How the House Ways and Means Committee Tax Proposal Impacts Private Wealth Services Clients

The Democratic majority of the House Ways and Means Committee has released a summary of the tax proposals which may be included in the proposed $3.5 trillion budget reconciliation legislation.  It is unlikely that all of these proposed tax changes will be incorporated in the final reconciliation bill.  It is also possible that the bill may not become law at all.  Senator Manchin has publicly stated that he will not vote in favor of a $3.5 trillion bill.  That being said, much of what is in the proposed bill may be enacted soon.

Below is a brief summary of the proposed tax law changes which, if enacted, would likely impact many of our private wealth services clients:

Increase in top marginal income tax rate:

• The maximum income tax rate would increase from 37% to 39.6% for single taxpayers with income over $400,000 and married taxpayers with income over $450,000.  This change would be effective for the 2022 tax year.

• The current 3.8% “Obamacare” surcharge on net investment income would:
  • Remain in effect for single taxpayers earning more than $400,000 and joint filers earning more than $500,000; and
  • Would be extended to include net investment income derived in the ordinary course of a trade or business.

• There would also be a new 3% surcharge for (i) all taxpayers (except those set forth in (ii) and (iii)) with adjusted gross income above $5,000,000; (ii) married taxpayers filing separately with adjusted gross income above $2,500,000; and (iii) estates and trusts with adjusted gross income over $100,000. This change would be effective for the 2022 tax year.

Increase in capital gain tax rate:

• The capital gain tax rate will increase from 20% to 25% for single taxpayers with income over $400,000 and married taxpayers earning above $450,000:
  • This is effective for taxable years ending after the date of introduction of the Act.
  • Gains recognized after the date of introduction of this Act that arise from binding transactions pursuant to a written contract entered into before the date of introduction of the Act are excluded.

• Assets inherited at death currently receive a “step up” in tax basis from cost to fair market value.  Although the Biden Administration previously communicated that the “step up” rule would be repealed (and that an automatic tax on appreciated property would be imposed at death), the proposed tax bill does not make any changes in this regard.

Reduction of the estate and gift tax exemptions:

• The current $11,700,000 estate and gift tax exemption would be “cut in half” to approximately $6,000,000 on January 1, 2022.
  • Amounts gifted during your lifetime reduce the remaining gift and estate tax exemption.
  • In order to effectively use the current estate and gift tax exemption, you would need to gift assets up to your full remaining exemption amount prior to the end of the year. 
    • If, for example, you used $5,000,000 of your $11,700,000 exemption by making a gift in 2021 (or earlier) and the new exemption amount is $6,000,000, your remaining exemption on January 1, 2022 would be only $1,000,000.

Changes to the grantor trust tax and valuation rules:

• Under current law, clients may fund an irrevocable “grantor trust” (with the trust income taxed to the grantor) for beneficiaries:
  • Assets held in such grantor trust are not included at death in the grantor’s estate for estate tax purposes.
  • However, a client may retain sufficient powers over the trust to allow the grantor to pay income tax on the trust income (effectively a “disguised gift” to the beneficiaries).

• The proposed changes to the grantor trust rules would include grantor trust assets in the gross estate of the grantor for estate tax purposes.

• The proposed changes could eviscerate the effectiveness of:
  • Sales to a grantor trust (which would be treated as a taxable event).
  • Irrevocable life insurance trusts.
  • Other estate planning techniques

• The changes to the grantor trust rules would be effective immediately on the date of enactment of the new tax law.

• Transfer of interests in entities owning nonbusiness and other passive investments (such as marketable securities) after the date of enactment of the Act would not be entitled to a valuation discount for gift and estate tax purposes.

Changes in IRA & Qualified Retirement Plan rules:

• There would be new required minimum distribution amounts for “mega-IRAs” (including Roth IRAs):
  • Mega-IRAs valued above $10 million would have a required annual taxable distribution equal to:
    • If valued between $10 million and $20 million, 50% of the value of the amount in excess of $10 million must be distributed as taxable income.
    • If valued at more than $20 million, 100% of the amount in excess of $20 million must be distributed as taxable income.
  • This change would be effective for the 2022 tax year.

• Future contributions to Qualified Retirement Plans are prohibited if the participant has a “mega-IRA” valued in excess of $10 million.

• Roth IRA conversions will be eliminated effective January 1, 2022 for single taxpayers with taxable income over $400,000 and  married taxpayers with taxable income over $450,000.

Please note that this summary covers the proposed tax bill as released by the House Ways and Means Committee. There will be a “mark up” of the bill and a Committee vote anticipated later this week, to be followed by considerable discussion and negotiation of the final terms of the budget reconciliation bill.  In addition, the $3.5 trillion price tag may be “watered down” over the coming weeks. Some (if not all) of the tax law changes described in this Tax Alert may never be enacted.

A separate Gunster Tax Alert has been distributed to communicate the proposed corporate, international and other tax law changes.  For those who are interested, below are links to the House Ways and Means Committee Revenue Summary and Full Text:

• Section by Section Summary

• Full Text (starting on page 525)

As none of the above changes have been enacted into law, relying on them may be premature. However, the above proposed changes may provide a window into what the future may hold. Any questions regarding the above should be discussed with your tax advisor.

Please do not hesitate to reach out to Gunster’s Private Wealth Services team if you have any questions or need assistance.

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