navigating possible tax policy changes

N A V I G A T I N G P O S S I B L E T A X P O L I C Y C H A N G E SI N S I G H T A T T H E I N T E R S E C T I O N O F C H A N G I N G T A X P O L I C Y A N D M A N A G I N G C O M P L E X W E A LT H

Congressional debate continues to shape the form of potential tax policy changes designed to fund President Biden’s proposed “Build Back Better” spending package.

Currently, the Democratic Party is working toward a $1.75–$1.9 trillion bill, down

from the original $3.5 trillion plan the White House proposed. To fund the new

proposed spending, two notable bills have been put forth in the House:

September: House Ways and Means Committee Bill Designed to fund a larger $3.5 trillion bill, this bill called for notable tax changes

like increasing the individual, corporate and capital gains rate, limiting grantor

trusts, and reducing the gift and estate exemption, among others.

Late October/Early November: House Rules Committee Bill Revenue-raising measures in this reduced $1.85 trillion bill include a surcharge

on individuals and trusts, expanding the Net Investment Income Tax, and IRA

restrictions, among others.

At the time of writing, the “Build Back Better” package and its specific proposals’

political pathway remains uncertain, complicated by several complex, and

rapidly evolving, Congressional dynamics. Omission of previously proposed

measures in the latest House Rules bill does not imply that they are off the table

for future legislation.

We continue to advise that it is far better to plan than predict as the political

environment suggests that some degree of change is probable. As such, we will

continue to communicate on the latest proposals and corresponding advice, as

developments merit.

N A V I G A T I N G P O S S I B L E T A X P O L I C Y C H A N G E S2

L I K E L I H O O D O F P O S S I B L E C H A N G E S

Proposed by House Rules Committee in October Proposed by House Ways & Means Committee in September Other Proposal

U N L I K E LY

Limit 1031 Exchanges

Eliminate the ability to defer capital gains tax on real estate exchanges for gains above $500,000

Eliminate Basis Step-Up at Death

Eliminate step-up basis — the increase of an asset’s basis to the property's fair market value at the date of the previous owner's death — for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions)

Reinstate Itemized Deduction, with Limitations

• Limit benefit of itemized deductions to 28% rate

• Reinstate Pease limitations for taxpayers with income greater than $400,000

L E S S L I K E LY

Reduce Gift and Estate Tax Exemption to $5 Million

• Exclusion applies to each individual and is indexed to inflation

• To start January 1, 2022

• Tax rate increase not proposed

Increase Carried Interest Holding Period

• Increase the holding period from 3 years to 5 years for carried interest to be taxed at capital gains rates

• Effective after December 31, 2021

Billionaires Income Tax

• Marketable assets will incur a capital gains tax on unrealized gains each year, regardless of whether the assets were sold during the year

• Applicable to individuals and married couples who have for three consecutive years $1 billion in assets, or $100 million in income (or a combination thereof)

Limit Individual Deduction for Qualified Business Income

Limit the maximum allowable deduction for individuals for qualified business income to $500,000 for joint returns and $10,000 for trusts or estates

Grantor Trust Limitations

• Significantly limit the use of grantor trusts in several estate planning strategies

• Effective for new trusts and contributions to existing trusts on or after date of enactment

Raise State and Local Tax (SALT) Deduction

• Raise the $10,000 cap on the state and local tax deduction to $72,500

• Extend cap through 2031

• Retroactively effective after December 31, 2020

Increase Top Individual Income Tax Rate to 39.6%• Joint filers with $450,000+ taxable income

• Single filers with $400,000+ taxable income

• Estates and trusts with $12,500+ in taxable income

• Effective after December 31, 2021

Increase Capital Gains Tax Rate to 25%• Increase the capital gains rate to 25% from 20%

• Effective for sales as of September 13, 2021, unless binding contract as of September 13 and sale occurs by year-end

M O S T L I K E LY

Surcharge on Individuals and Trusts

• Individuals: 5% surtax on modified adjusted gross income (AGI) over $10 million, and an additional 3% on modified AGI above $25 million

• Trusts & Estates: 5% surtax on modified AGI over $200,000, and an additional 3% on modified AGI over $500,000

Prior House Ways and Means Committee proposal included a lower modified AGI and trust/estate threshold with a 3% tax

Limit the Qualified Small Business Stock Exclusion• Limitation of the qualified small business stock

exclusion to 50% for most sales of QSBS after September 13, 2021

• Applies to taxpayers whose adjusted gross income exceeds $400,000 and trusts and estates at all income levels

Limit Excess Business Losses of Noncorporate Taxpayers• Limitation on excess business losses would no

longer sunset after 2025

• Disallowed losses may be carried forward into the following tax year

• Retroactively effective after December 31, 2020

Expand the 3.8% Net Investment Income (NII) Tax• 3.8% NII tax on business profits for material

participants making over $400,000

• 3.8% NII tax on joint filers over $500,000 and all trust and estates (regardless of income levels)

IRA Restrictions

• Prohibit individuals from making additional contributions to IRAs if the total value exceeds $10 million

• If IRA exceeds $10 million, at least 50% distributions are required

• End “backdoor Roth” conversion strategy

Corporate Tax Rate• A 15% minimum tax on corporations with more

than $1 billion in profits

• 15% global minimum tax on corporations

Prior proposal included a graduated tax rate increase instead of minimum


M O S T L I K E LY C H A N G E S

All included in the latest bill from the House Rules Committee, we discuss

the most likely potential tax changes, provide analysis surrounding their

impacts and offer corresponding wealth planning strategies.

M O S T L I K E LY

B U S I N E S S LO S S E S O F N O N C O R P O R A T E T A X PAY E R S

Q U A L I F I E D S M A L L B U S I N E S S S T O C K E X C L U S I O N

C U R R E N T L A W

Excess business losses (business deductions in excess of business income) are limited to a taxpayer’s aggregate deductions less any gross business income, plus a threshold amount adjusted for cost of living ($262,000 for individuals and $524,000 for joint filers in 2021). This limitation on excess business losses is set to sunset after December 31, 2025

P R O P O S E D C H A N G E

Limitations on excess business losses of non-corporate taxpayers would be made permanent (and would not sunset); however, any disallowed amounts may be carried forward to the following year

C U R R E N T L A W

Certain taxpayers may exclude up to 100% of the eligible gain from the sale or exchange of “qualified small business stock” held for more than five years


Limit the QSBS exclusion to 50% for most sales of QSBS after September 13, 2021 for taxpayers whose adjusted gross income exceeds $400,000 and for trusts and estates (for all income levels)

O U R T A K E

The Tax Cuts and Jobs Act placed limits on the ability of individual to use business losses to offset other ordinary income, with these limits sunsetting after 2025. Under the proposal, the limitations would be made permanent for tax years after 2020.

O P P O R T U N I T I E S F O R A C T I O N

Reassess the timing of future deductions and business losses in anticipation that the limits on excess business losses will no longer be lifted after 2025. Consider reevaluating business and holding company structures to spread deductions across entities in order to remain below the excess business loss limitation threshold.

O U R T A K E

The QSBS exemption is a valuable tax planning strategy for long-term investors in certain small businesses that provides significant capital gains deferral of up to 100% of eligible gains. The new proposal would effectively cut this tax benefit in half for certain investors. There may, however, be constitutional challenges to this proposal that argue the proposal retroactively removes a tax benefit that was originally intended to incentivize investment in small businesses.


If you currently hold QSBS eligible for capital gains deferral, assess the cash flow implications if the tax proposal is enacted and, if feasible, consider spreading out the sale across multiple years to offset any gains with other losses

S U R C H A R G E O N I N D I V I D U A L S , T R U S T S A N D E S T A T E S

P R O P O S A L

An income surtax applying a 5% percent rate on modified adjusted gross income (AGI) over $10 million, and an additional 3% (8% total) on modified AGI above $25 million. The income surtax thresholds are lower for trusts, applying a 5% surtax on modified AGI over $200,000, and an additional 3% surtax on modified AGI over $500,000

O U R T A K E

For those impacted by the 8% surtax, the change would bring the capital gain tax rate to 31.8%, including the 3.8% NIIT tax, and ordinary income rate to 45%. Note that, if enacted, the tax rates for non-grantor (taxable) trusts would generally be significantly higher if the trust accumulated the income, rather than distributing such income out to individual beneficiaries.


Explore income smoothing strategies to manage tax brackets and, when dealing with taxable trusts, consider distributing such income out to beneficiaries.

Proposed by House Rules Committee and House Ways and Means Committee




M O S T L I K E LY

N E T I N V E S T M E N T I N C O M E T A X

C U R R E N T L A W

3.8% tax on net investment income of individuals, trusts and estates


An expansion of the 3.8% net investment income (NII) tax to business profits for material participants making over $400,000, joint filers over $500,000 and all trust and estates (regardless of income levels)

O U R T A K E

While individuals are already subject to the net investment income tax on investment income, this change, as proposed, would bring the highest ordinary income rate to 40.8% for individuals with trade or business income. The NII tax would also apply to income from trusts and estates.


Consider strategies for managing income thresholds, such as maximizing contributions to IRAs, qualified retirement plans, and participating in nonqualified deferred compensation plans. For trusts and estates, consider contributing assets to a charitable remainder trust.

I R A R E S T R I C T I O N S

P R O P O S E D C H A N G E S

• Prohibition on Roth conversions for taxpayers with AGI above $400,000 (or $450,000 for married filing jointly), effective 2032, and general prohibition on Roth conversion of amounts held in qualified retirement plans, except to the extent the conversion is taxable, effective 2022

• Prohibition on contributions to retirement accounts (other than SEP and SIMPLE IRAs) when the total value of all defined contribution accounts and IRAs (including inherited accounts) is $10M or more, but only for taxpayers with AGI above $400,000/450,000, effective 2029

• Mandatory distribution of 50% of excess over $10M and mandatory distribution of all excess over $20M to be paid exclusively from Roth accounts, effective 2029

O U R T A K E

These changes would quickly reduce the value of high-balance IRAs and accelerate tax revenues from taxable accounts. The prohibition on Roth conversions seeks to prevent “back-door” Roth IRA funding, including “mega-back-door Roth IRAs,” which use qualified plan accounts to purchase shares in one account and roll them to a Roth IRA prior to a big increase in value. As of the end of this year, all Roth conversions from qualified plan accounts will only be permitted to the extent they are taxable.

Under the latest House Rules Committee proposal, the effective date is set further out to 2029 (from 2022) for both proposed rules targeting large IRA account balances. In addition, the more recent proposal does not prevent the purchase of interests in private placement investments.


• Before the end of this year, those who have automated after-tax contributions to their employer plans should review these elections and terminate all after-tax contributions, in most cases. Those who expect high income beyond 2031 should consider whether and how to benefit from a Roth conversion prior to 2032.

• Individuals with overfunded retirement accounts should consider shifting investment strategies between their retirement and taxable accounts so that fast-growing equity interests are in taxable accounts and bonds are held in retirement accounts.

• Those who have private placement investments in their IRAs should begin the process of redeeming their interests.




L E S S L I K E LY C H A N G E S

Despite previous proposals, the following measures’ political path

forward remains uncertain in an evenly divided congress.

L E S S L I K E LY

G I F T & E S T A T E T A X ( T R A N S F E R T A X )

C U R R E N T L A W

$11.7 million estate tax exemption, reverts to $5 million (inflation-adjusted) after 2025


The proposal would decrease the current exemption by half, reverting to $5 million per individual, indexed for inflation ($5.85 million)

O U R T A K E

The 40% rate did not change in the proposal, and retroactivity is not included. Note that under an additional proposal, taxpayers would no longer be permitted to utilize valuation discounts for transfer tax purposes when transferring entities holding non-business assets (passive assets not used in the active conduct of a trade or business). The removal of valuation discounts for non-business assets would have significant planning implications for families who hold assets in family limited partnerships and other pass-through entities.

If your taxable estate is above federal and/or state estate tax exemption amounts, understanding your estate tax liability is critical. Many people do not realize certain assets are included in their estate for estate tax purposes, such as individually owned life insurance. Also, numerous states have exemption amounts far below federal limits, so you may owe state estate tax and not be aware of it. If you are confident you have enough wealth to support your lifetime goals, various wealth transfer strategies can move excess wealth — and future growth on the assets you transfer — out of your taxable estate.


• Considering using the 2021 exemption to move assets out of your estate by end-of-year (or prior to enactment, if grantor trusts are utilized).

• Utilize valuation discounts for transfers prior to year-end where feasible and, going forward, consider revisiting the tax implications of how business interests and other assets are held across family limited partnerships and other passive entity structures.

Proposed by House Ways and Means Committee

I N D I V I D U A L I N C O M E T A X

C U R R E N T L A W

37% top individual ordinary income tax rate


Increase the top individual ordinary income tax rate to 39.6% for those making $400,000 or more

O U R T A K E

With the top individual ordinary income tax rate at a historical low, the proposed increase is relatively small and would return the top rate to 2013-2017 levels.


• Identify areas to accelerate near-term income, and consider deferring deductions and bunching charitable deductions next year, when rates may increase.

• Consider IRA Roth conversions, while remaining mindful of potential new rules impacting retirement accounts, discussed in the IRA Restrictions section on page 6.



L E S S L I K E LY

LO N G - T E R M C A P I T A L G A I N S A N D Q U A L I F I E D D I V I D E N D S

C U R R E N T L A W

The top rate is 20% for long-term capital gains and qualified dividends (+3.8% net investment income tax)


The proposal would increase the capital gains rate to 25% from 20%, effective for sales after September 12, 2021

O U R T A K E

As noted, the proposal would be effective for sales after September 12, 2021, unless the seller had a binding contract entered into before that date and the sale occurs by year-end. Significantly, the proposal cuts current 75% and 100% exclusion rates for qualified small business stock (QSBS, sec. 1202) gains for those earning more than $400,000. A baseline 50% exclusion, however, would remain available. Though we believe there is a chance the changes to sec. 1202 could be advanced, expect challenges to the constitutionality of such changes if they materially negate the tax benefit of existing incented investments.


• If passed as proposed, the opportunity to realize capital gains at the previous lower rate has passed. That said, it is worth reiterating that achieving your goals, rather than fluctuating tax laws, should drive planning decisions. If you need liquidity to fund short-term goals, consider lending alternatives or pairing sales with tax loss harvesting.


G R A N T O R T R U S T L I M I T A T I O N S


The proposal would significantly limit the use of grantor trusts in several estate planning strategies, including grantor retained annuity trusts (GRATs), spousal lifetime access trusts (SLATs), individual life insurance trusts (ILITs), intentionally defective grantor trusts (IDGTs), beneficiary deemed owner trusts (BDOTs) and beneficiary defective inheritance trusts (BDITs).

O U R T A K E

This proposal would negate the value of the above-listed trust strategies, as any grantor trust formed on or after the date of enactment would eventually be subject to transfer taxes (estate or gift tax). In addition, any transfer of property between such trust and the grantor would be treated as a taxable sale for income tax purposes. Existing grantor trusts would be “grandfathered,” but any portion attributable to a future contribution to such trust would not. Depending on the interpretation of contribution, there does not, however, seem to be any restriction on bona fide sale transactions between the grantor and such grandfathered trusts.


If you are confident you can fund your lifetime goals and wish to minimize your taxable estate, consult your advisor about funding the appropriate grantor trust, with an amendment power, before the date of enactment.



L E S S L I K E LY

C A R R I E D I N T E R E S T

C U R R E N T L A W

Carried interest is taxed as capital gains


Increase holding period from 3 years to 5 years for carried interest to be taxed as capital gains (with exclusions for real property, trades or businesses and certain taxpayers)

O U R T A K E

The House proposal fell short of the Biden administration’s initial proposal of taxing interest private equity managers earn from their investments as ordinary income. However, carried interest that does not meet the extended five year holding-period would be subject to the tax rate for ordinary income under the current proposal.


• Revisit the fee structure to account for after-tax returns.

• Consider creating co-investment vehicles to pool money from the firm’s fund managers and other investors alongside the fund to continue to receive capital gain tax treatment under traditional shorter holding periods.

• Time charitable donations to minimize the tax impact of carried interest.


S A LT D E D U C T I O N

C U R R E N T L A W

The State and Local Tax (SALT) deduction was capped at $10,000 in 2017 and is scheduled to sunset in 2025


Increases the SALT cap from $10,000 to $72,500 with a scheduled sunset in 2031. The change would be effective retroactively after December 31, 2020

O U R T A K E

Several issues and conflicting priorities are at play as all levels of government work to address budget deficits. In particular, lawmakers in high-tax states are seeking a full restoration of the deduction to stem the steady flow of residents to lower-tax states. In typical legislative tug-of-war, one possible outcome could be something short of either a full restoration or repeal. While the SALT proposal as written includes partial cap relief as well as an extension to the sunset period, this version of the deduction may draw compromise on a point that has been highly contested among lawmakers.

O P P O R T U N I T Y F O R A C T I O N

If you are considering moving out of a high-tax state, work with your advisors to understand and prepare for the financial implications of your move.

Proposed by House Rules Committee

N A V I G A T I N G P O S S I B L E T A X P O L I C Y C H A N G E S1 0

B I L L I O N A I R E S I N C O M E T A X

P R O P O S A L

Individuals and Married Couples:

• Applicable to individuals and married couples who have for three consecutive years $1 billion in assets, or $100 million in income (or a combination thereof)

• Taxpayers’ marketable assets will be marked to market annually and will incur a capital gains tax on unrealized gains regardless of whether the assets were sold during the year

• In subsequent years, taxpayers would pay capital gains taxes on any increase, or take a deduction for any decreases, whether or not they sell

• Hard-to-value assets, such as real estate, private businesses and art, would not be part of the annual mark-to-market tax levy and, instead, gains would be taxed when these assets are sold or, in some cases, otherwise transferred (via “applicable transfers”)

• When the asset is sold, taxpayers would pay a “deferral charge” akin to interest charged on deferred capital gains tax for each year the asset was held

• The capital gains tax and deferred charge together are not to exceed a total tax cap of 49%

Trusts:

• Applicable to trusts (other than grantor trusts) that have $100,000,000 in assets or $10,000,000 in income (or a combination thereof) for three consecutive years

• Pooled income funds, Charitable trusts and certain “split-interest” and other specified trusts are exempt

• Gifts, bequests and transfers made through trusts would trigger gain unless the transfer is to a spouse or charity

• Dynasty trusts set up to pass wealth through generations would have to pay taxes with deferral charges on property at least every 90 years

• Special rules apply to irrevocable grantor trusts

O U R T A K E

At a high level, this type of taxation presents several challenges:

• Asset values can fluctuate greatly

• Despite an asset increasing in value, the owner may not have cash to pay taxes (even with the five year installment election the first year)

• Taxpayers could move in and out of qualifying for this tax

• Taxing unrealized gains could force a sale of significant assets, some of which may be subject to company- or government-imposed restrictions, and material sales could move market prices

• The measure would result in a significant tax bill for billionaire families who have taken their company public and continue to hold very low basis stock in the company, complicated further if the family’s shares are subject to various super-voting provisions/structures

This concept differs from a “wealth tax,” discussed by other members of Congress, that would impose a small tax on the net worth of the wealthiest taxpayers each year.

In total, approximately 700 individuals would be impacted by the proposal. The measure would reportedly bring in $200-$250 billion over 10 years — roughly 10% of the amount needed to fund the current $1.7-$1.9 trillion package, Speaker Nancy Pelosi said. It is unclear how the reported revenue expectations are calculated and will be scored by the Congressional Budget Office.

The constitutionality of this tax measure could also be called into question.

L E S S L I K E LY

Other Proposal


U N L I K E LY C H A N G E S

The following tax proposals have been discussed by members

of congress and the White House, but have not been included in

draft bills from the House. While we believe these changes are

unlikely to become law as part of the reconciliation package, it is

possible that they could be revisited.

I T E M I Z E D D E D U C T I O N S

C U R R E N T L A W

No cap on itemized deductions, Pease limit suspended through 2025, Cap on the State and Local Tax (SALT) deduction


Previous proposals have advocated capping value at 28% and reinstating the Pease limit for income greater than $400,000, but neither item was advanced in the House Ways and Means Committee’s tax draft plan

O U R T A K E

Deferring deductions typically makes sense when they are more valuable to be used against higher rates. However, if these limitations were to go into effect, the result would mean taxpayers earning more than $400,000 with rates higher than 28% would face limited itemized deductions.


• Determine if it makes sense to accelerate charitable gifts in 2021 before any constraints on contributions take effect.

• Consider deduction of up to 100% of adjusted gross income for cash gifts to public charities under the CARES Act.

B A S I S S T E P - U P A T D E A T H

C U R R E N T L A W

The cost basis of assets is “stepped-up” to fair market value as of date of death, resetting the tax basis to fair market value, in turn reducing capital gains taxes owed


The House Ways and Means Committee’s tax draft did not address the basis step-up at death. In previous proposals, a realization of capital gains — in excess of $1 million per person — would be triggered upon transfer of appreciated assets at death or by gift, including transfers to and distributions from irrevocable trusts and partnerships. The proposal would provide certain protections for family-owned and operated businesses (which may or may not include farms), effective January 1, 2022.

Gains on unrealized appreciation would be recognized by a trust, partnership or other non-corporate entity if that property has not been the subject of a recognition event within the prior 90 years — with the first possible recognition event to take place on December 31, 2030. Under the proposal, gains at death could be paid over 15 years (unless the gain comes from liquid assets such as publicly traded securities). There would be no partial interest discount on any transfer nor gain recognition for transfers to spouses or charities at death.

O U R T A K E

Because any changes to this part of the tax code will be complex and difficult to execute, a total repeal of the rules, without substantial exemptions, is unlikely. Elimination of step-up in basis was tried before, in the 1970s, but was ultimately abandoned before implementation due to complexity.


• If the step-up in basis rules remain, consider maintaining low-basis assets in your estate, especially if your estate does not exceed the exemption amount and you are well into retirement.

• Work with your advisors to carefully analyze the viability of using the step-up in basis rules and the risk associated with continuing to hold low basis assets in a rising tax environment.

• Ensure trust vehicles incorporate flexibility to swap assets in and out of the trust depending on what is beneficial from an income tax standpoint once the final rules are structured.

• Make sure your assets are properly aligned with your goals. Under current law, low-basis assets are useful for both philanthropic and future wealth transfer goals. If the proposed change is passed, consider prioritizing philanthropic giving.

U N L I K E LY

Not Formally Proposed by Congress



1 0 3 1 E X C H A N G E S

C U R R E N T L A W

Defer capital-gains taxes on the sale of one property by reinvesting the proceeds in a similar property within 180 days


Minimize the benefit to only allow a deferral of $500,000 per year or $1 million if filing a joint return

O U R T A K E

The proposed tax change would potentially have a significant impact on families transitioning real estate assets, real estate investors reacting to an unsolicited offer or looking to retire with more passive assets, and business owners intending to use the proceeds from the sale of their business to build out a real estate portfolio. The current proposal would be effective January 1, 2022; however, it is unclear whether a taxpayer who enters into a 1031 transaction in 2021 but closes the transaction in 2022 would be subject to the new limitation.


Revisit your real estate holdings and investment plan:

• Understand the tax basis and hold period for each of your real estate investments.

• Identify legacy assets you are willing to hold indefinitely.

• Consider entering into a 1031 exchange transaction for low-performing or highly appreciated investment properties before year end (and ideally closing the transaction before year end if feasible).

U N L I K E LY



N O R T H E R N T R U S T. C O M / I N S T I T U T E

LEGAL, INVESTMENT AND TAX NOTICE. This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.

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navigating possible tax policy changes

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