Act was proposed by Senator Bernie Sanders on March 25, 2021. This Act has some similarities to the For the 99.8 Percent Act that Senator Sanders introduced in the Senate in January 2019. The For the 99.5 Percent Act proposes the following major changes (among others) to estate and gift taxes effective December 31, 2021:
- Reduce the estate tax exemption to $3.5 million;
- Reduce the gift tax exemption to $1 million;
- Establish new tax brackets with rates ranging from as low as 45% for taxable estates of between $3.5 million and $10 million to as high as 65% for taxable estates in excess of $1 billion;
- Allow a $10,000 per-donee annual gift tax exclusion, subject to a $20,000 per-donor cap;
- Prohibit a step-up in basis for assets held in grantor trusts that are not included in the grantor’s gross estate;
- Impose a 50-year limit on generation-skipping trusts (also known as dynasty trusts or GST trusts);
- Impose limitations on minority interest discounts when valuing certain transfers of non-business assets (for example, certain interests in closely held entities) for gift and estate tax purposes;
- Impose a 10-year required minimum term for GRATs; and
- Add Chapter 16 to the Code, an entirely new chapter with rules targeting the gift, estate, and generation-skipping transfer taxation of grantor trusts.
The For the 99.5 Percent Act, if passed, would not only significantly reduce many of the current benefits available to taxpayers via exemption and rate changes, but it also would severely limit many of the planning tools that have traditionally been used by taxpayers in estate planning. One of the tools most affected is the irrevocable grantor trust. Irrevocable grantor trusts have been used for a multitude of estate planning functions, but one of the most significant is as a vehicle to move assets out of a grantor’s taxable estate via sales, without incurring income tax. Under The For the 99.5 Percent Act, grantor trusts would be included in the taxable estate of the deceased grantor and distributions from the grantor trust to non-grantor beneficiaries will be treated as gifts (subject to gift tax). It is important to note that these proposed changes would only affect grantor trusts created, or receiving a contribution, on or after the date of enactment of The For the 99.5 Percent Act. Thus, many practitioners are pushing taxpayers to establish and fund these grantor trusts, while doing so is still immensely beneficial.
STEP Act – Proposed Reform
The STEP Act, while not formally introduced yet, was announced on March 29, 2021 by Senators Chris Van Hollen, Cory Booker, Bernie Sanders, Sheldon Whitehouse, and Elizabeth Warren, and offers a proposal to effectively end the benefits provided under Section 1014 for high-income taxpayers, effective retroactively as of January 1, 2021.[2] Section 1014 provides that when property is transferred from a decedent to an individual at the time of death, the basis of capital assets in the hands of the recipient is equal to fair market value on the date of death. This “step-up” in basis reduces capital gains tax liability on property passed to a recipient by excluding any appreciation in the property’s value that occurred during the decedent’s lifetime from taxation. If the recipient decides to sell this property immediately upon transfer, no capital gains tax would be owed. If the recipient decides to hold on to the property and sell in the future, any capital gain would be measured against the recipient’s new stepped-up basis, and the gain would be taxed at the recipient’s applicable capital gains tax rate. Importantly, the recipient does not have to realize the capital gain at all. Instead, the recipient could keep the property until death and give the property to a new recipient , at which time the property would take another step-up in basis to its fair market value, and the process would begin again.
The STEP Act does not attempt to straight up eliminate the step-up, rather it proposes to treat death and gifts or transfers of property to a non-grantor trust as sales, paired with an exclusion for up to $1 million of unrealized capital gains, along with an additional $250,000 ($500,000 if married) exclusion for personal residences. This would effectively retain the current step-up regime for the first $1 million in gain, while eliminating it for all amounts in excess thereof (subject to the $250,000 exclusion for personal residences). An example from the one-page of the legislation is:
If someone dies holding $6 million in property for which they paid $4 million, they would only pay taxes on $1 million of that $2 million gain. If someone dies holding $3 million in property for which they paid $2 million, none of that $1 million gain would be taxable.[3]
The STEP Act also proposes that property held in a non-grantor trust would be treated as sold every 21 years. As a transition, non-grantor trusts established in 2005 or earlier have their first deemed realization event beginning in 2026. Property in grantor trusts is treated as sold when transferred to another person, the grantor dies, or the grantor is no longer treated as the owner. Property transferred to or held by grantor trusts is also treated as sold if it would no longer be included in the owner’s estate for estate tax purposes.
Under the STEP ACT, trusts with more than $1 million of assets or more than $20,000 of gross income would also be required to provide a balance sheet, income statement, and list all trustees, grantors, and beneficiaries to the IRS.
Potential Issues with the STEP Act
Practically, there are several glaring issues remaining in the current draft of the STEP Act. First, although assets transferred under the STEP Act will be deemed to be sold for fair market value, no actual sale took place. Thus, the transferor did not actually receive anything in return and could be left without sufficient wherewithal to pay the associated tax liability. This could cause a large problem for estates with few liquid assets or assets that are not easily divisible. The fact that the tax liability that results from a transfer at death can potentially be paid over 15 years will likely not help. As Caryn B. Keppler of Pierro, Connor & Strauss LLC expressed concern that the $1 million threshold is too low, she also illustrated the potential wherewithal to pay issue. Keppler stated, “I live in Harlem, and there are an enormous amount of brownstones that were purchased for very little money that are now selling for millions.”[4] Under the STEP Act, the tax would be imposed at death, not when the property was sold, so “you might have this family that owns this lovely brownstone that they paid next to nothing for, that’s now worth $2 million or $3 million, and they don’t have the cash or liquidity to pay the tax.”[5]
Another issue with the STEP Act, and the mark-to-market system in general, is valuation. Assets such as ownership interests in privately held business are notoriously difficult to value. Not only would requiring such a valuation increase costs to taxpayers, but then the IRS would be responsible for reviewing the accuracy of those valuations. This of course would lead to the costs associated with each side in the inevitable events of disagreement.
Biden’s Scheduled April 28, 2021 Speech
President Biden’s speech will come as he hits 100 days in office, an unofficial milestone upon which modern U.S. presidents have been judged for what their administrations have accomplished at the start of their four-year term. The address will take place in the House of Representatives. House Speaker Nancy Pelosi invited Biden to speak in a letter on April 13, 2021, asking him to “share your vision for addressing the challenges and opportunities of this historic moment.”
President Biden is anticipated to reveal details of the second package in his Build Back Better plan, including an array of tax hikes on wealthy households. Potential tax hikes include the intent to repackage several proposals from Biden’s presidential campaign, including raising both the top individual income tax rate and the tax rate on capital gains to 39.6 percent and repealing stepped-up basis. During his campaign, Biden proposed pairing his top 39.6 percent tax rate on capital gains with a $1 million exemption.
White House press secretary Jen Psaki affirmed Biden’s ongoing commitment to his campaign pledge that he would not raise taxes on families earning less than $400,000, and then reversed her earlier position and clarified that that threshold applies on an individual basis.
Bloomberg Tax also indicates that that the White House is mulling keeping the 3.8 percent net investment income tax intact as part of raising the capital gains tax rate to 39.6 percent, which would effectively render the top federal capital gains rate 43.4 percent.[6]
After this article was originally drafted, but prior to being posted to the website, an update on Biden’s intentions developed. According to Bloomberg Tax, President Biden and his economic team are planning to forgo an expansion of the estate tax in the administration’s coming individual tax-hike proposals.[7]
Conclusion
While we have not seen anything definite yet, it appears several tax reform proposals are on the horizon. President Biden, backed by a Democratic controlled Senate and House, appears to be poised to implement many of the changes he proposed during his campaign. This includes major reform to grantor trusts, imposing a periodic recognition of unrealized gain on certain trusts, significantly reducing exemption amounts while simultaneously increasing applicable rates, and revising the step-up for certain taxpayers. However, many remain dubious of the likelihood of passage for some of the more progressive elements of the policies discussed here, especially those presented in the For the 99.5 Percent Act. The Democratic majority in Congress is very slim and mid-term elections are set for later this year.
If legislation were passed sooner than expected, depending on the effective date of any such legislation, time may be limited for taxpayers to get their affairs in order. This is especially true with the current retroactive effective date of January 1, 2021 for the STEP Act. Recent comments by the Treasury suggest tax policy is not a near-term priority, and retroactivity is not favored, but left the door open for tax increases later this year. Retroactive tax increases are not only rare, but also unpopular. Typically, tax legislation is prospective, and not likely to come into effect until January 1, 2022. Regardless, clients would be well advised to discuss their current estate plan with their attorneys to determine whether there are any opportunities available under current law that they may wish to consider exploring in light of potential changes to the law.
[1] Caroline Linton, Biden to address joint session of Congress on April 28 (April 14, 2021), https://www.cbsnews.com/news/joe-biden-address-joint-session-congress-april-28/.
[2] The current discussion draft of the STEP Act can be found at: https://www.vanhollen.senate.gov/imo/media/doc/STEP%20Act%20discussion%20draft.pdf.
[3] The one-pager can be found at: https://www.vanhollen.senate.gov/imo/media/doc/One%20pager%20-%20STEP%20Act.pdf.
[4] Jonathan Curry, STEP Act Highlights Difficulty of Tackling Stepped-Up Basis (April 22, 2021), https://www.taxnotes.com/tax-notes-today-federal/trusts-and-estates-taxation/step-act-highlights-difficulty-tackling-stepped-basis/2021/04/22/52gfq.
[5] Id.
[6] Laura Davison, Allyson Versprille, Michael Shepard, and Patrick Ambrosio, Biden Eyeing Tax Rate as High as 43.4% in Next Economic Package (April 22, 2021), https://news.bloombergtax.com/daily-tax-report/biden-to-propose-capital-gains-tax-as-high-as-43-4-for-wealthy.
[7] Laura Davison and Nancy Cook, Biden to Omit Estate-Tax Expansion From Coming Economic Plan (April 27, 2021), https://news.bloombergtax.com/daily-tax-report/biden-to-omit-estate-tax-expansion-from-coming-economic-package.
