As professionals, we monitor the progression of proposed tax law changes that might have significant impact on our clients’ planning. In most instances, monitoring is a futile endeavor. This year’s proposed tax changes are no exception.
In the most recent (October 28th) framework, the “never going to happen” and the "slam dunk" proposed changes did not survive.
One of the most talked about (and concerning) proposed changes — eliminating the step-up basis treatment of asset values upon death — falls under the “never going to happen” column and has gone to its final resting place. Likewise, capital gain rates will remain at current law for high income taxpayers. On the flip side, the “slam dunk” proposed changes for defective grantor trusts, a controversial but legal tool to reduce taxable estates, also were removed.
So, what are the primary tax increases?
- S Corporation Shareholders with adjusted income (known as “MAGI”) greater than $400,000 (single)/$500,000 (joint), will pay the 3.8% net investment income tax on S corporation profits. This tax will be phased in.
- Higher Income Surtaxes: A surtax of 5% is assessed on Modified Adjusted Gross Income (MAGI) over $10 million, and an additional 3% above $25 million, regardless of the type of income (ordinary or capital gain). It is likely these surtaxes will also impact tax rates applied to income retained in complex trusts, which accelerate to high tax rates at income levels much lower than individual tax rates.
- Qualified Small Business Stock Treatment: Reduce the 100% capital gains excluded on the first $10 million of gain from sale of a qualified business to 50%.
- A New 15% Corporate Minimum Tax on Large Corporations: Many corporations report zero taxable income, while producing financial statements reflecting profitable operations. This happens because the rules for recognizing expenses or using tax credits as provided in the tax code is different than accounting rules for reporting income. These new rules will purport to lessen the impact of the tax benefits of such difference between tax and financial reporting. Minimum tax assessments are not a new idea. For years, the IRS rules have employed a stringent minimum tax on individuals by tempering the impact of various deductions on reducing income.
- Miscellaneous extensions for various tax credits.
While estate and gift taxes escape any change under these new proposals, it is important to keep in mind that the current exemption levels sunset in 2026. The 2017 Tax Cut and Jobs Act temporarily doubled the exemption amount to the current estate and gift tax exclusion amount to $11.7 million (as adjusted by inflation indexing). Without action by Congress, the exclusion will revert to prior levels in 2026.
But, it ain’t over till it’s over. Tossed proposals occasionally creep back into negotiations as the vote comes near. A couple of days ago, a post-October 28th revision increases allowable state tax deductions for 2022 from the current $10,000 deduction to $72,500 (through 2031).