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Benjamin Franklin famously wrote, “In this world, nothing can be said to be certain, except death and taxes.”
If you’re nervous about upcoming changes to tax laws and the economy in general, you’re not alone. But before you radically overhaul your portfolio and gift away your assets, pause and take a closer look under the surface.
In late May, specific details of President Biden’s tax proposals were released, including:
- The treatment of gifts at death as sales that require capital gains tax to be paid on amounts over $1 million;
- A retroactive (to April or May of 2021) increase in long-term capital gains rates for taxpayers with adjusted gross income above $1 million; and
- The elimination of Section 1031 exchanges to defer capital gains on real property.
Interestingly, and likely because of the proposed changes to capital gains taxes, no changes to the current federal estate and gift tax exemption were included in the proposals. This would leave the present, historically high exemption of $11.7 million to sunset back to $5 million (indexed for inflation) at the end of 2025.
The most frightening of these proposals for many investors may be the retroactive increase in capital gains tax rates. Is this a real possibility?
On multiple occasions, the U.S. Supreme Court has held that retroactive changes to the Internal Revenue Code may be made if the changes are supported by a legitimate purpose “furthered by rational means.” Historically, however, retroactive changes which increase taxes are rare. The last time a significant tax increase was enacted retroactively was in August 1993, when the top estate tax rate was increased.
Because of ongoing supply chain uncertainty, uneven economic recovery, and the lingering specter of the pandemic, Congress is most likely to use its broad discretion to enact any tax increases later this year or in 2022 without retroactive application to avoid rocking a rather precarious financial boat.
The IRS has also provided reassurance for families worried about whether gifts made prior to a reduction in the federal gift and estate tax exemption would be subject to a “clawback” – that is, the IRS requiring that money be paid back – if those gifts exceeded the later reduced exemption amount. Regulations published in November 2019 made clear that this will not be the case, and that the higher exemption amount may be used to calculate an estate’s tax credit.
For example, if a person uses their full exemption to make a gift of $11.7 million in 2021 and dies in 2026 after the current exemption sunsets back to an indexed $5 million, the estate may compute its tax credit using the full earlier exclusion amount of $11.7 million. For this reason, gifts to Spousal Lifetime Access Trusts are rapidly becoming more popular as an estate tax planning tool for married couples to take advantage of the current estate and gift tax exemption.
Low interest rates dominated 2021 and contributed to robust real estate markets, the increased use of intrafamily loans, and the use of certain types of irrevocable trusts in estate tax planning. Interest rates are expected to remain quite low well into 2022, and these loans and trusts will only become more popular going into the next year as planning tools for wealthy families. Property sales and leasing, especially in connection with commercial properties and the development of mixed-use projects in the Denver metropolitan area, are also primed to continue to thrive in this environment and provide investment opportunities.
As long as materials are available (and relatively reasonably priced), there will be no shortage of cranes on the horizon any time soon.
The overall best course of action right now is to stop, take a breath, and remember that change is usually quite slow in coming. Congress is in charge of public funds and taxation, and all of these changes must first be crafted into bills to be debated, rewritten, and passed by congressional vote before they become law.
Thin majorities in both the Senate and the House will make passing any tax increases into law difficult, and concessions and compromises will need to be made on both sides. It is very doubtful that any new tax laws will be passed this year; in addition, the current gift and estate tax exemption will likely stay in place until its built-in expiration at the end of 2025, allowing plenty of time to plan and make lifetime gifts.
A thoughtful wait-and-see approach for the rest of 2021 will avoid premature planning moves, which could do more harm than good in the long run.
Heidi J. Gassman is a partner at Denver-based law firm Moye White where she serves as the co-chair of the firm’s Business Section. She can be reached at [email protected] or 303.292.7929.