Dr. Mark Lee Levine, Professor
TAX TIP ON POTENTIAL FEDERAL CHANGES COMING SOON
Revisiting the Changes Income and Estate/Gift Tax Rules:
In prior Tips, we have examined several proposed Federal Income and estate/gift changes.
This Tip focuses on an update of these same areas of potential tax changes on the Federal level.
A few of these key areas include the following. (Keep in mind that most of these are on the Federal level; and, these proposals continue to be modified by the position from the White House under President Biden as well as the positions announced by the House of Representatives and the Senate.)
Estate and Gift:
In prior notes, I cautioned taxpayers and planners to be alert for major proposed changes to modify a few areas as to estate and gift tax. One major change was to eliminate the current law under the Internal Revenue Code of 1986 as modified (Code) relative to what has been known as the “stepped up” basis rules. That is, for example, if X was to die today, the basis of assets from X, the decedent, and received by B, the beneficiary, has generally been the fair market value of the property on the date of death of X. See Code Section 1014. This proposed change “appears” to not be going anywhere and that such proposed change will not take place. (Yes, things can change!) Avoiding this change is crucial for many, many taxpayers.
Another proposed change was to tax all potential gain on assets owned by X, the decedent, on the death of taxpayer X. This proposal has horrible tax implications for many taxpayers. As an example, if X owned an asset at death worth $300,000, but X had an adjusted basis in this asset of $100,000, the $200,000 ($300,000 less the $100,000) would be taxed on the death of X. However, this proposal also appears to have been put on the back burners. Thus, it “appears” this change will not be made under the current proposals that are moving forward on the Democratic side of the equation.
One estate and gift tax proposal that seems to be moving forward at this stage is to reduce the exemption that now exists relative to taxing estates and to taxing gifts made during life. At the present time, the law provides for a lifetime unified exemption for estate and gift transfers, as long as the total transfer does not exceed, basically, $11.7 million per taxpayer. Thus, this means that X, on death, could, under this provision, if no prior taxable gifts (lifetime transfers) had consumed any of this $11.7 million exemption, give property, with no estate tax on the same, of up to the exemption of $11.7 million.
However, as stated, it appears that this exemption will be reduced. There have been many proposals as to the amount of the reduction. As of this writing, it appears the support for the change is to reduce the exemption to an amount of around 6 to 6.5 million. Again, this is good news compared to proposals that would have reduced the exemption to much less than this 6+ million level. However, this is still a large change, when compared to the current $11.7 exemption.
Keep in mind that there are other deductions or exceptions that will allow the taxpayer/decedent, X, to reduce the net taxable estate, such as the spousal deduction, which eliminates all estate tax or gift tax when transfers are made to the spouse by X.
Taxpayers need to keep their eyes open for this change that could reduce the exemption as noted.
The proposals for tax rate changes in the income and estate/gift tax areas continue.
In the ordinary income tax area, there is a strong push to move the maximum ordinary income tax rate back to the level of 39.6%. It appears that this change is very likely to take place if there is any tax bill that is passed by Congress and signed by the President.
As for the capital gains tax, the current rate for most taxpayers being taxed on long-term capital gain is 15%, although the rate can move to 20%, where the taxpayer has a substantial capital gain. (For more on this, see Real Estate Transactions, Tax Planning, by Levine, Mark Lee and Segev, Libbi Levine, published in 2021 by Thomson/West; See Chapter 1 of this text.) The proposals have been-- on the extreme side-- to increase the rate to the same high rate used for ordinary income. However, more recently, it appears that the rate, if raised, will move to a maximum of 25%.
There is also a proposal to increase the highest estate tax rate from the current 40% to 45%.
As of this time, there has little discussion on this potential change.
There has been a proposal by the Biden Administration, supported by many others, to repeal Code Section 1031, which allows for the deferral of gain when there is a qualified tax-deferred exchange under Code Section 1031. Other proposals have been to allow the deferral under Code Section 1031, but to limit its application as to a maximum gain deferral or a maximum valuation. It “appears” that this change will not take place.
However, it is likely that this issue will continue to be raised and discussed. This Section has been under attack for many years. Only recently, Congress changed Section 1031 and eliminated the use of that Section when personal property, not real estate, was involved. (For more in this area, see Levine, Mark Lee, “Handbook on Exchanging Real Estate,” 2020 edition, PP&E, Inc. and on Amazon.com.)
Corporate Tax Rate:
The current tax rate for C corporations (regular corporations) is 21%.
The Biden administration's position and under recent tax proposals is to increase this rate to 28%. The 28% is a huge increase and it has been attacked by many folks in Congress and by many practitioners. It appears the rate will be increased if legislation on tax is passed. However, it appears likely that this rate will be changed to around 25% to 26.5%.
Other Proposals Moving Forward:
There are many other proposals for tax changes on the Federal level. Tax credits, deductions, etc. for individuals and business entities (corporations, partnerships, LLCs, etc.) are still being proposed. There are several proposals that impact corporations doing international business that are being considered. These include limits on foreign tax credits, rate increases, reduction of deductions for foreign income, etc.
Another important proposed change for syndications and other group investments impacts the timing as to when an interest paid to a sponsor or syndicator is taxed and what rate (ordinary or capital gain) will be used. These matters are still being considered for new legislation. How long the holding period must be for the sponsor to obtain capital gain treatment, if applicable, remains to be determined. It appears, if long-term capital gain applies, the holding period required will be somewhere between 3 and 5 years; it will not simply be a requirement to hold for a period in excess of one year.
What dates we will see these changes also remains to be seen. That is, most of the above changes, if they come about, are not effective for the calendar year 2021. However, there is still some discussion to apply new tax rates on capital gains for sales in the latter part of 2021. Again, it remains to be seen what will be passed on this issue.
There is much more that could be said for this area of proposed tax changes.
The proposals are moving fast.
Dr. Mark Lee Levine, JD, LLM (tax), PhD, CCIM, CRE
University of Denver