TREASURY RELEASES BIDEN TAX REFORM PROPOSAL
March 12, 2024
The U.S. Treasury Department this afternoon released the “Green Book” [PDF 2 MB]. Treasury’s “General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals” (“Budget Proposal”) is a 256-page explanation of the tax proposals in the Biden Administration’s FY 2025 budget, also released and transmitted to Congress. Most of the administration’s revenue proposals are familiar, having been included in previous budgets. However, the administration is unveiling new proposals in a few areas including proposals to increase in the corporate alternative minimum tax (CAMT), limit depreciation and increase certain fuel taxes for some private planes, create a new tax credit for certain first-time homebuyers, and modify deadlines for certain information returns. These proposals would increase and reform corporate taxation, as well as increase individual taxes on those with annual earnings exceeding $400,000. According to the administration, these proposals are intended to “reduce the deficit by cracking down on fraud, cutting wasteful spending, and making the wealthy and corporations pay their fair share.” The Biden Administration claims to reduce the 10-year deficit by $3 trillion over the next decade. It is noteworthy to mention what was not included in the Budget Proposal. The Obama Administration’s revenue proposals for fiscal year 2017 included provisions to repeal the treatment of net unrealized appreciation in employer securities; increase the estate and gift tax and generation-skipping tax rates; reduce the estate and gift tax exclusion amounts and the GST exemption; subject to estate tax assets sold to intentionally defective grantor trusts; and reduce the benefit of certain tax expenditures. These provisions were not included in the Administration’s revenue proposals for fiscal year 2024. If Congress does nothing, the estate and gift tax exclusion amount and the GST exemption, presently $13,610,000, will revert to pre-2018 levels in 2026. Except for a change in the method of indexing, the pre-2018 levels are 50% of the current level.
Tax Rate Increase. The top marginal tax rate would increase from 37% to 39.6% on taxable income over $450,000 for married individuals filing a joint return ($400,000 for unmarried individuals). The corporate tax rate would be increased from 21% to 28%. Phase Out of Capital Gains Rates. Long-term capital gains and qualified dividends would be subject to ordinary income rates to the extent taxable income exceeds $1 million ($500,000 for married taxpayers filing separately). Increase in Medicare Tax and Net Investment Income Tax. For taxpayers with more than $400,000 in earnings, the top rate for the Medicare tax on employment earnings would be increased from 3.8% to 5%. Similarly, the top net investment income tax rate would be increased from 3.8% to 5% for taxpayers with more than $400,000 in income. Expansion of the Net Investment Income Tax. The net investment income tax would be expanded to apply to business income of taxpayers with adjusted gross income over $400,000 ($200,000 for married taxpayers filing separately) to the extent such income is not otherwise subject to the net investment income tax or self-employment tax. This provision would apply to income allocated to a taxpayer from an S corporation or partnership. Treat Death and Gifts as Taxable Events. The proposal would treat transfers of appreciated assets by gift or death as realization events subject to capital gains tax, subject to a $5 million per donor lifetime exclusion and certain other exceptions (e.g., transfers to a spouse or charity). The proposal would include a deemed transfer for property held by a trust, a partnership, or other non-corporate entity to the extent such property has not been subject to a recognition event in the past 90 years. Gift Tax Annual Exclusions and Crummey Powers. In order to qualify for the gift tax annual exclusion, a gift must be a present interest. In Crummey v. Commissioner, the Ninth Circuit held that a transfer in trust that would otherwise be a gift of a future interest can qualify as a present interest if the beneficiary (or the beneficiary’s legal representative) has the unrestricted right to withdraw the contribution from the trust, even if such withdrawal right exists only for a limited period of time and thereafter lapses if not exercises. These withdrawal rights are thus called Crummey powers. The Administration proposes to limit the total annual exclusions for certain transfers to $50,000 per year, indexed for inflation after 2025. This limit would not provide annual exclusions in addition to the annual per donee exclusion. Rather, it would be a further limit on those amounts that otherwise would qualify for the annual per-donee exclusion. Thus, a donor’s transfers in the new category in a single year in excess of a total amount of $50,000 would be taxable (absorbing lifetime exemption, if available), even if the total gifts to each individual donee did not exceed $18,000. Limit Duration of GST Exemption. Each taxpayer has a GST exemption. The GST exemption is $13,610,000 for 2024 and is indexed for inflation. It is scheduled to be cut in-half 2026. The common law rule against perpetuities is lives in being plus 21 years. Florida’s rule was recently changed from 360 years to 1000 years. The Budget Proposal would only allow GST exemption to apply to (a) direct skips and taxable distributions to beneficiaries no more than two generations below the transferor, and to younger generation beneficiaries who were alive at the creation of the trust, and (b) taxable terminations occurring while any person described above is a beneficiary. The provisions resetting the transferor upon the payment of GST tax would not apply, and existing trusts would be treated as having been created on the date of enactment. Grantor Trusts. The grantor trust rules for income tax purposes are not the same as the rules for inclusion in the gross estate for estate tax purposes. Accordingly, it is possible to create a trust that is a completed gift for gift tax purposes, is not included in the estate for estate tax purposes, but which is a grantor trust for income tax purposes. The Budget Proposal provides that if a taxpayer creates a grantor trust that is not fully revocable, sales between the grantor and the trust would be taxable, effective for sales on or after the date of enactment. In addition, the grantor’s payment of the income tax on the trust’s income and gains would be treated as a taxable gift, effective for trusts created on or after the date of enactment. Grantor Retained Annuity Trusts. A “GRAT” is a commonly used trust which is designed to shift wealth above a given retained rate of return out of a taxable estate, and it is typically advisable to do so over short terms, such as two years. The Budget Proposal requires that a GRAT must have a minimum term of 10 years, and a maximum term equal to the life of the annuitant plus 10 years. The remainder interest must have a value at least equal to the greater of 25% of the value contributed to the GRAT or $500,000, but not more than the value of the assets contributed. Under the proposal, the annuity payments can not decrease during the GRAT term, and the grantor is prohibited from engaging in a tax-free exchange of any assets held in the trust. This proposal would be effective upon enactment. Charitable Lead Annuity Trusts. It is possible to structure a charitable lead annuity trust (“CLAT”) such that the value of the remainder interest is minimal or zero, even though the actual value of the remainder interest is expected to be substantial. This effectively leverages the use of a charitable lead interest to remove substantial wealth to family members, as remainder beneficiaries. It is also possible to have the annuity payments vary within certain limits. Having smaller payments in the early years may also increase the value of the remainder interest without gift tax consequences. The Budget Proposal requires that the annuity payments be level over the term of the CLAT, and that the remainder interest be at least 10% of the value of the property contributed to the CLAT. This proposal would be effective for CLATs created after the date of enactment. Consistent Valuation of Promissory Notes. At present, taxpayers may take inconsistent positions on the value of a promissory notes in estates for estate tax purposes. A taxpayer may sell an asset for a note with interest at the applicable Federal rate, and subsequently claim a valuation discount for the note on death. The Budget Proposal requires that the discount rate of the note for estate and gift tax purposes be limited to the greater of the interest rate of the note or the applicable Federal rate for the remaining term of the note. The proposal would be effective for valuation dates on or after the date of enactment. Valuation Discounts. Taxpayers are often able to take advantage of discounts for lack of control and lack of marketability when transferring interest in closely-held entities, real estate, and other personal property. The Budget Proposal requires that intrafamily transfers of partial interest in property, in which the family collectively owns at least 25%, be valued based on the interest’s pro rata share of the collective fair market value of the interests held by the taxpayer and the transferor’s family members. In the case of an interest in a trade or business, passive assets would be valued separately from the trade or business assets. This provision would apply to valuations as of a valuation date on or after the date of enactment. Administration of Trusts and Estates. The Budget Proposal has various changes affecting the administration of trusts and estates. For estate tax purposes, if there is no executor or administrator appointed, qualified and acting, any person in actual or constructive possession of any property of the decedent is considered a statutory executor. However, this concept only applies for estate tax purposes. The Budget Proposal expands this concept to other tax matters, and allows the IRS to adopt rules to resolve conflicts among multiple executors. This change would be effective upon enactment. An estate may elect special use valuation to reduce the value of the estate by up to $1,390,000. The Administration proposes to increase this limit to $14 million, effective for estates of decedents dying after the date of enactment. There is a special estate tax lien for 10 years from the date of a gift or from the date of death. The Budget Proposal extends the lien during any deferral or installment period for unpaid estate and gift taxes. Trusts do not presently have to report the value of their assets. The Budget Proposal requires trusts with an estimated value over $300,000 or gross income over $10,000 to report their value, in each case indexed after 2024. Net Wealth Minimum Tax. A 25% minimum tax that includes a mark-to-market regime with respect to unrealized capital gains for taxpayers with a net worth exceeding $100 million. The proposal would include installment payment options as well as an election for “illiquid taxpayers” to only include unrealized gains from tradable assets in the calculation of their tax liability; however, such illiquid taxpayers would be subject to a deferral charge (of no greater than 10 percent) upon recognizing gain on non-tradable assets subject to the election. For this purpose, a taxpayer is illiquid if tradable assets make up less than 20% of their wealth. Phase Out of the Carried Interest. For partners with taxable income (from all sources) exceeding $400,000, a partner’s allocable share of income from profits interests in investment partnerships (i.e., carried interest) would be subject to tax as ordinary income and self-employment tax regardless of the character of the income at the partnership level. Excess Business Losses. The proposal would make permanent the excess business loss limitation that was introduced in the Tax Cuts and Jobs Act and is currently set to expire for taxable years beginning after January 1, 2029. In addition, any excess business loss carried forward from a prior year would be treated as an excess business loss in the current year instead of as a net operating loss carryforward. Expansion of Recapture Under Section 1250. With respect to depreciation deductions taken on section 1250 property (e.g., depreciable real estate) after the effective date of the proposal, gain on the disposition of such property would be treated as ordinary income. Depreciation deductions taken on section 1250 property prior to the effective date of the proposal would be subject to the current rule and recaptured as ordinary income (subject to a maximum rate of 25% with respect to noncorporate taxpayers) to the extent such depreciation exceeds cumulative straight-line depreciation. The proposal would not apply to noncorporate taxpayers with adjusted gross income of less than $400,000 and would be effective for depreciation taken on, and dispositions of, section 1250 property in taxable years beginning after December 31, 2023. Observation: The recapture proposal could have a significant impact on real estate investors. Individual taxpayers would see more gain on disposition recharacterized as ordinary income and subject to full ordinary income rates. Corporate taxpayers may also be impacted to the extent they have capital losses. Assuming section 1031 remains in its current form, this change may increase the gain recognized on otherwise tax-free section 1031 exchanges involving the swap of section 1250 property (e.g., a building) for non-section 1250 property (e.g., land). Partial Repeal of Section 1031. The proposal would limit gain deferred under section 1031 to $500,000 ($1 million in the case of married individuals filing a joint return) per taxpayer per year. Depreciation Recapture for Real Estate. Section 1245 generally provides for depreciation recapture upon the sale of most depreciable assets. However, depreciation recapture for real estate is generally governed by Section 1250. Under Section 1250, there is generally no depreciation recapture on the sale of real estate. The Budget Proposal requires depreciation recapture on the sale of depreciable real estate. This change would not apply to taxpayers with adjusted gross income under $400,000 ($200,000 for married filing separately). This change would be effective for depreciation after December 31, 2024, and sales after December 31, 2024. Special Large Retirement Account Balance Rules. The Budget Proposal provides special distribution rules on high income taxpayers with large retirement account balances. A high-income taxpayer with vested account balances over $10 million as of the last day of the previous year would have to distribute at least 50% of the excess. In addition, if the vested account balances exceeded $20 million, the taxpayer would have to distribute the lesser of the excess above $20 million or the amount held in Roth IRAs or designated Roth accounts. For this purpose, a high income taxpayer is one with modified adjusted gross income over $400,000 (single) or $450,000 (joint). The taxpayer may choose the source of the distributions, except that if the vested balances are over $20 million, the additional distributions must come first from Roth IRAs and then from designated Roth accounts. This change would be effective for taxable years beginning after December 31, 2024. Limit Rollovers and Conversions to Designated Roth Accounts or Roth IRAs. This provision would prohibit a high income taxpayer from rolling over to a Roth IRA an amount distributed from a traditional IRA or an eligible retirement plan other that a designated Roth account. It would also prohibit a high income taxpayer from rolling over amounts distributed from a traditional IRA or an employer plan other than a designated Roth account into a Roth IRA or a designated Roth account. For this purpose, a high income taxpayer is one with modified adjusted gross income over $400,000 (single) or $450,000 (joint). This change would be effective for distributions made after December 31, 2024. Clarifying That an IRA Owner is a Disqualified Person. The Budget Proposal clarifies that an IRA owner is a disqualified person for purposes of the self-dealing rules. This provision would be effective for transactions after December 31, 2024. Extend Statute of Limitations on Valuation of IRA Assets and Prohibited Transactions. The Administration proposes to extend the statute of limitations in the case of a substantial error in valuing IRA assets and for the excise tax on prohibited transactions from three years to six years. This change would be effective for taxes for which the three-year window would end after December 31, 2024. Tax carried interests as ordinary income. A partner may have an interest in future profits (a carried interest) in exchange for services. If the partnership recognizes long-term capital gain, the partner holding the carried interest reflects his or her share of the gain as long-term capital gain. The Budget Proposal seeks to tax as ordinary income a partner’s share of income on an investment services partnership interest (“ISPI”) in an investment partnership, regardless of the character of the income at the partnership level, if the partner’s taxable income from all sources is over $400,000. The proposal explains that although profits interests are structured as partnership interests, the income allocable to such interests is received in connection with the performance of services, and that a service provider’s share of partnership income attributable to a carried interest should be taxed as ordinary income and subject to self-employment tax because it is derived from the performance of services. An ISPI is defined as a carried interest in an investment partnership held by a person who provides services to the partnership. This income would be subject to self-employment tax. The gain on the sale of an ISPI would also generally be taxed as ordinary income if the partner’s income is above the threshold.
These proposals are not law but are more accurately thought of as a Biden Administration wish list of changes to our present Internal Revenue Code. Given that both the House and the Senate are nearly equally divided between the parties, attempting to predict tax legislation is difficult. However, these revenue proposals are worth watching. Some of them may be enacted soon. Some of them may be enacted eventually. Some of them may never be enacted, but they should be monitored for possible changes in the tax law. In this regard, clients are generally advised to take action now to utilize their tax exemptions well in advance of possible enactment of some of these provisions. Best Regards, Joseph C. Kempe, Esquire, LL.M.
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