10 February 2016 President's budget proposals for individuals, or all that's left The Obama Administration's FY 2017 Budget includes many of the same proposals to increase individual income and estate taxes on high-income individuals that were included in prior budgets, but have yet to be enacted. The President would increase the highest tax rate on long-term capital gains and qualified dividends from 20% to 24.2% (a 21% increase in the tax rate). Because the 3.8% net investment income tax would continue to apply, the maximum total capital gains and dividends tax rate, including the net investment income tax, would rise to 28% (a 17.6% increase in the combined tax rate from the current maximum combined rate of 23.8%). The definition of net investment income would be expanded to include gross income and gain from any trades or businesses of an individual that is not otherwise subject to employment taxes. This change would affect limited partners and members of limited liability companies or other entities taxed as partnerships who materially participate in their firms but claim the limited partner exclusion from Self-Employment Contributions Act taxes. The President once again proposed the "Buffett Rule," which is intended to require the wealthy to pay their "fair share" of taxes. Individuals earning over $2 million a year would be subject to a 30% minimum federal tax rate. Labelled the "Fair Share Tax," it would be phased in starting at $1 million of adjusted gross income (AGI). One of the more notable proposals would limit the total amount that an individual can build-up in a tax-favored retirement plan such as an IRA, a Section 401(a) plan and a Section 403(b) plan. Starting next year, an individual would not be able to accumulate in those plans any more than the amount necessary to provide the maximum annuity permitted for a qualified defined benefit plan under current law, which is $210,000, payable in the form of a joint and 100% survivor benefit commencing at age 62. The maximum permitted accumulation for an individual age 62 is approximately $3.4 million. Once the limit is reached, an individual would not be allowed to make any further contributions, but the individual's account balance could continue to grow with investment earnings. Another notable proposal would allow 401(k) plan participants to take a distribution of a lifetime income investment through a direct rollover to an IRA or other retirement plan if the annuity investment can no longer be held under the plan, regardless of whether another event allowing a distribution has occurred. The 10% additional tax would not apply to the distribution. The President also proposed requiring minimum required distributions to be made from Roth IRAs, just as they are required for all other tax-favored retirement accounts, including designated Roth accounts (Roth accounts held within qualified employee retirement plans). Under current law, Roth IRA original account owners, as well as a surviving spouse named as beneficiary, can leave amounts invested in their Roth IRAs for as long they like during their lifetime. Additionally, the President proposed requiring non-spouse beneficiaries of qualified retirement plans and IRAs to take distributions over no more than five years. Under current law, non-spouse beneficiaries are entitled to take distributions over their lifetimes, i.e., the stretch IRA. The proposal would allow exceptions for eligible beneficiaries. Notably, the President would eliminate the step-up in basis in appreciated property acquired from a decedent by treating the bequest of that property (to one other than the deceased's spouse) as a sale. The deceased owner of an appreciated asset would realize a capital gain at the time the asset is bequeathed to another. Decedents would be allowed a $200,000 per couple ($100,000 per individual) capital gains income exclusion, as well as a $500,000 per couple ($250,000 per individual) exclusion for personal residences. The proposal would exclude tangible personal property, except for art and similar collectibles (e.g., bequests or gifts of furniture or other household items), from capital gains income. Families that inherit small, family-owned and operated businesses would not owe tax on the gains until the assets were sold and closely held businesses would be allowed to pay the tax on gains over 15 years. And, just as notably, the President would treat a lifetime gift of appreciated property to one other than a spouse as a deemed sale. The exclusion noted earlier for transfers at death, however, would not apply to lifetime gifts. When the gift or bequest was made to the donor/decedent's spouse, the donor/decedent's basis would carry over and the deemed sale would occur when the spouse disposes of the asset during lifetime or bequeaths it at death. Although the American Taxpayer Relief Act of 2012 (the Act) permanently set the estate, gift and generation-skipping transfer (GST) tax exemption at $5 million and the top tax rate to 40% as of January 1, 2013, the President proposed restoring the estate, gift and GST tax parameters to those in effect in 2009. The top tax rate would be 45% and the exclusion amount would be $3.5 million for estate and GST taxes, and $1 million for gift tax beginning in 2017. These amounts would not be indexed for inflation. Portability of unused estate and gift tax exclusions between spouses would be allowed. The President would eliminate the present interest requirement for gifts to qualify for the gift tax annual exclusion and would define a new category of transfers (regardless of the existence of any withdrawal or put rights). The new category of transfers would include transfers in trust (other than to a trust described in Section 2642(c)(2)), transfers of interests in pass-through entities, transfers of interests subject to a prohibition on sale, and other transfers of property that, regardless of withdrawal, put, or other such rights in the donee, cannot immediately be liquidated by the donee. Additionally, the President would impose an annual limit of $50,000 (indexed for inflation after 2017) per donor on transfers of property that are within the new category. The new $50,000 limit would not provide an additional exclusion to the annual per-donee exclusion. Instead, it would be a further limit on the amounts that otherwise would qualify for the annual per-donee exclusion. The President would require grantor retained annuity trusts (GRATs) to have a minimum term of 10 years and a maximum term of the life expectancy of the annuitant, plus 10 years. The President also would require the remainder interest in the GRAT at the time the interest is created to have a minimum value equal to the greater of 25% of the value of the assets contributed to the GRAT or $500,000. In other words, an individual would not be able to virtually "zero-out" a GRAT so that there are no gift tax consequences to its creation. Additionally, a grantor would be prohibited from engaging in a tax-free exchange of any asset held in the trust, which is something that many who use GRATs regard as a means to enhance the overall wealth transfer benefit of the technique and/or preserve some flexibility to keep a valuable asset from passing to a now-disfavored beneficiary. Any of these proposals, which would be effective for GRATs established after date of enactment, would curtail the potential wealth transfer benefit or planning flexibility of a GRAT. Taken together, these proposals would severely limit the GRAT's utility as a wealth transfer vehicle. In an apparent effort to limit the benefits of the intentionally defective grantor trust (IDGT), the President proposes that, if a person who is a deemed owner of all or a portion of any other type of trust under the grantor trust rules engages in a transaction with that trust that is a sale, exchange or comparable transaction that is disregarded for income tax purposes by reason of the person being a deemed owner, the portion of the IDGT attributable to the property received (and not paid for) by the IDGT in that transaction would be subject to estate tax as part of the gross estate of the deemed owner. It also would be subject to gift tax at any time during the deemed owner's life when his or her treatment as a deemed owner of the trust is terminated. Further, it would be treated as a gift by the deemed owner to the extent any distribution is made to another person during the deemed owner's life, except in discharge of the deemed owner's obligation to distribute. It's noteworthy that these IDGT proposals would apply to transactions done after date of enactment, even if the IDGT itself existed before then. The proposal would not change the treatment of trusts that are already includable in the grantor's gross estate under existing provisions of the Code (e.g., grantor retained income trusts, GRATs, personal residence trusts). In addition, the proposal would not apply to irrevocable trusts with assets that consist of one or more life insurance policies on the grantor's or grantor spouse's life. But planning with irrevocable life insurance trusts would become far more problematic. The Budget also proposes the following changes, some of which we have seen before, either in the same form or with slight variations: — Limiting the tax value of specified deductions or exclusions from adjusted gross income and all itemized deductions to 28% of the specified exclusions and deductions — Limiting the annual deduction for charitable contributions of property other than cash to 30% of adjusted gross income regardless of the type of property donated, the type of charity receiving the donation or whether the contribution is to or for the use by the charity receiving it (the contribution limit for cash contributions to public charities would remain at 50%) — Extending the carryforward period for charitable contributions exceeding annual limitations from five to 15 years — Eliminating the 80% charitable deduction for required contributions to athletic foundations as a pre-requisite to purchasing tickets to college sporting events — Limiting Roth conversions to pre-tax dollars, thereby eliminating the ability to convert after-tax amounts (i.e., those attributable to basis) held in traditional IRAs or eligible retirement plans — Repealing the exclusion of net unrealized appreciation in employer stock received in a distribution from a qualified retirement plan for participants who are under age 50 as of December 31, 2016 — Allowing a "Second-Earner Tax Credit" of up to $500 for two-earner married couples filing jointly based on a percentage of the lower earner's earned income — Increase the standard mileage rate for automobile use by volunteers (14 cents per mile for 2016) to equal the rate set by the IRS for the medical and moving expense mileage deduction (19 cents per mile for 2016) — Imposing a consistency in basis and reporting requirement on transfers of property subject to gift and estate tax A reasonable person could understandably give the President's proposals short shrift since he has a short time in office and this is an election year anyway. As we observed recently in Tax Alert 2016-165, however, these proposals might not be as lame duck as they seem. Depending on which side prevails in November, there could be more ... or less ... predictive value to these proposals. Maybe winter isn't such a bad time for a hedge after all.
Document ID: 2016-0292 | |||||
