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Wealth Planning

Tax law: New bill is a mixed bag for the wealthy

by:

Amanda Lott Executive Director, Head of Goals-Based Planning
Jordan Sprechman Vice Chairman, Practice Lead, U.S. Wealth Advisory
Tom McGraw Managing Director, Head of Tax Advisory, Advice Lab
Nov 03, 2021

The already serpentine journey to a potential new tax law last week took what many found to be an unexpected turn.

A revised bill was introduced that would increase the highest marginal tax rate for top earners further. But the new proposal took off the table other provisions, including ones that would have largely nullified the tax effectiveness of grantor trusts. It did leave some provisions the same, including limitations on a valuable tax benefit for entrepreneurs who start up successful “qualified small businesses.”

On October 28, a revised “Build Back Better Act” bill (the “revised bill”) was introduced in the House of Representatives.1 That legislation (the byproduct of weeks of intense negotiation among Congressional Democrats and members of the Biden administration) significantly modified many of the tax-related provisions that were included in a bill approved by the House Ways & Means Committee on September 15 (the “original bill”).

Of course, the legislative path frequently zigs and zags—with no guarantee that a bill will cross the finish line and turn into a law. That’s why any action you take should be motivated first and foremost by your goals and what you need your wealth to do for you, your family and community. It should never be just a reaction to potential tax law change.

Still, it is important to keep informed about what the federal lawmakers are proposing and explore what actions might make sense for you. So here are some of the more notable differences between the revised bill and the original bill, a look at what hasn’t changed, and what actions you might take.

What’s new?

Income taxes

The proposed marginal rate for top earners would be higher.

In the original bill, the top ordinary income tax rate was set to increase to 39.6% (from 37%); the top capital gains tax rate, to 25% (from 20%); and the top corporate income tax rate, to 26.5% (from 21%). The revised bill drops these proposed tax rate increases.

However, the revised bill would impose a 5% surtax on the amount an individual taxpayer’s “modified” adjusted gross income (AGI) is in excess of $10 million. Also proposed: An additional 3% surtax on the amount an individual taxpayer’s modified AGI is in excess of $25 million.

This is a significant change as it would mean the impact would be felt by a smaller number of taxpayers than the original bill. But for those who are impacted, the effect could be greater: the highest marginal U.S. income tax rate for a wealthy taxpayer could be as high as 45% (37% plus 5% plus 3%). On top of all that, one has to add the current 3.8% Medicare surtax.

This 5% surtax would apply to non-grantor trusts’ modified AGI in excess of $200,000, with the additional 3% surtax applying to those trusts’ modified AGI in excess of $500,000.

Removed from the original bill were provisions requiring owners of individual retirement accounts with assets in excess of $10 million to distribute assets more rapidly than under current law, and to sell investments available only to “accredited investors.”2

One much-discussed and controversial provision—what some called a wealth tax—is excluded from the revised bill, as it was from the original bill. The proposal would have imposed an annual tax on the unrealized capital gains of assets held by wealthy (e.g., those whose net worth exceeds $1 billion) taxpayers.

Wealth transfer taxes

There is good news for those who wish to transfer wealth tax-efficiently: In the revised bill, no reference is made to any reduction in the exemption from gift, estate and generation-skipping transfer taxes. Therefore, those exemption amounts will be increased to $12.06 million on January 1, 2022. Removed from the original bill was a proposal to cut those exemption amounts in half.

There also is good news for grantor trusts and GRATs, two powerful estate planning techniques:
The revised bill removes provisions that would have greatly reduced, if not entirely eliminated, their usefulness. Indeed, the revised bill leaves the significant tax benefits of those trusts unchanged.

Also gone in the revised bill was a provision that would have made no longer available valuation discounts that historically had been applied to the transfer of “passive assets,” such as minority interests in family investment partnerships.

What’s the same?

Several tax-related provisions in the original bill have been retained. Among the more prominent ones are the:

  1. Elimination, for high-income taxpayers and all non-grantor trusts, of the 75% and 100% exclusion from capital gains tax for the sale of qualified small business stock (QSBS) up to the greater of $10 million or 10 times the owner’s basis in those shares
  2. Expansion of the 3.8% Medicare surtax to business profits
  3. Application of constructive and wash sale rules to digital (among other types of) assets, including cryptocurrency
  4. Permanent limitation on the use of excess business losses by principals of operating businesses classified as partnerships or S corporations for tax purposes

The revised bill shares with the original bill utter silence regarding the cap on the deduction for state and local taxes (SALT) paid. However, there is still every reason to believe the cap on the deduction will be lifted, perhaps entirely, for a couple of years, as this is a requirement for many of the Democrats whose votes are necessary for any bill to ultimately pass.

What’s next?

We believe some tax-related legislation will be enacted by the end of the year, but we expect still more revisions to this revision.

Meanwhile, there are some key actions you might take that could be beneficial—regardless of how the legislative process plays out. One example: If you have the capacity and desire to make gifts to your family, doing that sooner rather than later would likely be beneficial. 

Speak with your estate planning lawyer, accountant and other advisors, including your J.P. Morgan team, to determine what steps may be right for you and the rest of your family. 

But, as always, we advise against letting the tax tail wag the dog. Any and all of your decisions should be made with your goals foremost in your mind and with this perspective: Tax law will likely keep changing—as it has for many decades.

1. H.R. 536, Build Back Better Act, October 26, 2021, Rules Committee Print 117-17, as reported by the Committee on the Budget, with modifications.
2.

 An “accredited investor” is a taxpayer deemed by law to be financially sophisticated enough to invest in unregistered, and thus considered inherently riskier, securities.

 

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