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  • Dr. Mark Lee Levine, Professor

LOSING PART OF YOUR INVESTMENTS—UNDER NEW TAX PROPOSALS


Proposals


Recent tax proposals made under the Biden Administration (BA) and by others in the House of Representatives and the Senate should alert all taxpayers. These proposals—at least a few of the bigger ones—are examined below. This Tip is a follow-up on a prior Tip on some of these points. However, it appears the BA is pushing, with others, to be certain that taxpayers with appreciated assets pay more taxes, now, during their life—or on their death, via their estate and/or their beneficiaries.


One does not have to be a billionaire, nor a millionaire to recognize that these proposals will impact a large part of the population of taxpayers in the US. These proposals are not limited to income tax issues. Yes, income tax changes that are being proposed are very important. However, other proposals impact estate tax, gift tax, and other areas of taxation, including a newer type of tax that is labeled as a “wealth tax” (WT). Together, this array of tax changes will affect many taxpayers, not just the ultra-wealthy.

Consider only a few of the proposals that have been put for by the BA.

A. Rates of Income Tax on Ordinary Income:

The Federal income tax rates for the last few years have been fairly low when considering the history of such income taxes. The Federal income tax rate is progressive in that a given taxpayer with a lower income level of earnings may pay no tax, whereas the highest rate for Federal income tax over the last few years has been at the rate of 37%. The BA has proposed to push this rate to 39.6%. This higher rate is the level that Federal income tax was charged to taxpayers making the most taxable income. That is, before the Trump Administration (TA), the highest rate was the 39.6% rate. That rate was lowered during the TA under the Tax Cuts and Jobs Act of 2017 (TCJA). Once again, the BA is proposing to raise this back to the 39.6% level.

Such a change is not particularly disturbing to most taxpayers, since only a few taxpayers (as a percentage of all taxpayers) are impacted by such an increased rate. And, those taxpayers that are impacted would not find the 2.6% increase to be that damaging. However, this change, coupled with the other changes, noted below, are important. (Note that this proposed change is for individuals. The proposal by the BA as to the corporate tax rate is to move it from the current 21% to a rate of 28%. This increase of 1/3 of the base of 21% is very large and there is a good deal of opposition to this change.)

B. Tax on Long Term Capital Gain:

A major proposal by the BA is to raise the capital gain rate from a current high level of 20% at the Federal level to a level that matches the proposed ordinary income tax rate of 39.6%.

It is readily apparent that such an increase, almost double the rate that exists in 2021, is huge. Such a proposed increase has exceptions. One such exception provides that the increased rate will apply only if the capital gain by the taxpayer exceeds 1 million dollars. For some taxpayers, this qualification eliminates their (current) concern with the proposed increase. However, other taxpayers will find this increase too much to accept. Such taxpayers will be searching for legal alternatives to avoid such a rate of almost 40%. (As noted below, there can be an additional tax, beyond the 39.6% rate, such as the investment tax of 3.8% that can apply in some cases in addition to the 39.6% high-income tax rate. If applicable, the taxpayer might be hit with the 39.6% and the 3.8%, resulting in a total Federal income tax in this setting of 43.4%.)

C. Estate and Gift Tax Proposals:

In addition to the income tax proposed changes noted above, the BA has proposed other, major, substantial changes in the areas of estate and gift taxes.

1. Exemption

In general, most estates pay no Federal estate tax. Why? Because the exemption allowed in 2021 for most estates is 11.7 million. What this means is that most estates will not pay any estate tax as the total estate does not exceed, for most taxpayers, the sum of 11.7 million. (A married couple will have such exemption for each spouse.)

There is no gift tax to be paid by most taxpayers, since the exemption noted above for estates also applies, in a unified fashion, to gifts made during life. That is, if X taxpayer, for example, gave a potentially taxable gift of 5 million during X’s life, this gift simply reduces the exemption available on the death of the given, X. Thus, in the example given, if the gift was 5 million, the 11.7 million exemption is then reduced to 6.7 million.

However, the BA has proposed to reduce the exemption to the amount-- or close to the amount-- that existed before the 2017 TCJA change, which was about 5 million dollars. (There have even been talks in the BA to reduce the exemption to 3.5 million—or less-- and not 5 million.)

Thus, if the larger exemption is lost, this will create more taxable estates and more taxable lifetime gifts.


2. Estate Tax Rates

If an estate is subject to tax, today, it is at a rate of 40%. However, the BA has proposed changing the rate to a higher level of 45%. Further, other proposals have been made by Senator Warren and Senator Sanders to raise the rates even higher, with very, very large estates. (In some instances, the rates could go as high as 65%.)


3. Basis of Assets from Decedent


Another major change suggested by the BA is to eliminate the increase in the AB when an asset is given by a decedent to a beneficiary. The law, today, is that the asset given to a beneficiary on the death of the decedent is the fair market value of the asset at the date of death of the decedent, at least in most instances. However, the BA has proposed that the basis to the estate and the beneficiary will be the basis of the decedent. If this is the case, the beneficiary could have a large, taxable gain that could be taxed at the rates, stated above.

As an example, if D, Decedent, owned property worth 5 million dollars on D’s death, but the basis to D was only 1 million, there is a 4 million, potential gain. Had D sold the property before his death, there would have been a 4 million dollar taxable gain. Under current law in 2021, because of D’s death, the gain is wiped out as the basis to the beneficiary is 5 million. If the BA proposed change as to basis takes place, the beneficiary or estate will have to pay tax on this gain.

4. Property Taxed on Death of Decedent—Gain

Another related proposal made by the BA is to tax gains on the death of the decedent, even if the estate or beneficiary does not sell the property. To illustrate this point, assume that the same facts, noted above, apply. D dies and owns the property worth 5 million, with D’s basis of 1 million. In such instance, the estate would be taxed on the 4 million dollars of gains, EVEN IF THE ESTATE DID NOT SELL THE PROPERTY AND IT TRANSFERRED THE PROPERTY TO THE BENEFICIARY, WHO RETAINED THE PROPERTY. Thus, what can be easily seen is that with the BA proposals, if they become law, using the example given, this will result in:

A 4 million gain;

Taxed currently; and

Taxed at higher rates.

Of course, under the proposals discussed, the estate is already burdened with higher estate rates, a lower exemption, and more demands on cash needed to pay taxes.

D. Wealth Tax

Another tax that is being proposed by both Senator Elizabeth Warren and by Senator Bernie Sanders, with other co-sponsors, is what is labeled as a Wealth Tax (WT). Moving from the setting of the death of the taxpayer, to a setting where we assume the taxpayer is well and is building a strong net worth, there is the WT on the horizon. This new proposal is to tax, ANNUALLY, the wealth of the taxpayer. In the current format of the proposals, only very large estates, such as those over 32 million, might be subject to this WT. The rate of tax, as now proposed, might be in the range of 2 to 8%, depending on the level of wealth. However, consider a few points on this WT:

  1. It is an annual tax that can be charged each year to taxpayers that fit within certain parameters

2. The tax rate is low, now; however, it can be increased over time


3. This tax applies regardless of whether the owner disposes of property or holds it.


Summary:

With these considerations, many wealthy taxpayers should be very concerned. This is especially true if the net worth subject to tax is reduced, to say 20 million, 10 million, or 5 million, etc. Recall that when the income tax was passed in the United States, the idea was that the rate would remain very low. This first income tax was imposed at the time President Lincoln was in office in 1861. It was passed to support the needs of the country during the Civil War. The rate of tax was only at 3% on income over $800. (The 16th Amendment, bringing in the permanent income tax within the Constitution, went into effect in 1913.) Times have changed the income tax; they may change the WT too, if passed!


What is not in doubt are the many tax proposals that are on the table to raise taxes in the USA on individuals and corporations.

By

Dr. Mark Lee Levine

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