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Biden Greenbook Estate Tax Proposals: Should You Care?

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Yet Another Tax Proposal

The Biden administration released its budget and tax proposals on March 28, 2022. This is called the “General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals,” or more affectionately the Greenbook. Should you care? Honestly, who knows. Speakers at a major estate planning conference speculated that it was unlikely for any of this to get enacted. So, if the gurus suggest this is unlikely to be enacted why should you give it any attention? Cuz no one can predict what might happen in Washington. With so many serious issues such as Ukraine, inflation, perhaps another Covid surge, etc. etc. will Congress be able to focus on tax legislation that is similar to what was rejected previously? While the gurus might be right that it’s unlikely to happen, what if they are wrong? Predicting tax law changes is a bit less precise then predicting the weather.

Strategic Changes to the Tax Proposals Might Enhance Potential for Enactment

There have been a number of strategic changes made to the tax proposals which may have been made to address objections, e.g. from the life insurance lobby, so that the new proposals have a better shot to get passed. Some of these will be explained below. Also, there has been some “repackaging” of the proposals to perhaps make the proposals play better on Main Street. A major piece of the repackaging is the so-called “billionaire tax.” The Administration may be calculating that the public will view taxation of the bad billionaires as a good thing to do. After all those really rich billionaires don’t pay their fair share of tax, live in houses that are too big, and spend money on extravagances like rocket ships. While none of that may be true or reasonable, and the so-called billionaires’ tax really applies to people with net worth of $200 million, not the advertised $1 billion, it might sound good to some of the populace. The point is that these strategic changes might result is some portions of these changes actually getting enacted.

What Should Chicken Little Do

So what do you do? No question that us tax geeks have sounded like Chicken Little squealing for years now that “The estate tax sky is falling!” “The estate tax sky is falling!” So, what is the practical approach to address they latest in a seemingly endless series of harsh estate tax proposals? Ignoring the changes may be at your peril (or at least to the detriment of your heirs). Getting exercised about them doesn’t make much sense ‘cause nothing may happen. But prudent planning, taking steps that will protect your estate if any of the changes are enacted, that are reasonable for you even if nothing happens, seems to be the appropriate middle ground. The following discussion of some of the many changes proposed will also highlight practical steps and parameters that might help taxpayers work with their advisers to identify reasonable planning steps.

Income Tax Increases

Hey this is supposed to be an estate tax planning article, why mention income taxation? The reality is that income taxes have a profound impact on the size of estate you will be able to accumulate, the administration of trusts and estates, and more. Income and estate tax planning have become more interrelated and important to address as part of a holistic plan in recent years. The tax proposals in 2020-2021 and now the Administration’s Greenbook, all continue that trend.

Increase the top rate to 39.6% beginning in 2023. The top rate would apply to taxable income over $400,000 (single) or $450,000 (joint) in 2023. Note that the higher rates will apply at dramatically lower levels to complex or non-grantor trusts. Dividends and long term capital gains are proposed to be taxed at the highest ordinary tax rate rather than the favorable 20% rate under current law.

So-called carried interests that investment pros may earn on certain investment partnerships will be taxed on both income and sales proceeds as ordinary income. Under current law these often are taxed at more favorable capital gains rates. If the income tax are increased to 39.6% that could represent an almost doubling of tax costs. This will be further compounded by state income taxes as states generally pattern their tax systems after the federal rules. So in some instances the marginal tax rates on this income could more than double.

Real estate owners have benefited from the ability to exchange one real estate property for another and to defer any income tax. This rule has been under attack for years and the Greenbook proposes to cap this benefit at $500,000 per taxpayer. That would quash what has been a popular planning technique. While this change would not directly affect estate planning it could have a significant impact on overall planning for real estate developers. For example, a common planning technique for real estate developers has been to sell real estate entities to a grantor trust to lock in discounted values and shift substantial appreciation outside their estates. These interests generally cannot qualify for a step-up in income tax basis (the amount on which gain on sale is computed) unless the property interests are swapped back into the estate. After the developer dies these low basis real estate assets would be costly to sell. However, these real estate interests may then be exchanged in the future to retain tax deferred growth in these trusts. That exit strategy will essentially be eliminated for large property owners. This change may be exacerbated by proposed changes to depreciation recapture rules for real estate developers. This all may change the dynamic in planning approaches to be used.

The Supposed “Billionaires’” Tax

First, what was proposed is not a tax on Billionaires and is an unusual newfangled type of tax. The title of the tax certainly seems to be intended to play well with voters. The tax is also different than a wealth tax, like those proposed previously, perhaps because the Administration was concerned that a pure wealth tax might not pass a Constitutional challenge. Both aspects are part of what was referred to above as some of the strategic repackaging of the prior tax proposals (and perhaps a reason not to ignore them). This does not mean that there might not be a Constitutional challenge, but perhaps the Administration views that risk as reduced by the modifications as the tax is really an income tax on unrealized gain, not a tax on wealth.

Certainly, the headliner of the 2023 Green Book is the billionaire tax. This is a tax based on wealth, but isn’t a wealth tax as traditionally understood (that is, a tax computed as a percentage of a taxpayer’s total wealth). In contrast, the Biden proposal, while only applying to individuals meeting a threshold wealth, would impose a minimum tax rate on income, gains and unrealized gain rather than total wealth. That might make it more likely to withstand a Constitutional challenge then the wealth tax Senator Elizabeth Warren had proposed previously.

Rich folk, defined as those with more than $100 million in net worth could face a new type of income tax. Hey how did $1 billion become $100 million? Dunnoh! This proposed new tax would be at the rate of 20% of an expanded version of taxable income that includes unrealized appreciation. Unrealized appreciation is capital gain you have not triggered. For example, you hold $25 million of Apple stock that you purchased for $2 million, it would seem that you would have to pay a tax of 20% on the $23 million of appreciation. There would be an adjustment for the tax paid when you sell the stock to avoid taxing you on tax you paid. The tax would be phased in from $100 to $200 million of wealth. To administer this tax presumably anyone worth $100 million or more will have to file a new type of tax return reporting all of this. The compliance, calculating appreciation, valuing non-marketable assets like rental real estate, family…

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