Planning for high-net-worth families with possible tax law changes

If certain proposed changes to federal tax law pass, they could have a big effect on high-net-worth individuals and families.
While it is unclear exactly what changes will go through, now is the time for people who might be affected to plan ahead.
Currently, individuals can give up to $11.7 million in assets during life or at death without paying gift or estate taxes. Couples can give up to $23.4 million without paying these taxes.
These exemption levels are the highest they have ever been. They are scheduled to sunset on Dec. 31, 2025, reverting to pre-2018 levels in 2026. The exemption will go back down to between $6 million and $7 million, adjusted for inflation (with twice that amount for a couple).
At that time, gifts larger than those amounts will incur gift or estate tax at approximately 40% of the amount transferred.
Under current law, a recipient of a gift or bequest is not required to pay income taxes on the amount received. Instead, a recipient of a lifetime gift takes a “carryover” in basis in the gift, retaining the basis of the person who made the gift. That means that the unrealized gain the giver accrued will be taxed when the recipient sells the asset.
Assets transferred at death are given a “step-up” in basis to fair market value, which removes any unrealized gains in the assets owned at the time of death.

Changes proposed

In May, the U.S. Treasury Department released General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals laying out the Biden administration’s revenue proposals.
Here are the proposals that could affect high-net-worth taxpayers:

Income tax rates would increase.

The top income tax rate for individuals (and likely trusts) would increase from 37% to 39.6%. That was the rate prior to 2018. In 2022, the new rate would apply to taxable income over $509,300 for joint filers and $452,700 for single filers. After 2022, the tax rates would be adjusted based on inflation.

Taxes on long-term capital gains and qualified dividends would change.

Long-term capital gains and qualified dividends would be taxed at ordinary income rates for taxpayers with adjusted gross incomes over $1 million ($500,000 for married filing separately). The result would be a federal tax rate as high as 43.4%, which is equal to a proposed tax rate of 39.6% plus 3.8% Net Investment Income Tax. The higher tax rate would apply only to the portion of a taxpayer’s adjusted gross income that is greater than $1 million. The change would be retroactive to April 2021.

Gifts and transfers at death would be “income realization events.”

Under the proposals, any gifts and transfers at death would be treated as “income realization events.” In essence, that means that gifts and bequests would be treated as though the donor (1) sold the property and realized any gain or loss; (2) repurchased the property; and (3) gifted identical replacement property.
As a result, the donor would recognize any previously unrealized gain and pay income taxes on the “phantom” gain. Most transfers of appreciated property to trusts and distributions from trusts would trigger realization of gain and income taxes.
Here are some of the exemptions that would apply:

  • The first $1 million worth of “phantom gain” would be exempt from tax for single taxpayers ($2 million for married couples).
    For capital gains on the sale of a principal residence, single taxpayers could exclude an additional $250,000 in gains and married taxpayers could exclude an additional $500,000 in gains.
  • Transfers of appreciated property to charity would not be considered a taxable capital gain.
  • While transfers to a surviving spouse at death would not trigger immediate gain recognition, the surviving spouse would take a carryover basis in the transferred assets. That means that the assets would be taxed either at the death of the surviving spouse or sooner if they were gifted during life. This change would begin in 2022.

What to do

While these proposals are not set in stone, here are some planning options to consider:

  • Ensure that your adjusted gross incomes in 2022 is less than $1 million to avoid higher rates on long-term capital gains and qualified dividends. Deferring charitable contributions into 2022 or later could be beneficial.
  • Bring some income into 2021 before tax rates potentially rise, such as by converting a traditional IRA to a Roth IRA.
  • Consider taking advantage of the current lower income tax rates on long-term capital gains by accelerating gains and recognizing them in 2021.
  • Make larger gifts in 2021 to take advantage of the large gift tax exemption and potentially avoid income tax on gifts in future years.
  • Consider moving assets with a higher basis into your taxable estate.

The future of these proposals is uncertain. Consult an estate planning attorney to decide what’s best for your plan.

Office Hours

Mon. - Fri.: 8:30 am - 5:30 pm

The Spectrum Building
613 N.W. Loop 410, Suite 840
San Antonio, Texas 78216-5507

Phone: (210) 742-1410
Fax: (210) 742-1414

9.3Gilbert Vara Jr.
powered by Birdeye