Stableford Capital Insights

In the previous Mark’s Corner, I discussed the Hidden Surprises in the Biden Green Book Tax, (“BGB”). These Surprises were the main revenue raisers in the proposed spending bill now known as the “Build Back Better”, (“BBB”) bill. Since then, there have been many developments and, in this commentary, I will attempt to examine the original surprises and explain what they look like currently in the BBB version, plus some new additional surprises, that were passed by the House of Representatives on November 19^th.

Increase Capital Gains Tax

The original rate proposed on households earning more than $1 million was 43.4% — a number that includes an existing 3.8% surtax to help pay for the Affordable Care Act — from the current 23.8%. This rate was proposed to be effective retroactively as of around April 28^th of 2021. In the House version most tax rate increases, including the increase in capital gains rates are not included due to concerns from some Senators whose votes are needed to pass the BBB like Senator Kyrsten Sinema (D-AZ). This development is very encouraging.

Two New Income Tax Surcharges Included in BBB

The House version does contain a “new” tax surprise, a surtax on high-income individuals, estates, and trusts which would be effective as of Jan. 1, 2022. A 5% surtax will be applied to individuals with modified adjusted gross income, (“MAGI”), (which includes capital gains), in excess of $10,000,000 ($5,000,000 for a married individual filing separately. On top of that, if the individual has MAGI, again including capital gains, in excess of $25,000,000 ($12,500,000 for a married individual filing separately), an additional 3% surtax will be applied on the excess amount. For trusts and estates, the Act would impose these surcharges at thresholds 98% lower than those for individuals: 5% on MAGI of more than $200,000 and an additional 3% on MAGI of more than $500,000. In effect, these surcharges would create an “intermediate” 31.8% tax bracket on capital gains, about halfway between the current 23.8% maximum long-term capital gains tax rate and the 40.8% maximum ordinary income tax rate. In other words, an additional 8% tax on a transaction that closes in 2022 vs 2021. We encourage those that are considering a significant capital gain transaction, to close the transaction prior to the end of 2021 and to move any income from 2022 to 2021 if possible.

If it is not possible to accelerate the significant capital gain into 2021, there are other potential strategies for entrepreneurs selling a business. You may want to consider structuring the business sale to recognize gain in stages, by accepting an installment note or retained equity in lieu of cash. This would enable the seller to recognize reduced amounts of gain over time as the purchaser makes note payments or on a later sale of the retained equity so that the income thresholds are not reached.

For those with a charitable bent, one could transfer business interests to a charitable remainder trust (CRT), which as a nontaxable entity, will avoid immediate recognition of gain on trust-owned interests at the time of sale. Instead, the seller will recognize this deferred gain on receipt of annual distributions from the CRT generally for the seller’s lifetime or the joint lives of the seller and the seller’s spouse.

Dynasty & Grantor Trusts

The BGB proposed to charge a capital gains tax when assets are transferred into, or distributed from, certain kinds of trusts. The House version of the BBB no longer contains this proposal.

Closing Loopholes

The BGB proposed to plug potential loopholes like the Buy, Borrow, Die strategy by taxing the large unrealized gains that would be transferred to heirs in the Die part of the strategy. The House version does not contain this proposal either.

Gift to the Wealthy

The House version of the BBB does contain a gift to property owners in expensive housing markets—particularly in the coastal blue states where you have high state income taxes and property taxes. The $10,000 cap on state and local tax (“SALT”) deductions—aka the “Trump penalty”—would be increased to $80,000, which would be applicable in 2021 and continue through 2030.

The end of the Peter Thiel Roth IRA?

The House version of the BBB contains a proposal for those holding very large “mega IRAs”, but not until 2029, since these provisions would be effective for tax years beginning after Dec. 31, 2028. That’s when taxpayers earning more than $400,000 (or $450,000 for joint filers) who have a combined traditional IRA, Roth IRA and defined contribution retirement account balance exceeding $10 million would be required to withdraw half of their balance over $10 million. And for those with retirement plan balances over $20 million, 100% of the excess over $20 million would have to be withdrawn from Roth accounts. Further, high-income taxpayers wouldn’t be permitted to contribute to traditional and Roth IRAs if the aggregate balance of a taxpayer’s retirement accounts exceeds $10 million.

What happens to the BBB moving forward?

The House version now goes to the Senate, where it’s possible the bill will undergo additional changes. For instance, Sens. Kyrsten Sinema (D-AZ), Joe Manchin (D-WV), or other Senate Democrats may demand additional changes to secure their vote. In addition, there still seems to be an issue with some members, like Bernie Sanders (D-VT), over a provision to expand the state and local tax deduction.

With a 50-50 split between the parties, the Democrats cannot lose any votes in the Senate to pass the BBB using “budget reconciliation”. If changes are made in the Senate, the House would have to approve that amended version before the legislation could be delivered to President Biden for his signature. With the debt limit deadline looming Dec. 15, and approval of a new defense budget bill, final action on this legislation likely will not come until the end of the Congressional year or sometime in 2022. The final language in any tax bill will be up to Congress and assuming this legislation is eventually enacted, some details might not be even settled until the IRS issues regulations.

Tax Planning tip

Here is a tool that in my opinion is greatly underutilized for those who are charitable and over age 70 1/2, known as a qualified charitable distribution, (“QCD”).

Potential benefits of using QCDs

A QCD can be a very tax-effective way to support a cause. QCDs do not provide a charitable deduction for taxpayers, regardless of whether you itemize deductions. Instead, with a qualified charitable distribution, a check is sent directly from an IRA to a charity. This allows the donor to exclude the amount from taxable income. To illustrate the benefits, here are four ways RMDs can increase taxes:

1. 1. RMDs can push retirees into a higher tax bracket. Since distributions are ordinary taxable income, it can push some retirees into a higher marginal tax bracket.
   2. Medicare surtax. RMDs also increase the taxpayer's MAGI, which could trigger the 3.8% Medicare surtax. The surtax applies to the lesser of net investment income or MAGI in excess of $200,000 for individuals or $250,000 for married couples filing jointly.
   3. Taxing Social Security. Even modest withdrawals from a retirement account can cause Social Security benefits to become taxable, up to 85% for single filers with income above $34,000 annually or married couples with income above $44,000.
   4. Medicare Part B and D premiums are calculated using a taxpayer's MAGI from two years prior. So large RMDs can cause sharp increases to your Medicare costs, with the wealthiest taxpayers shouldering up to 80% of the cost.

To use this tip, the retirement account owner must be age 70 ½ or older. The donation must go directly from a Traditional or Roth IRA to the qualified public charity, which must be a 501(C)(3) charity. Churches and institutions of higher learning are included. You need to contact the administrator of the IRA and instruct them as to what charity you want the RMD sent to. It does not have to be one charity but can be divided among several charities.

QCDs can offer big tax savings as tax rates on regular income are usually the highest. If you don't benefit from itemizing your tax deductions and are of age, then QCDs could be a good option. In 2021, the standard deduction will be $12,550 for single filers and $25,100 for married couples, filing jointly. With the SALT limit capped at $10,000, it's not always easy to benefit from itemizing given the high standard deductions.

I will continue to keep you apprised of the latest tax and estate changes that can affect your investments in Mark’s Corner – An Estate and Tax Newsletter in the coming months.

Our advisors have the experience necessary to develop a financial plan that works for you, your family, and your future. Reach out for a complimentary 15-minute consultation today by calling 480.493.2300 or contact us online.