Green Book proposals would increase tax for the wealthy 

| 6/2/2022
Green Book proposals would increase tax for the wealthy

On March 28, President Joe Biden released his proposals for the fiscal year 2023 budget, which begins Oct. 1, 2022, including the tax-focused “General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals” (Green Book). Many of the tax proposals are not new and have a very uncertain future in the current Congress. However, the tax proposals provide insight into possible future legislation and important data points for planning.

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Highlights of the Green Book tax proposals that affect high-income individuals and wealthy families include:

  • Increase the top marginal rate from 37% to 39.6%. The tax proposal would increase the top marginal income tax rate from 37% to 39.6% for those with taxable income of more than $450,000 for married individuals filing jointly, $400,000 for single filers, $425,000 for heads of household, and $225,000 for married individuals filing separately, indexed for inflation.

  • Tax long-term capital gains and qualified dividends at ordinary rates. Currently, most long-term capital gains and qualified dividends are taxed at graduated rates based on taxable income, with the highest rate set at 20%. For individuals with taxable income of more than $1 million, the proposal would tax long-term capital gains and qualified dividends at ordinary rates.

  • Recognize inheritance and gifting for capital gains. Currently, taxpayers who inherit or are gifted appreciated property receive a basis in the property equal to the fair market value on the date of death or the basis of the donor in the case of a gift. Under the proposals, appreciated property that is gifted or passes to heirs upon death would realize capital gain at the time of transfer. The amount of gain realized is the excess of the asset’s fair market value on the date of the gift or death over the donor’s or decedent’s basis in the asset. A trust, partnership, or other noncorporate entity that owns appreciated property that is gifted or inherited recognizes gain on unrealized appreciation if that property has not been the subject of a recognition event in the prior 90 years.

  • Impose a 20% minimum tax on high-income taxpayers. The tax proposal would impose a 20% minimum tax on income (including unrealized capital gains) on taxpayers with wealth calculated to be more than $100 million. Taxpayers could choose to pay the first year of minimum tax in nine equal annual installments and then pay the minimum tax imposed in five equal annual installments for subsequent years.

  • Limit the use of grantor retained annuity trusts (GRATs). A GRAT is a commonly used estate planning technique in which an individual transfers ownership of highly appreciating assets to an irrevocable trust for a specified term of years (the GRAT term) that the grantor must outlive. A typical term is two years. A shorter term improves the chance the grantor survives the term, while a longer term decreases the value of the gift, thereby reducing transfer taxes. During the GRAT term, the grantor receives an annual payment from the trust and is treated for all income tax purposes as owning the trust assets. Annual payments received by the grantor from the trust are added to the grantor’s estate and potentially become subject to estate taxes if not disposed of prior to death. If the grantor survives the GRAT term, trust assets are not included in grantor’s estate.

    The proposal would require that a remainder interest in a GRAT has a minimum value equal to the greater of 25% of the value of the assets transferred or $500,000 (not to exceed the value of assets transferred) for gift tax purposes. The proposal also would impose a minimum GRAT term of 10 years and a maximum term of the life expectancy of the annuitant plus 10 years during which the GRAT makes the annual payments to the grantor. Finally, the proposal would prohibit a decrease in the annuity during the GRAT term.

    A 10-year minimum term makes a GRAT less attractive as an estate planning technique for individuals who are elderly and less likely to survive such a long term. Additionally, placing a minimum value on the remainder interest better ensures some gift tax is paid since “zeroed out GRATs,” that is, GRATs where the present interest of the annuity payments equals the fair market value of the transferred property, no longer will be possible.

  • Place valuation discount limits on notes. When a grantor sells appreciated assets to its grantor trust in exchange for a promissory note, no income tax is imposed on the sale. If the value of the assets held in trust exceeds the amount of interest due on the note, the difference between the interest due and the appreciated value of the assets is not subject to gift tax.

    Under the proposal, when a grantor sells appreciated assets to its grantor trust in exchange for a promissory note with a rate of interest that is properly tied to the applicable federal rate, any valuation discount for gift and estate tax purposes would be limited to the greater of the note’s actual interest rate or the applicable minimum interest rate for the note’s remaining term on the date of the taxpayer’s death.

  • Limit the duration of generation-skipping transfers (GSTs). The GST tax imposes a tax on gifts and transfers in trust to or for the benefit of individuals who are two or more generations below the transferor (a “skip person”). The lifetime GST tax exemption is $12.06 million for 2022. Currently, allocating the exemption to a trust can effectively make the trust GST-exempt in perpetuity.

    The proposal would limit the duration of the GST exemption for trusts by providing that GST-exempt distributions are restricted to beneficiaries no more than two generations below the transferor and to those beneficiaries alive at the creation of the trust. Therefore, the benefit of the GST exemption would not last as long as the trust could last, but only as long as the life of a trust beneficiary who is no younger than the transferor’s grandchild or is a member of the younger generation but was alive at the trust’s creation.

    As a result of this proposed change, the use of dynasty trusts, a common planning technique, would be severely limited because they are currently designed as long-term trusts to pass wealth from generation to generation free of all estate and GST taxes. The proposal effectively would eliminate the dynasty trust by making the assets in the trust eventually subject to tax.

Looking ahead at the tax proposals

Individuals should not make changes to their existing plans for wealth preservation and transfer based solely on the Green Book since it only provides the administration’s proposals. However, taxpayers should discuss the tax proposals with their advisers when reviewing their estate plans.

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Peter Trieu
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Lauren Shapiro
Washington National Tax