Financial Planning 2021: Remaining Flexible for Worst-Case Scenarios of Build Back Better


Steve Kohler, CFP®, CPFA and Nancy Kunz, CFP®, ChFC®, CLU®


On September 15, the House Ways and Means Committee approved the tax provisions of the proposed Build Back Better (BBB) Act, which would fund President Biden’s social and education reforms. Eventually, an updated bill will head to the Senate where it will be further amended. It is unknown when the Bill will make it out of Congress and to the President’s desk, but we might see increased pressure as a new deadline to raise the debt limit approaches.


There are many components of the bill that we are watching. As a result, we are discussing with high-net-worth and high-income clients the need to maintain flexibility in the face of potential changes to income taxes, estate taxes, and grantor trusts among other issues.

That said, we must be careful not to overreact to proposals in Washington. By the time they become legislation, there could be significant changes made through compromises and negotiations. However, it would be foolish to do nothing to prepare for some of the worst-case scenarios being discussed.


Income taxes may be going up

Currently, individual filers who earn $523,601 or more and married couples filing jointly who earn $628,301 or more pay a 37% marginal federal tax rate. BBB proposes raising the rate to 39.6% while also lowering the highest earner threshold to $400,001 for single filers and $450,001 for married couples filing jointly

Additionally, long-term capital gains and qualified dividends will be subjected to ordinary income tax rates. The rate applicable to long-term capital gains and qualified dividends would be increased to 39.6 percent for households earning more than $1 million. The BBB will also apply the 3.8 percent "Medicare" tax to taxpayers making more than $400,000. Under current law, the Medicare tax is a 3.8 percent tax imposed only on a portion of a taxpayer's income.


To prepare: It is wise to consider taking income sooner in this tax year at the lower rate and delaying expenses into next year if the higher tax rates are approved.


Transfer Tax exemptions might be going down


The BBB Act reduces the federal estate, gift, and generation-skipping transfer tax exemption to $5 million, adjusted for inflation. It also increases the limitation on the estate tax valuation reduction for certain real property used in farming or other trades or businesses to $11.7 million. The Act would cause trusts to be included in the grantor's gross estate for federal estate tax purposes to the extent the grantor is treated as the deemed owner of the trust for income tax purposes at the time of their death.


We will also need to review how assets for gift and estate tax purposes are valued. For example, it is currently possible to take advantage of appropriate discounts when the transferred asset is not publicly traded or otherwise hard to value. The Act targets this valuation strategy by disallowing a valuation discount for the transfer of nonbusiness assets.


To prepare: Work closely with your financial professionals to see whether current trust documents meet your future goals given potential changes. You may want to consider and/or reevaluate your year-end gifting in light of future changes.

All Irrevocable Grantor Trusts could be treated as separate taxable entities


Traditionally, grantor trusts have provided an opportunity to tax efficiently transfer assets to the next generation. As a grantor trust, the income and the deductions of the trust flow through to the grantor and are reported on the grantor’s income tax return and the grantor is responsible for the trust’s income tax which is not considered a gift. The trust thus grows free of income tax.


BBB would eliminate most, if not all, of the gift planning currently done with irrevocable grantor trusts. Because of how grantor trusts are taxed, when a grantor sells appreciated assets to a grantor trust, no capital gain is triggered. Any interest payments on the associated promissory note are also income tax free. The proposed legislation would add new Section 1062 and require gain be recognized on such sales, but it would deny the recognition of a loss.


To Prepare: Keep watching news out of Washington, DC and remain in touch with financial professionals to act according to your plan and personal situation.


Conclusion


In the face of potential sweeping changes, it will be critical to proactively plan for ways to protect your assets and your estate. We will continue to update you on Build Back Better legislation and follow up when (if) the bill reaches the President’s desk. But if you have any questions as to how these changes will impact your personal situation, your estate, or income tax situation, please feel free to contact us.



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Steven Kohler, CFP®, CPFA

Senior Financial Advisor

Financial Planning Chair

skohler@dbroot.com


Nancy Kunz, CFP®, ChFC®, CLU®

Financial Advisor

nkunz@dbroot.com


This material has been provided for general, informational purposes only, represents only a summary of the topics discussed, and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice or recommendations. Rather, they simply reflect the opinions and views of the author. D. B. Root & Company, LLC. does not provide legal, tax, or accounting advice. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation. There can be no assurance that any particular strategy or investment will prove profitable. This document contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information derived from such sources, and take no responsibility therefore. This document contains certain forward-looking statements signaled by words such as "anticipate," "expect", or "believe" that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the expectations, beliefs, views and opinions expressed in this document will come to pass. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

All investment strategies have the potential for profit or loss. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses.

The impact of the outbreak of COVID-19 on the economy is highly uncertain. Valuations and economic data may change more rapidly and significantly than under standard market conditions. COVID-19 has and will continue based on economic forecasts to have a material impact on the US and global economy for an unknown period.



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