As we launch into the second quarter of the year, there are many new and proposed laws which impact or may impact businesses and wealthy individuals. Lobb & Plewe will do our best to keep you updated as we move forward.

Proposed Federal Tax Law Changes:

On March 28, 2022, President Biden released his fiscal year 2023 budget (the “2023 Budget”) which consists of approximately $5.7 trillion in spending. The U.S. Treasury has released the “Green Book,” which provides details related to revenue provisions in the 2023 Budget. The revenue proposals in the 2023 Budget rely on a baseline that presumes enactment of the revenue provisions in the Build Back Better Act (the “BBBA”) as passed by the House of Representatives on November 19, 2021.

The revenue proposals described in the Green Book are intended to be in addition to the provisions in the BBBA. This is a curious story line because the BBBA stalled in the Senate at the end of 2021 and never became law.

It is up to Congress to pass a budget so the revenue proposals in the 2023 Budget may be included in future legislation. The way the proposed budget is being presented by the Administration appears to be a plea for Congress to enact pieces of the BBBA in order to declare a win in the context of the failed proposed legislation in 2021.

To raise revenue to pay for the spending contained in the FY2023 Budget, high-net-worth individuals and businesses are the piggy bank. The focus of the revenue raising proposals, encompass raising individual tax rates, raising capital gain and qualified dividend rates, taxing exchanges between grantors and grantor trusts, imposing restrictions on grantor retained annuity trusts and taxing dispositions of appreciated property at death. A summary of the proposed changes of interest to high-net-worth individuals include the following:

• An increase in the C corporation tax rate from 21% to 28%.
• An increase to the top marginal individual income tax rate from 37% to 39.6%. For taxable year 2023, the rate would apply to taxable income over $450,000 for married individuals filing jointly ($225,000 for married individuals filing separately), $425,000 for head of household filers and $400,000 for single filers. This proposal will be effective for taxable years beginning after December 31, 2022.
• A limitation on gain deferred under IRC section 1031 to $500,000 for a single filer and $1MM for married individuals filing a joint return per taxpayer per year.
• The imposition of ordinary income tax rates on long-term capital gains and qualified dividends for taxpayers with taxable income exceeding $1MM. If the proposal for raising the ordinary income tax rate to 39.6 % becomes law, then the maximum tax rate on capital gains would effectively be 43.4% (39.6% plus net investment income tax rate of 3.8%).
• The application of ordinary income tax rates and self-employment tax for partners with taxable income from all sources exceeding $400,000. This subjects a partner’s allocable share of income from profits interests in investment partnerships such as carried interest to tax as ordinary income and self-employment tax regardless of the character of the income at the partnership level.
• A wealth tax which consists of a minimum tax of 20% on taxable income, inclusive of unrealized capital gains, for taxpayers with a net worth in excess of $100 million. Payments of the minimum tax will be treated as a prepayment available to be credited against taxes on future realized capital gains. The minimum tax liability in subsequent years will equal 20% of (1) the taxpayer’s taxable income and unrealized gains reduced by (2) the taxpayer’s unrefunded, uncredited prepayments and regular tax. The tax due for the first year can be paid in nine equal annual installments. For subsequent years, the minimum tax could be paid in five equal annual installments.
• The proposal does not eliminate the $500,000 exclusion currently available to joint filers nor the $250,000 for unmarried filers, upon the sale of their principal residence. It also does not eliminate the current exclusion on the sale of qualified small business stock under IRC 1202.

Estate Planning Changes:

Once again, the Administration seeks to limit estate tax planning. The proposal includes the following in the context of estate planning:

Transfers of appreciated assets by gift or death will be treated as realization events subject to capital gains tax, subject to a $5MM per donor lifetime exclusion. The proposal to tax unrealized capital gains on transferred appreciated property upon the occurrence of certain realization events, include:

• Transfers of appreciated property by gift.
• Transfers of appreciated property on death.
• Transfers of property to, or distributions of property from, trusts, other than wholly revocable trusts.
• Distributions of property from a revocable grantor trust to any person other than the deemed owner or U.S. spouse of the deemed owner, other than distributions made in discharge of an obligation of the deemed owner.
• Terminations of a grantor’s ability to revoke a trust at death or during life.
• Transfers of property to, and distributions of property from, partnerships or other non-corporate entities if the transfer is a gift to the transferee.
• Recognition of gain on the unrealized appreciation of property held by trusts, partnerships or other non-corporate entities.

The proposal allows for some exclusions which include the following:

• Transfers by a donor or decedent to a U.S. spouse will not be a taxable event, and the surviving spouse will receive the decedent’s carryover basis. The surviving spouse will recognize the gain upon disposition or death.
• Transfers to charity will not generate a taxable capital gain. Transfers to a split interest trust, such as a charitable remainder trust, will generate a gain with an exclusion allowed for the charity’s share of the gain. Transfers of tangible personal property, such as household furnishings and personal effects are excluded. This exclusion does not include collectibles.
• Once a donor has exhausted the lifetime gift exemption, the proposal allows a $5MM per donor exclusion from the recognition of additional unrealized capital gain on property transferred by gift or held at death. Any unused exemption by a deceased spouse would be portable to the surviving spouse, effectively making the exclusion $10 million per couple. This additional exclusion amount would be indexed for inflation after 2022. The transferee’s basis in the property shielded by this exemption will be the fair market value of the property at the time of the gift or the decedent’s death.

If passed into law, the proposal will be effective for transfers by gift, and on property owned at death by decedents dying after December 31, 2022, and on property owned by trusts, partnerships and other non-corporate entities on January 1, 2023.

The proposal allows payment of the tax on the appreciation of certain family owned and operated businesses to be deferred until the business is sold or ceases to be family owned and operated. The capital gains tax on appreciated property transferred at death is eligible for a 15-year fixed rate payment plan. Family businesses electing the deferral will not be eligible for the payment plan. Furthermore, contributions of appreciated property to charitable remainder trusts, will no longer have the favorable tax treatment afforded under current law.

Planning in 2022:

We are back to the same looming uncertainty experienced in 2021 as to how to plan for taxable events and estate tax. Because of Democrats not coming together to support the full BBBA, the manner in which the BBBA has been delivered to Congress by the Administration, it is clear the Administration is looking for pieces of the BBBA to be consumed in the final budget. Some of the “pieces” such as the wealth tax have been altered, but the underlying theme of raising taxes on companies and individuals to cover the massive budget remain. Which pieces will survive? Guessing could be costly so my mantra of “plan for the worst and hope for the best” will be repeated this year.

As to the changes in tax rates, planning early is best. If the changes in capital gains are to occur, the changes may be made with a retroactive effective date. This was the push by Democrats in 2021. Contrary to the opinion of some legal pundits, Congress can enact retroactive tax legislation. The Supreme Court unanimously upheld a retroactive increase in the estate tax rate in the 1994 case of United States v. Carlton. There are a few hurdles, but it can be done.

As to estate tax planning, many people began the creation and funding of grantor trusts in 2021 but did not complete the effort when it became clear the BBBA was not going to get through the Senate. If you have begun the process of creating and funding a grantor trust, it is a good idea to pick up where you left off.

If you have not begun the process, now is the time. Like 2021, professional advisors assisting clients with estate planning will become overloaded with work and may stop taking in new matters earlier in the year than normal.

In the context of estate planning, the revenue generating provisions of the 2023 Budget materially alters the rules for recognition of income when it comes to capital assets. Under current law, there generally must be a sale or exchange of property to generate a capital gain. The proposal will “deem” a sale when there was no sale. You must consider an estate’s likely liquidity. To pay the tax, the taxpayer will need cash to pay the capital gains tax. If the estate will not have sufficient cash, life insurance options must be considered.

Sales between a grantor and the grantor’s intentionally defective trust are not currently taxable events. The proposal will recognize such sales and require the seller to recognize gain on the sale of appreciated assets. It is imperative to understand the size of a taxable estate under the current rules as opposed to the rules which will exist if the 2023 Budget is passed in order to evaluate the planning which needs to be accomplished. An updated financial plan will be a great place to start.

The proposal will overturn IRS Revenue Ruling 85-13, which disregarded transactions between a grantor and the grantor’s trust for income tax purposes. This proposal will not be retroactive to transactions which occur before passage of the 2023 Budget. Under no circumstances should planning of this nature be delayed to the end of the year. Hastily structuring installment sales into grantor trusts is not prudent.

This article briefly touches on some of the provisions of the 2023 Budget and the fallout for companies and wealthy individuals, but it should spur some concern to plan now and not wait for the end of the year to see how things are going to settle. We are already in the second quarter of the year and it is not advisable to wait to the fourth quarter to start planning so we are left with five months to start and finish a comprehensive strategy to deal with the 2023 Budget. Provisions will obviously change but there will be a budget and the attack on companies and wealthy individuals will be a source of revenue funding.