Apple Growth Partners

Preparing for Potential Income Tax Changes

By Jason Bogniard, ASA, CVA, EA, MBA | Principal

October 11, 2021

In recent weeks the members of the House and Senate have been unable to agree on the amount of the total spending as part of the Congress’ ongoing $3.5 trillion budget reconciliation process. It’s becoming clear that price tag when brought to a vote will be significantly less, as much as half. As a result, many of the proposed tax increases will be lowered, eliminated or otherwise modified. AGP will be keeping a close eye on any developments in the legislative process that will impact the House Ways & Means Committee draft legislation.

Big changes to the United States personal and corporate tax rules are coming. On September 13th , 2021, the House Ways and Means committee offered recommendations to raise revenue to pay for infrastructure investments and other initiatives, many involving raising various income tax rates on wealthy individuals and corporations. It is important to note that the published recommendations are truly only recommendations and both the U.S. House of Representatives and Senate will need to take up formal legislation to put these tax increases into law. However, it is likely that President Biden would  sign such tax increases into law if given the opportunity.

Therefore, what potential tax changes could take place this year or next depending on how fast the U.S. Congress acts? Just a few of the proposed tax changes include:

  • Gift, Estate, and Generation Skipping Tax lifetime exemption declining from the current $11.7 million per individual ($23.4 million for a married couple) to 2011’s amount adjusted for inflation or, $6.0 million per individual ($12 million for a married couple).
  • Elimination of valuation discounts, including for lack of control and lack of marketability, when valuing entities that hold “non-business” passive assets and investments.
  • Top Long-Term Capital Gain tax rate increasing from 20.0% to 25.0% for individuals with income in excess of $400,000. The additional 3.8% Net Investment Income Surtax would continue to apply and the types of income it applies to would expand to include active pass-through business income.
  • Top individual income tax rate would revert back to the pre 2018 level of 39.6% from 37.0%.
  • Corporate income tax rates would change from the current flat 21% to three brackets including 18% for income under $400,000, 21% from $400,000 to $5.0 million and 26.5% for income over $5.0 million.
  • The Section 199A 20% deduction for most passthrough business income to be capped the amount of the deduction to $500,000 for couples and $400,000 for single fillers.

There are many other proposed changes to the tax code, including a host of changes to grantor trusts commonly used in estate planning, which are beyond the scope of this article.  No matter if any of the proposed changes become law, it is clear that the democratic-controlled Congress is looking to make good on President Biden’s agenda to increase income and estate taxes on businesses and higher income earners.

So, what steps can business owners and higher-income earners take to lessen the impact of potential tax increases? There are many: some of the most effective wealth preserving strategies involve estate planning. These techniques often involve employing an independent business valuation of the ownership interest in question.

Maximizing Valuation Discounts While They Last

The current estate and gift tax lifetime exemption amounts are a lofty $11.7 million for individuals and $23.4 million for a married couple. The current tax law change recommendations would basically half these amounts. Outright gifts or sales of business ownership interests to properly structured trusts can lock in the current favorable estate and gift tax exclusion levels. The specifics of each technique are beyond the scope of this article, particularly in light of the significant proposed changes to grantor trust, and are best explored with seasoned estate planning legal counsel.

However, one very common estate planning vehicle will potentially be taken off the table and is worth discussing. The proposed legislation targets a very effective and commonly used estate planning technique which is the use of family owned and controlled partnerships and limited liability companies as holding companies for passively held wealth including marketable securities, real estate and other passive investments. The strategy typically involves gifting non-controlling (less than 51% ownership interests) in the partnership or limited liability company, which holds the passive assets to family members. These gifts typically will have a fair market value well below their respective pro-rata share of underlying asset value due to the proper use of a discount for lack of control (typically %5 to 25%) and a separate discount for lack of marketability (typically 5% to 40%). The proposed changes provide that no valuation discount is permitted for “non-business assets.” Non-business assets are passive assets that are held for the production of income and not used in the active conduct of a trade or business.  Investment real estate and marketable securities clearly fall within the definition of non-business assets. There are some exceptions to the non-business asset definition, but none as of the date of this article that would exclude investment real estate and marketable securities. These provisions are written to be effective for tax years beginning after December 31, 2021.

Any individual with remaining estate and gift tax exclusion should consider using the remaining lifetime exclusion prior to year-end. This is particularly true if the individual’s estate includes appreciating passive assets such as real estate and marketable securities.

While the final legislation is yet to be determined, including a date of potential implementation, Apple Growth Partners advises business owners and high-net-worth individuals to prepare for changes proactively. Along with monitoring pending developments, contact your AGP professional for a detailed review of your portfolio for personalized recommendations and scenarios.

Subscribe to receive our blog and other interest based updates.