The presidential election is now seven months behind us and with a shift of power in the White House and Senate we’re beginning to have a bit more insight into the potential direction of tax legislation this year. Several new measures, The STEP Act (Sensible Taxation and Equity Promotion (STEP) Act). and the “Made in America Tax Plan,” have potential tax consequences for the transfer of property and corporate taxes.
Read on for more background on possible tax changes and feel free to share this article with your advisor to see if might be impacted by them.
President Biden’s “Made in America Tax Plan” focuses on corporate taxes. The administration has also proposed the “American Families Plan” that seeks $1.8 trillion of additional spending and the extension of some tax credits previously enacted under the American Rescue Plan. It also contains provisions designed to help pay for additional spending by doing the things listed below:
- Enhance IRS enforcement of top earners by requiring financial institutions to report information on account flows. The goal is to ensure that earnings from investments and business activity are subject to reporting (like wages already are).
- Increase the IRS’ enforcement budget and ensure that additional resources focus on 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.
The consistent theme of these proposals 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 the Sensible Taxation and Equity Promotion (STEP) Act.
The STEP Act has two core proposals. Both aim to prevent the use of trusts to circumvent the general requirement that the gain on appreciated assets is taxed at least once per generation.
- 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, 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 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 be passed as is, it gives insight into the Biden Administration’s tax policy, this legislation (as drafted) would be retroactive to January 1, 2021.
Please feel free to call us to see how we can help you understand these tax acts and help you with your charitable plan.