Senator Joe Manchin of West Virginia famously signaled his opposition to the Build Back Better plan in December, dashing other Democratic leaders’ hopes of passage by the end of 2021. However, despite the perception that the legislation is finished, it’s possible that some reduced version could make it through. The good news is that many of the most extreme proposals were eliminated by the latest U.S. House proposal, which should allow for continuation of some valuable estate planning techniques.
Wiggle Room on Taxes
To consider why the legislation may not be entirely dead, consider the positions of some of the key players. Senator Manchin’s opposition has, in general, not been to tax increases, and indeed he sympathizes with the President’s view that the rich should “pay their fair share.” Rather, he has objected to the size of the plan, and its potential to increase inflation and the budget deficit. Meanwhile, Senator Kyrsten Sinema (D-AZ) has been adamant about avoiding tax increases for most Americans, which has already led to the House proposal’s focus on the very rich and large corporations to generate revenues. In other words, if progressives can stomach major program reductions and the elimination of what Manchin has called funding “gimmicks,” then there may be a viable pathway—particularly given the belief that Democrats need to pass something to avoid electoral carnage in November.
What’s In and What’s Out?
Over the past couple years, legislators have introduced many proposals to increase taxes, ranging from the moderate to the draconian. At this point, we feel that the best guide to potential changes remains the U.S. House bill passed in November. The following are its key tax provisions affecting individuals, as well some high-profile ideas that fell by the wayside—items that were important to include here in case they are somehow resuscitated.
- Surtax on “high-income taxpayers.” A surtax of 5% would apply to personal income over $10 million and an additional 3% tax would be imposed on income over $25 million; these taxes would apply to trusts and estates at much lower thresholds of $200,000 and $500,000, respectively.
- Expansion of “SALT” rules. In a positive move for those in high-tax states, the cap on deductions for state and local taxes would rise from $10,000 to $80,0000 through at least 2030. Many progressives (and most Congressional Republicans) oppose this idea.
- Limitations on QSBS. If certain qualifications are met, long-term holders of qualified small business stock currently receive 75% and 100% exclusions on sales (up to certain dollar limitations). Under the House plan, this exclusion would be reduced to 50%.
- Retirement accounts. Beginning in 2029, the House would prohibit new contributions and mandate required minimum distributions once aggregated account values exceed $10 million; in addition, conversion of traditional individual retirement accounts to Roth IRAs would be prohibited for “high-income taxpayers” beginning after December 31, 2031. Conversions of all after-tax contributions to Roth IRAs would be disallowed beginning in 2022.
- Net investment income tax. The current tax on investment income above certain thresholds would be expanded to include a 3.8% tax on business profits for high-income taxpayers.
- Wash sale rules. Traditional assets like stocks and bonds are currently subject to wash sale rules, which require a waiting period prior to their repurchase. These rules would be extended to cryptocurrencies.
- Corporate taxes. The House proposal would establish a 15% minimum tax on large corporations with income over $1 billion and impose a 1% excise tax on stock buybacks.
- Tax rates. Neither ordinary income nor long-term capital gain rates would change, other than the surtaxes (noted in What’s In) above certain income thresholds.
- Cost basis rules. Some proposals would have wiped out or reduced the current “step-up” in cost basis to fair market value at death. The House bill has no such changes.
- Billionaire’s tax. Another eliminated idea would have required a “mark-to-market” tax on appreciated investment positions (generally for those worth $1 billion or more), meaning that the positions would have been taxed based on their market value at a given time.
- Small business income. Despite proposals to the contrary, deductions for 20% of qualified small business income remain in place for now.
- Estate and gift taxes. Various legislators would have reduced the current $12.06 million exemption from estate and gift tax. Although still in effect, the exemption is set to sunset back to around $6 million in 2026.
- Grantor trusts. No change is anticipated to popular estate planning strategies where income is attributable to the grantor of the trust.
- Valuation discounts. Some have sought to curb the use of valuation discounts of assets based on lack of marketability and/or minority ownership for estate and gift tax purposes, but the approach remains unscathed.
- Dynasty trusts. In some jurisdictions, current laws allow for the creation of trusts that can last for several generations. These trusts also appear to have survived.
- Retirement accounts. Some proposals would have required investors to sell any private equity investments in their IRAs by the end of 2023; these have been removed.
- Carried Interests. There will be no change of the three-year holding period currently required to obtain long-term capital gain treatment of so-called carried interests, which are a key compensation source for private equity managers.
Opportunities to Consider: Interest Rates and More
Although much attention is being paid to potential legislative changes, we believe that significant opportunities for planning may revolve around still-low interest rates—which many expect to climb on the back of central bank tightening over the next couple of years.
Certain “estate freeze” techniques, including grantor retained annuity trusts (GRATs) and intentionally defective grantor trusts (IDGTs), generally allow for the tax-free transfer of assets to beneficiaries above certain interest rate hurdles set by the IRS. The lower the rate (the “Section 7520” rate for GRATs is currently 1.6%, while the “midterm” 3- to 9-year rate for IDGTs is 1.3%), the easier it may be for trust investments to surpass it. The difference between the current rates and, for example, a 3% or 4% rate might seem insignificant in the context of multiyear double-digit equity returns. However, assuming a more modest market outlook, two or three percentage points could make considerable difference—reinforcing the value of considering such techniques sooner rather than later. Should rates indeed rise, then other estate planning strategies such as qualified personal residence trusts (QPRTs) and charitable remainder trusts (CRTs) would become more attractive.
Beyond interest rate-oriented strategies, we believe the takeaway from Washington, DC may be to capitalize on techniques that appear likely to survive the current legislative cycle. For those with the available assets, using the gift and estate tax exemption is a natural step—especially given the 2026 sunset mentioned above. Regular annual gifting, capitalizing on retirement accounts, the use of asset discounts and engaging in structured charitable giving, among others, may also be appropriate. Talking with your advisors about such ideas, in light of your overall wealth and estate plan, can help you benefit from current opportunities while structuring your financial picture to seek long-lasting success.
10 Questions: Wealth Planning in the New Year
Below are some key questions to ask yourself about your financial and estate picture as we move into 2022. See our Wealth Planning Checklist for further details.
- Do you have a will or revocable trust to properly dispose of your estate and which names fiduciaries (guardians, executors, trustees)? If so, when was the last time it was reviewed or updated?
- Do you have living wills, health care proxies and powers of attorney?
- How do you hold title to your assets?
- Have you properly named designated beneficiaries of your retirement accounts and life insurance?
- Are you fully insured?
- Are you saving for education through a 529 plan?
- Are you contributing the maximum amount to retirement accounts?
- Do you have a “financial plan” that fully considers your overall picture?
- For those with larger estates, have you considered advanced estate planning strategies to minimize your estate tax burden?
- Do you contribute to charity? Have you considered more structured techniques like donor-advised funds?
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Investment decisions and the appropriateness of this material should be made based on an investor’s individual objectives and circumstances and in consultation with his or her advisors. This material is not intended as a formal research report and should not be relied upon as a basis for making an investment decision. The firm, its employees and advisory clients may hold positions within sectors discussed, including any companies specifically identified. Specific securities identified and described do not represent all of the securities purchased, sold or recommended for advisory clients. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. Neuberger Berman, as well as its employees, does not provide tax or legal advice. You should consult your accountant, tax adviser and/or attorney for advice concerning your particular circumstances. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Any discussion of environmental, social and governance (ESG) factor and ratings are for informational purposes only and should not be relied upon as a basis for making an investment decision. ESG factors are one of many factors that may be considered when making investment decisions. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. The use of tools cannot guarantee performance. Diversification does not guarantee profit or protect against loss in declining markets. As with any investment, there is the possibility of profit as well as the risk of loss. Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Unless otherwise indicated, returns reflect reinvestment of dividends and distributions. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
Tax planning and trust and estate administration services are offered by Neuberger Berman Trust Company. “Neuberger Berman Trust Company” is a trade name used by Neuberger Berman Trust Company N.A. and Neuberger Berman Trust Company of Delaware N.A., which are affiliates of Neuberger Berman Group LLC.
Hypothetical growth examples are for informational and educational purposes only.
Neuberger Berman Investment Advisers LLC is a registered investment adviser. The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.