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Editor's note: This story has been updated to reflect opposition by Sen. Joe Manchin, a West Virginia Democrat, to Biden's "Billionaire Minimum Income Tax" proposal. Manchin's lack of support, first reported by Bloomberg News, means that the proposal to tax unrealized gains is almost certainly no longer an option, given that support from all 50 Senate Democrats is needed for the budget to pass.
It’s déjà vu all over again, and a new bout of uncertainty for financial advisors, in the White House’s latest proposal to increase taxes on the wealthiest Americans.
President Joe Biden’s federal budget , released on March 28, revives earlier plans to end tax-free wealth transfers to heirs and to collect tax on investors' paper profits. (Currently, capital gains are taxed only when stocks or other assets are “realized,” or sold.) The budget for the government's 2023 year also calls for ending a longstanding loophole in which people who inherit stocks, property or businesses don’t owe tax on the paper profits piled up since the original owner acquired the assets. One key element omitted in the document: a prior proposal to impose severe curbs on tax-free Roth retirement accounts. It's possible that other parts of the budget would accomplish that.
The Biden administration's suggested $2.5 trillion in tax hikes is on top of $1.5 trillion in tax increases embedded in a stalled version of the Build Back Better bill. Both face a battle in Congress — and exasperation from advisors.
“They couldn’t pass anything last year — how are they going to get it through this year with so much more on their plate?” like inflation and Russia-Ukraine, asked Martin Shenkman, an estate planning lawyer in Fort Lee, New Jersey. “We’re all, ‘oh golly, it’s all proposed all over again.’ But clients don’t want to hear the Chicken Little routine anymore." Shenkman added that clients "have planning fatigue. It’s like (the movie series) 'Friday the 13th' — how many sequels were there?”
Still, he said that planners have to let clients know what’s happening. Here’s what affluent investors and financial advisors need to know:
A 20% tax on centi-millionaires and billionaires on all of their “income”:
The “ Billionaire Minimum Income Tax ” would require ultra rich people to pay at least 20% in taxes on their income and — crucially — unrealized gains. It would hit the richest 20,000 American households, according to The Wall Street Journal , and raise $361 billion over 10 years, according to the Treasury Department’s latest “ Green Book ,” which lays out the administration’s proposed spending and tax increases.
The mega-tax is a misnomer as it would hit people earning at least $100 million. Top earners who pay less would owe the difference up to 20%. Boston Consulting Group defines those earning at least $100 million as ultra high net worth and said their assets rose nearly 16 percent in 2020 to $5.3 trillion compared to the prior year.
The idea of taxing profits that exist on paper , not as cash in a bank account, first appeared last year in various proposals from Biden and lawmakers in both chambers. The calls failed. The Green Book said that “reformed taxation of capital income would even the tax treatment of labor and capital income and eliminate a loophole that lets some capital gains income escape income taxation forever.”
Under current “ step-up in basis ” rules, someone who inherits an asset that swelled in value in prior years doesn’t have to pay income tax on the increase. That’s unfair, according to Treasury. Why? Because less-wealthy people who have to spend their savings during retirement pay income tax on their realized capital gains. “This dynamic increases the inequity of the tax treatment of capital gains,” the Green Book said.
A new top ordinary income tax rate of 39.6%, up from 37%:
- The top rate would start in 2023 and apply to married couples earning more than $450,000 and single filers making more than $400,000.
- For 2022, the current top 37% rate is paid by married couples making more than $647,850 and individuals making more than $539,900.
- The increase would raise nearly $187 billion over a decade.
- Long-term capital gains and qualified dividends for people earning more than $1 million would be taxed at the proposed top ordinary rate of 39.3%, plus 3.8% for the Affordable Care Act. Currently, capital gains are taxed at 23.8%, including the Obamacare levy.
- Unrealized gains would be taxed when an owner dies.
Estate and gift taxes and trusts:
Last fall, grantor trusts, the engine of wealth transfers to heirs, were on the chopping block . That’s in part because an early version of the climate and social spending bill known as Build Back Better treated future sales between trusts and their owners — a common planning technique — as a taxable sale.
Now trusts are facing another hatchet. Biden’s budget proposes to “
modify income, estate and gift tax rules for certain grantor trusts
.” The changes would raise nearly $42 billion. Under the budget:
- Donors would recognize a capital gain when transferring an asset to an heir. The paper profit would consist of the amount of appreciation in the asset since it was originally acquired.
- A donor could exclude, or not owe tax on, $5 million of unrealized capital gains on property transferred by gift or owned at death. Portions of the $5 million exclusion that aren’t used during a donor’s lifetime would carry over to a surviving spouse.
- The $5 million exclusion is in addition to the lifetime exclusion, now just over $12 million (twice that for couples).
- The rule would go into effect in 2023.
- The rule would affect “certain property” owned by trusts, partnerships and other non-corporate entities.
- Taxpayers could choose not to recognize unrealized appreciation of a family-owned and -operated business until the business is sold or passes out of the family’s hands. They’d have 15 years to pay tax on appreciated assets transferred at death. With a deferral, taxpayers would have to put up “security” to the IRS if asked.
- If a trust, partnership or other non-corporate entity hasn’t recognized gain on its assets since 1939, it would be forced to do so come 2030.
- The rules for grantor retained annuity trusts, or GRATs, get tighter. They’d be required to have a minimum value for gift tax purposes of at least 25 percent of the value of the assets transferred to the GRAT or $500,000, whichever is bigger.
- A trust would be banned from swapping assets without recognizing gain or loss. The trusts would last a minimum 10 years and a maximum of 10 years plus the owner’s life expectancy.
Private equity and hedge funds:
So-called “carried interest” profits would be taxed at ordinary rates, not lower capital gains rates.
Steve Wittenberg, the director of legacy planning at SEI Private Wealth Management in Oaks, Pennsylvania, said in an email that there’s “fatigue from taxpayers coming out of the frequent rollercoaster of potential proposals to change tax laws.” The proposals, he added, “more often than not do not come to fruition.”