2021 tax planning strategies
2021 STRATEGIC TAX PLANNING
HOW THE SHIFTING BALANCE OF POWER IN CONGRESS WILL IMPACT YOUR TAX PLANNING STRATEGIES
By: Simon Levin and Donald A. Kress
As we theorized in our December 14, 2020 article in the Business Section of the Miami Herald, due to the 50/50 split in the Senate, with the Vice-President having the deciding vote, the Democrats effectively control both houses of Congress. As such, our prediction that this will lead to significant tax legislation this year is likely to materialize. President Biden will probably use the budget reconciliation process to push through his Covid relief package this fiscal year. Only one budget reconciliation act is permitted per fiscal year.
Thus, when the next federal fiscal year begins on October 1, 2021, Biden and the Democratic controlled Congress will have the opportunity to press forward with their proposed changes to the tax laws, which could become effective in 2022, or possibly at time of enactment in 2021, or some provisions could even be made retroactive to January 1, 2021. So what are the key tax changes which are under discussion and what should you do now to mitigate the effects of any such changes:
First, the reduction of the federal estate, gift and generation-skipping tax exemption from $11,700,000 to $5,000,000 or perhaps even down to $3,500,000. Any such reduction in the exemption could be retroactive. Thus, it is imperative that you consider using your $11,700,000 exemption as soon as possible and that you carefully structure any such planning to insure that you are not subject to a large federal gift tax if the reduction in the exemption is, in fact, made retroactive. Consultation with a sophisticated estate planning attorney and CPA is critical to avoid (or at least minimize) unnecessary estate and gift tax exposure though it should be noted that under certain circumstances, the payment of gift taxes can be beneficial. It is also possible that federal estate tax rates might be increased on some sort of graduated scale from the current 40% rate up to as much as 77% on extremely large estates.
Second, elimination of discounting techniques. Discounting from the market value of limited liability partnerships or corporations due to minority interests, lack of marketability, etc. has been a very effective technique in the past to reduce such asset values by as much as 30-40% for gift and estate tax purposes.
Third, substantial cutbacks in or the elimination of discounting techniques using deferred gifts in trust, such as Grantor Retained Annuity Trusts ("GRATS"), Charitable Lead Annuity Trusts ("CLATS"), Qualified Personal Residence Trusts ("QPRTS") and Charitable Remainder Trusts ("CRTS").
Fourth, taxing what are known as "grantor trusts" (sometimes referred to as intentionally defective grantor trusts- ("IDGTS") in the grantor's estate. Currently, such trusts are considered "owned" by the grantor for income tax purposes, but at death, the IDGT is not includable as an asset of the grantor's estate for estate tax purposes.
Fifth, elimination of the step-up in tax basis at time of death. Currently, the taxpayer's unrealized capital gains at time of death are not subject to capital gains tax and the beneficiaries of the estate receive a new basis in those assets equal to market value as of date of death. Furthermore, if the asset is depreciable, such as real estate, the beneficiaries can take depreciation deductions based on the new stepped-up basis. We might see an attempt to revert to the "carryover basis" concept, where the beneficiaries receive the assets with the same basis the decedent had. Another proposal is that the federal estate tax would be eliminated in favor of recognition of all capital gains at time of death. This is the system currently used in Canada.
Sixth, limiting the generation-skipping exemption to a specific term of years, possibly every 50-90 years, with estate tax payable by the then current income beneficiaries or by the trust itself. This could even be extended to currently existing generation-skipping trusts which have been in existence longer than the 50-90 years. The social policy behind this proposal is, of course, to prevent the estate tax free buildup of assets in generation-skipping trusts over multiple generations.
Seventh, reduction in the use of the gift-tax-free annual exclusion. Currently a taxpayer can make tax-free gifts of $15,000 to as many individuals as the taxpayer wishes. Spouses can join in the gifts, which can double the tax-free gift each year to $30,000 per donee. Proposals under consideration would cap the amount of gift tax exclusion which could be used each year to as little as a total of $20,000 to $50,000 for all donees.
Eighth, an increase in income tax rates for higher earning taxpayers. The current 37% rate is proposed to move to 39.6% on a graduated scale. Additionally, for upper-bracket taxpayers the long-term capital gains and qualified dividends preferred 20% tax rate might disappear and all such gains and dividends be taxed as ordinary income.
Ninth, a cap on the benefit derived from income tax deductions and, for upper income taxpayers, the elimination of up to 80% of their deductions.
Tenth, the imposition of 12.4% Social Security tax currently imposed on compensation income up to $142,800 on all such income in excess of $400,000.
Eleventh, elimination of tax-free exchanges of real estate under IRC Section 1031. Similarly, the benefit of offsetting taxable gains by investments in "Opportunity Zones" is expected to be curtailed.
Twelfth, similar to real estate taxes, imposition of an annual wealth ("Stealth") tax requiring the payment of some percentage of one's wealth, but assessed on the value of all assets.
Thirteenth, limitations on the size to which IRA or other retirement accounts may grow, and/or penalties assessed on accounts which exceed such limits.
Finally, it is clear that taxpayers need to take immediate action with regard to gift and estate tax planning in order to maximize after tax dollars getting to their beneficiaries. This planning needs to occur sooner rather than later. Taxpayers must pay close attention to the development of tax legislation proposals in Congress and Regulations proposed by the Treasury so as to position themselves to act quickly when adverse tax legislation and regulations become a reality. Sitting back and watching is not a realistic option. It will require not only acting quickly during this possible window of opportunity to utilize as much as possible the potentially expiring traditional planning tools, but adaption to newly-developing strategic tax and financial planning alternatives.