A lot of attention lately has been focused on the debt ceiling, but advisors also need to watch proposed tax increases in the Biden Administration’s fiscal year 2024 budget.
On March 9, 2023, the Biden Administration unveiled a fiscal year 2024 budget that includes revenue proposals aimed at reducing the federal deficit. Part of the plan includes raising taxes on high-income/high-net-worth individuals and large corporations. Simultaneously, the Treasury released the General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals, also known as the “Greenbook.”
Below are several key changes outlined in the proposal that impact individual taxes, retirement planning, and trust and estate and gift-tax planning. The following is not an all-inclusive list of items in the proposal but touches on important highlights.
Individual income tax changes
Here are a number of income tax changes in the proposal specifically targeting high-income taxpayers:
- Increasing the net-investment income tax (NIIT) rate by 1.2% for taxpayers with more than $400,000 of income (indexed for inflation). This would bring the NIIT rate to 5%. The proposal also calls for increasing the additional Medicare tax by 1.2% for taxpayers over this income threshold. Further, the NIIT base would also be expanded to ensure that all pass-through income of high-income taxpayers would be subject to either NIIT or Self-Employment Contributions Act (SECA) tax. This would be effective after December 31, 2022.
- Increasing the top federal marginal tax rate to 39.6% from 37% on individual income for single filers earning over $400,000, head-of-household filers earning over $425,000 and joint filers earning over $450,000. The thresholds would be indexed for inflation after 2024. This would be effective for tax years beginning after December 31, 2022.
- Taxing long-term capital gains and qualified dividends at ordinary income rates for taxpayers with taxable income exceeding $1 million ($500,000 for married filing separately. These figures, to be indexed for inflation after 2024, would be effective for gains recognized and dividends received on or after date of enactment. Currently, taxpayers with taxable income exceeding $1 million are taxed at preferential rates.
- Imposing a minimum tax of 25% on total income, including unrealized capital gains, for all taxpayers with wealth greater than $100 million. This would be effective for tax years beginning after December 31, 2023.
Retirement plan changes for high-income taxpayers
Another objective in the 2024 revenue proposal is to curb high-income taxpayers from accumulating excessive assets in in retirement accounts. For these purposes, a high-income taxpayer is one with a modified adjusted gross income over $400,000, or $450,000 in the case of married filing jointly, or $425,000 for head of household. These changes would be effective after December 31, 2023. The proposal includes:
- Requiring high-income taxpayers with an aggregate vested account balance under a tax-favored retirement arrangement, including IRAs, in excess of $10 million as of the last day of the preceding calendar year, to distribute 50% of the excess.
- Distributing the lesser of (i) the excess over $20 million, or (ii) the remaining balances in Roth IRAs and designated Roth accounts, if the total vested balance of such an account exceeds $20 million.
- Prohibiting rollovers and conversions to Roth accounts for high-income taxpayers.
Planning with grantor trusts and estate and gift taxation
The 2024 revenue proposal includes a number of estate, gift tax and generation-skipping transfer planning items. The proposal also includes other income tax items meant to limit use of grantor trusts in planning. Additionally, it imposes a tax on unrealized capital gains in appreciated property in certain events, including upon gift or death, with certain exceptions.
Transfers of Appreciated Property
Under the 2024 revenue proposal, a donor or deceased owner of an appreciated asset would realize the capital gain at the time of the transfer, with certain exceptions for transfers to U.S. spouses and charities. Gain on unrealized appreciation would also be recognized by a trust, partnership or other non-corporate entity that owns property that has not been the subject of a recognition event within the prior 90 years. This would apply to property held on or after January 1, 1942 that has not had a recognition event since December 31, 1941. The asset’s first recognition event would be deemed to occur on December 31, 2032. A recognition event might include one of the following:
- Transfers of property into, and distributions in kind from, a trust, other than a grantor trust that is deemed to be wholly owned by the donor.
- Transfers of property to, and distributions by, a partnership or other non-corporate entity, if the transfers have the effect of a gift to the transferee.
- Distribution of assets from a revocable grantor trust to any person other than the deemed owner or the U.S. spouse of the deemed owner, not including distributions made in discharge of an obligation of the deemed owner; or at the deemed owner’s death or at any other time when a revocable trust becomes irrevocable.
A $5 million per-donor exclusion from recognition of unrealized capital gains on property transferred by gift during life will be available. However, this exclusion would apply only to unrealized appreciation on gifts to the extent that the donor’s cumulative total of lifetime gifts exceeds the basic exclusion amount in effect at the time of the gift. This exclusion would be portable to the decedent’s spouse and would be indexed for inflation after 2023.
In addition, there are a number of deferral elections including for family-owned and operated businesses until they are sold or cease to be family owned and operated. A 15-year fixed payment plan may also be available.
The proposal would be effective for gains on property transferred by gift, and on property owned at death by those dying after December 31, 2023, and on certain property owned by trusts, partnerships, and other non-corporate entities on January 1, 2024.
Gift Tax Annual Exclusion
The proposal would impose an annual limit of $50,000 per donor, indexed for inflation after 2024, on a new category of annual gift tax exclusions. This new $50,000 limit would not provide an exclusion in addition to the current annual per-donee exclusion of $17,000. Instead, it would be a further limit on those amounts that otherwise would qualify for the annual per-donee exclusion. The proposal would be effective for gifts made after December 31, 2023.
Currently, a sale between the grantor and an irrevocable trust that is a defective grantor trust is not a taxable event. However, the proposal would make such a sale a taxable event. As a result, the seller would recognize gain on any appreciation in the transferred asset. This would include sales as well as the satisfaction of an obligation (such as an annuity or unitrust payment) with appreciated property. This would apply to all transactions between a grantor trust and its deemed owner or any other person occurring on or after the date of enactment.
Also under the proposal, the payment of the income tax on the income of a grantor trust (other than a trust that is fully revocable by the grantor) would be considered a gift, occurring on December 31 of the year paid, unless the grantor is reimbursed by the trust in the same year. This would apply to all trusts created on or after the date of enactment.
Grantor Retained Annuity Trusts (GRATs)
The proposal would require that the remainder interest in a GRAT at the time the interest is created has a minimum value for gift tax purposes equal to the greater of 25% of the value of the assets transferred to the GRAT, or $500,000 (but not more than the value of the assets transferred).
In addition, the proposal would prohibit any decrease in the annuity during the GRAT term and would prohibit the grantor from acquiring in an exchange an asset held in the trust without recognizing its gain or loss for income tax purposes.
The proposal would also require that a GRAT have a minimum term of 10 years and a maximum term of the life expectancy of the annuitant plus 10 years.
These GRAT changes would apply to all trusts created on or after the date of enactment.
Other Items for Consideration
The proposal contains a number of other items that limit planning opportunities. For example, it would:
- Require that if a gift or bequest uses a defined value clause to determine value based on the result of involvement of the IRS, then the value of that gift or bequest must report that value on the corresponding gift or estate tax return.
- Prevent the ability to create dynasty trusts by generally limiting the use of the GST (generation-skipping tax) exemption.
- Eliminate certain discounts on intrafamily transfers of partial interests in property in which the family collectively has an interest of at least 25% of the whole.
With a divided Congress, the proposed changes may not go far, but it would not be surprising to see certain portions that attract bipartisan support included in legislation.
Keith Grissom, an officer at Greensfelder, counsels businesses and individuals on matters including estate planning and closely held business succession planning. Keith’s experience includes addressing income, estate, generation-skipping transfer and gift tax issues related to estate planning and trust administration.