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March 21, 2023

Biden Administration's budget proposes significant tax increases on businesses and high-net-worth individuals

  • The Administration's budget proposal for 2024 focuses heavily on increasing taxes paid by high-income individuals.
  • The budget proposes numerous changes to business, income and estate taxes that would affect high-net-worth individuals.
  • Although the proposals are unlikely to be enacted, given the makeup of the current Congress, understanding what is being proposed could nonetheless be important for taxpayers who would be affected and the tax professionals who represent them.

The Biden Administration's Fiscal Year 2024 budget proposal, released March 9, 2023, includes numerous tax changes that would affect high-net-worth individuals, as well as certain trusts and estates. Treasury's FY24 Green Book explains the Administration's budget proposal. Highlights of the provisions affecting individual taxpayers follow. In most cases, the proposals would be effective for tax years beginning after December 31, 2023.

Many of these proposals are identical to those published as part of last year's Green Book released in March 2022 (FY23 Green Book), or that were included as part of the 2021 Build Back Better Act that ultimately failed to pass in the Senate. What has changed, however, is that Republicans now control the House of Representatives, so bipartisan support will be necessary for any of the President's proposals to become enacted legislation. Given the nature of the proposals, any consensus is extremely unlikely.

Business tax changes affecting individuals

Increase the top marginal income tax rate for high-income earners

Effective for tax years beginning after December 31, 2022, the proposal would increase the top marginal tax rate from 37% to 39.6%. The top rate would apply to taxable income exceeding $450,000 for joint filers, $400,000 for unmarried individuals (other than surviving spouses), $425,000 for head-of-household filers, and $225,000 for married individuals filing separately. After 2024, the thresholds would be indexed for inflation using the Chained Consumer Price Index for All Urban Consumers (C-CPI-U).

Implications. This proposal is an identical provision from the FY23 Green Book.

The Administration eventually dropped the proposed increase to the top rate when Senator Kirsten Sinema (D-AZ) refused to support any legislation that increased individual tax rates. At this point, there is no reason to believe the opposition to these proposals within the party has changed.

Even if the proposal to increase the top rate on ordinary income does not become a reality, that rate is slated to return to 39.6% in 2026, when changes made by the Tax Cuts and Jobs Act (TCJA) expire. In addition to raising the top individual rate, the President's budget proposal would lower the threshold at which the top rate takes effect; to illustrate, the 2023 top rate of 37% applies once taxable income exceeds $578,125 for a single filer and $693,750 for those married filing jointly. The budget proposal would impose a top rate of 39.6% once taxable income exceeds $400,000 for a single filer and $450,000 for married individuals filing jointly.

Reform the taxation of capital income

The Administration proposes to tax the capital income of high-income earners at ordinary rates, increasing the top rate from 20% to 39.6%. Long-term capital gains and qualified dividends of taxpayers whose taxable income exceeded $1 million ($500,000 for married individuals filing separately) would be taxed at ordinary rates; the highest rate would generally be 37%. The income level would be indexed for inflation after 2024. The proposal would be effective for gains required to be recognized and for dividends received on or after the date of enactment.

Implications. This proposal is also identical to a provision from the FY23 Green Book. Given that this proposal was not adopted during the development of the Build Back Better Act (BBBA), it seems unlikely to get a different reception in Congress this year.

Tax carried (profits) interests as ordinary income

If a partner's taxable income from all sources exceeds $400,000, the partner's share of income on an investment services partnership interest (ISPI) in an investment partnership would be treated as ordinary income (not capital gain), regardless of the income's character at the partnership level. "An ISPI is a profits interest in an investment partnership that is held by a person who provides services to the partnership," the FY24 Green Book notes. The proposal would also repeal IRC Section 1061 for taxpayers with taxable income from all sources exceeding $400,000.

The Administration does not intend this proposal to adversely affect qualification of a real estate investment trust (REIT) owning a profits interest in a real estate partnership, according to the Green Book.

Implications. This proposal is an identical provision from the FY23 Green Book. Carried interest reform might be redundant, considering the Administration's proposal to increase capital gains rates to ordinary income rates for high-income taxpayers. If the preference for long-term capital gain ends, the Administration's carried interest proposal would only affect a narrow subset of carried-interest recipients, namely profits-interest holders with taxable income below $1 million (the threshold in the long-term capital gain proposal) and above $400,000 (IRC Section 1061 would still apply to those with income from all sources of $400,000 or less). This limited, partial repeal of IRC Section 1061 would lead to new tax complexities and compliance burdens as two different regimes could apply to the same partnership, depending on the income thresholds of the partners.

The Administration's proposal differs from existing carried interest rules (IRC Section 1061 and its regulations) in several ways:

  • The proposal would convert what is otherwise long-term capital gain into ordinary income (IRC Section 1061 converts certain long-term capital gains into short-term capital gains taxed at ordinary rates)
  • The treatment as ordinary income would apply regardless of the holding period (IRC Section 1061 generally applies to gains on dispositions of assets held for three years or less)
  • Self-employment taxes would apply to this income

Private equity, private capital, and other alternative asset management funds and their professionals could face increased tax liabilities if either the carried interest proposal or the proposal to increase capital gains rates is enacted.

Treat transfers of appreciated property by gift or at death as realization events

This proposal generally would require the donor or deceased owner of an appreciated asset to realize a capital gain at the time of its transfer, calculated as the excess of the asset's fair market value (FMV) on the date of the gift or date of death over the decedent's basis in the asset. Other attributes of the proposal include the following:

  • The gain would be reported as taxable income to the donor or to the decedent's estate on the federal gift or estate tax return or on a separate capital gains return.
  • Capital losses and carryforwards from transfers at death could offset capital gains and up to $3,000 of ordinary income on the decedent's final income tax return.
  • Tax imposed on gains deemed realized at death would be deductible on the decedent's estate tax return.
  • Gain on unrealized appreciation also would be recognized by a trust, partnership or other non- corporate entity that owns certain property if the property has not been involved in a recognition event within the prior 90 years (applicable to property held on or after January 1, 1942, that is not subject to a recognition event after December 31, 1941, so that the first recognition event would be deemed to occur on December 31, 2032).

Generally, transfers would be defined under the Code's gift and estate tax provisions and would be valued at the value used for gift or estate tax purposes. For purposes of imposing capital gains tax:

  1. A transferred partial interest generally would be valued at its proportional share of the FMV of the entire property
  2. Transfers of property into, and distributions in-kind from a trust, other than a grantor trust deemed to be wholly owned and revocable by the donor, would be recognition events
  3. Transfers of property to and by a partnership or other non-corporate entity would be recognition events if the transfers have the effect of a gift to the transferee

Various exclusions would apply, including the following:

  • Transfers to a US spouse or to charity would convey the donor's or decedent's carryover basis
  • Gain would not be recognized on tangible personal property, excluding collectibles
  • The current $250,000 per-person exclusion for capital gain on a principal residence would apply to all residences and would be portable to the decedent's surviving spouse
  • The current exclusion for capital gain on certain small-business stock would also apply
  • A lifetime gift exclusion of $5 million per-donor would be provided for recognition of other unrealized capital gains on property transferred by gift

A taxpayer could elect not to recognize unrealized appreciation of certain family-owned and -operated businesses until the business is either sold or ceases to be family-owned and -operated. Also, a taxpayer could elect a 15-year fixed-rate payment plan for the tax on appreciated nonliquid assets transferred at death.

The proposal would be effective for gains on property transferred by gift and on property owned at death by decedents dying after December 31, 2023, and on certain property owned by trusts, partnerships and other noncorporate entities on January 1, 2024.

Implications. These proposals are consistent with those originally set forth in the Administration's Build Back Better agenda. The changes to the income tax treatment of gifts and bequests were met with wide resistance from moderate Democrats and were soon abandoned.

The provision would cause an income tax realization event at the time of the transfer equal to the FMV of the asset on the date of transfer less the basis the taxpayer had in the asset on the date of transfer. Therefore, the taxpayer will be deemed to have sold the transferred asset resulting in phantom income with no corresponding proceeds from the deemed sale to pay the income tax resulting from the deemed sale.

Regarding the gain realized by a trust, partnership, or other non-corporate entity, this part of the provision is aimed at preventing taxpayers from being able to steer clear of the deemed sale rule for the assets transferred to these entities, even if they were subject to the deemed sale rule because the transfer was by gift or bequest. While this provision may be relatively easy to apply to transfers in trust, it would be very complicated to apply to partnerships and non-corporate entities — especially if these entities are carrying on a trade or business. Presumably, S corporations are corporate entities and, therefore, not subject to this provision. Regarding trusts, this provision is similar to a Canadian tax provision that subjects the assets of a trust to a deemed sale rule every 21 years.

Impose a minimum income tax on certain high-net-worth individuals

For tax years beginning after December 31, 2023, the proposal generally would impose a 25% minimum tax on the total income, including unrealized capital gains, of any taxpayer with wealth (assets minus liabilities) exceeding $100 million. Taxpayers could elect to pay the first year of minimum tax liability in equal installments over nine years. For each year thereafter, a five-year installment plan would be available.

Taxpayers with wealth above the $100-million threshold would be required to report to the IRS annually, providing total basis and total estimated value for each class of their assets.

Tradable assets, such as publicly traded stock, would be valued using end-of-year market prices. Annual market valuations of non-tradable assets would not be required; rather, they would be valued using the greater of the original or adjusted cost basis, the last valuation event from investment, borrowing, or financial statements, or other methods approved by the Treasury Secretary.

Implications. This proposal is nearly identical to a provision from the FY23 Green Book, although the current proposal increases the minimum tax rate from 20% to 25%. At first blush, this appears to be one way — though complicated — to eliminate step-up in basis for high-end taxpayers. Because no legislative text accompanied the proposal, there are more questions than answers about how, if the gating constitutional questions can be overcome, the tax would actually work and interact with the existing tax code. Some questions that come to mind include the following:

  • What about unrealized appreciation before the effective date?
  • What happens if you are in the $100-million base one year and not the next?
    • Will it work like the proposal set forth by Sen. Wyden (see Tax Alert 2021-1957) — i.e., once you've satisfied the definition of a "billionaire" you'll be categorized as such going forward even if your asset value decreases?
  • How do you determine if you are a "$100-million household"?
    • Must all assets be valued annually?
    • How does attribution of trusts, children, etc. work?
    • How would values of assets, such as noncontrolling interests, be determined for this threshold? Will valuation discounts apply?
  • How are grantor trusts dealt with?
  • How are nongrantor trusts dealt with?
    • If they are standalone taxpayers, is the threshold going to be much lower?
    • If they get attributed with an individual, is there going to be a consolidated-return concept so you can blend them together?
    • How do charitable remainder trusts fit into all of this?
  • Do we keep the current alternative minimum tax (AMT) system?
  • When we compare the 25% AMT base to current tax — what is the current tax?
    • Is it IRC Section 1? Or IRC Section 1 plus AMT? Plus net investment income tax (NIIT)? Plus SECA tax (Self-Employed Contribution Act)? Plus FICA tax (Federal Insurance Contributions Act)?
    • How do credits work? Foreign tax credits? Business credits?
  • Will net operating losses (NOLs) — and most other types of carryovers — be rendered largely useless because they will depress taxable income, and only cause you to pay more of this new minimum tax?
  • Do we get basis in the asset's appreciation when this tax is paid?
    • Does basis give rise to new depreciation/amortization? New IRC Section 743 adjustments? New IRC Section 465 at-risk considerations? Or cause the release of IRC Section 704(d)/1366(d) losses in passthrough entities?
    • If it is net appreciation, do we have to step-down basis for depreciating assets?
  • Do we get a credit like in the current AMT system?
    • How do you use it? What happens to it when you die?
    • In a year in which a taxpayer experiences a large drop in value, will the taxpayer be eligible for a refund of previously paid minimum taxes?

Strengthen the limitation on losses for noncorporate taxpayers

Effective for tax years beginning after December 31, 2023, the Administration proposes to make the excess business loss limitation under IRC Section 461(l) permanent and treat excess business losses carried forward as current-year business losses, rather than as NOLs. IRC Section 461(l) currently disallows noncorporate taxpayers from claiming excess business losses for tax years 2021 through 2028. Excess business losses are defined as the excess of current-year net business losses over a specified amount (for 2023, $578,000 for married couples filing jointly and $289,000 for other taxpayers).

Implications. Under current law, the denial of losses under IRC Section 461(l) amounts to a one-year deferral because the suspended loss is converted into an NOL. The proposal would cause any loss suspended to remain an IRC Section 461(l) loss and enter into the computation of net business income during the following year. As a result, the loss can be suspended indefinitely, and perhaps lost forever.

Taxation of high-income taxpayers

Apply the net investment income tax (NIIT) to high-income taxpayers' passthrough business income

Effective for tax years beginning after December 31, 2022, the proposal would expand the NIIT base to ensure that all passthrough business income of high-income taxpayers is subject to either the NIIT or SECA tax.

To calculate the amount of trade or business income subject to the NIIT, taxpayers would calculate "potential NIIT income" by adding together their:

  1. Ordinary income derived from S corporations for which the owner materially participated in the trade or business
  2. Ordinary business income derived from either limited partnership interests or interests in limited liability companies (LLCs) classified as partnerships to the extent a limited partner or LLC member materially participated in the partnership's or LLC's trade or business
  3. Other trade or business income to the extent it was not subject to NIIT or SECA under current law

A specified percentage of the potential NIIT income would be subject to the NIIT. This specified percentage would be between 0 and 100, increasing as a couple's adjusted gross income (AGI) increased from $400,000 to $500,000 ($200,000 to $250,0000 for married taxpayers filing separately). Material participation standards would apply, generally meaning a taxpayer who worked for a business for at least 500 hours per year materially participated in it.

Implications. This proposal is identical to a proposal included in the BBBA, which ultimately failed to pass the Senate in 2021. The Administration's proposal effectively would subject all business income to either the self-employment tax or NIIT. This proposal would ensure that non-passive shareholders of an S corporation and limited partners in a limited partnership will be subject to the NIIT on their passthrough income.

Increase the NIIT rate and the additional Medicare tax rate for high-income taxpayers

Effective for tax years beginning after December 31, 2022, the proposal would increase the additional Medicare tax rate by 1.2 percentage points for taxpayers with more than $400,000 in earnings. This would effectively bring the marginal Medicare tax rate up to 5% for those earning more than $400,000.

The proposal would also increase the NIIT rate by 1.2 percentage points for taxpayers with more than $400,000 in income. For taxpayers with positive net investment income (NII), the NIIT would increase by 1.2% on the lesser of (1) NII or (2) any excess of modified AGI exceeding $400,000. Both thresholds would be indexed for inflation.

Implications. This is the first time the Administration has proposed to increase the NIIT rate to 5% for high earners. When coupled with a top marginal rate of 39.6%, the top rate on ordinary income subject to the NIIT would reach 44.6% if both proposals were enacted.

Repeal gain deferral for like-kind exchanges

The proposal would require a taxpayer to recognize gain from any like-kind exchanges exceeding $500,000 ($1 million for a joint return) during a tax year. No changes would be made to the gain deferral for like-kind exchanges up to an aggregate $500,000/$1 million for individual/joint filers.

Implications. Although IRC Section 1031 has been the subject of recent attention by both the Administration and Congress, IRC Section 1031 exchanges have been part of the Internal Revenue Code since 1921. The Congress that passed the TCJA limited IRC Section 1031 and considered eliminating the statute. So, we continue to see attention to like-kind exchanges.

Limiting the benefit of deferral to the extent proposed by the Administration would curtail a time-honored tax-savings strategy whereby a taxpayer exchanges appreciating real estate on a tax-free basis throughout his or her life while borrowing against the value. Upon the taxpayer's death, the heirs would take a stepped-up FMV basis in the real estate, and the appreciation would have escaped taxation completely. In this regard, the proposal to reduce the benefit available from deferral under IRC Section 1031 appears redundant, given the Administration's proposal to also subject the appreciation inherent in one's assets upon death to income tax. In addition, when real estate is evenly exchanged and gain is recognized under the proposal, taxpayers may find themselves facing a tax bill with no corresponding cash generated from the transaction.

Require 100% recapture of depreciation deductions as ordinary income for some depreciable real property

When real property is sold or otherwise disposed of, this provision would treat any gain on IRC Section 1250 property held for more than one year as ordinary income to the extent of any cumulative depreciation deductions taken after the effective date of the provision. However, this provision would not apply to noncorporate taxpayers with AGI below $400,000 ($200,000 for married taxpayers filing separately). Partnerships and S corporations would be required to (1) compute the character of gain/loss on business-use property at the entity level, and (2) report to entity owners the relevant amounts for ordinary income/loss, capital gain/loss, and unrecaptured IRC Section 1250 gain under both the current tax law and the proposal. Taxpayers with income at or above the threshold would use amounts calculated under the proposal in completing their returns. The proposal would be effective for (1) depreciation deductions taken on IRC Section 1250 property in tax years beginning after December 31, 2023, and (2) sales, exchanges, involuntary conversions or other dispositions of IRC Section 1250 property completed in tax years beginning after December 31, 2023.

Implications. This proposal would cause post-2023 depreciation deductions on real property to be recaptured upon sale at ordinary rates as high as 37% under current law. Query, however, whether as ordinary income, this recapture would be treated as qualified business income for purposes of IRC Section 199A. If so, the top rate on the recapture income in many instances would rise from 25% under current law to only 29.6% (37% x 80%). This arbitrage would expand, however, should the top ordinary rate increase to 39.6% as proposed, and should IRC Section 199A expire as scheduled at the end of 2025.

When combined with the prior capital gains provision, and the carried interest provision discussed later, this provision appears to only affect individuals/estate/trusts with incomes below the $1-million threshold and not allocable to carried interests.

It would also detrimentally affect estates and heirs inheriting real estate held in S corporations and partnerships without IRC Section 754 elections because the outside step-up in basis will generate a capital loss when the property is sold and the entity is liquidated, but the IRC Section 1250 gain giving rise to the post-death basis increase will be ordinary. Under current law, these would offset; under the proposal, they would not, thus causing a noneconomic tax increase followed by a capital loss carryover that may take years (or decades) to recover.

Finally, the change would not affect SECA tax or NIIT.

Estate and gift tax changes

Require a defined value formula clause to be based on a variable that does not require IRS involvement

If a gift or bequest used a defined value formula clause that determines value based on the result of the IRS's involvement, the proposal would deem the value of the gift or bequest to be the value as reported on the corresponding gift or estate tax return. However, a defined value formula clause would be effective if (a) the unknown value is determinable by something identifiable (other than IRS activity), such as an appraisal that occurs within a reasonably short period after the date of the transfer (even if after the due date of the return), or (b) the defined value formula clause is used for the purpose of defining a marital or exemption equivalent bequest at death based on the decedent's remaining transfer tax exclusion amount.

Implications. This provision is new. Taxpayers use defined value formulas in association with gifts of property that do not have a readily ascertainable market value (e.g., closely held stock) as to not incur unintended gift tax consequences. Various types of these clauses are used in gifts of property, but all consider a defined value "as finally determined for gift tax purposes." In general, the donor obtains an appraisal to determine value. However, the value is not definitive until the IRS can no longer challenge it (generally, three years from the date on which the gift tax return disclosing the gift is filed). If the IRS challenges the value of the gift on the return and successfully establishes that the value was higher than disclosed on the return, the defined value clause requires the excess to be returned to the donor, be transferred to the donor's spouse or to charity, or become an incomplete gift. The IRS has challenged these types of clauses in the courts based on public policy concerns (see Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944) and generally has been unsuccessful.

Simplify the exclusion from the gift tax for annual gifts

The proposal would eliminate the present interest requirement for gifts that qualify for the gift tax annual exclusion. Instead, the proposal would define a new category of transfers (without regard to the existence of any withdrawal or put rights) and would impose an annual limit of $50,000 per donor, indexed for inflation after 2024, on the donor's transfers of property within this new category that would qualify for the gift tax annual exclusion. The new $50,000 limit would not provide an exclusion in addition to the annual per-donee exclusion; rather, it would be a further limit on amounts that otherwise would qualify for the annual per-donee exclusion. Thus, a donor's transfers in the new category in a single year that exceed a total of $50,000 would be taxable, even if the total gifts to each individual donee did not exceed $17,000. The new category would include transfers in trust (other than to a trust described in IRC Section 2642(c)(2)), transfers of interests in passthrough entities, transfers of interests subject to a prohibition on sale, transfers of partial interests in property, and other transfers of property that the donee cannot immediately liquidate, without regard to the donee's rights of withdrawal, rights to put property to the donee in return for cash, or similar rights.

Implications. This provision is new. Under current law, a gift might be structured to allow a donee or donees to immediately withdraw from the transfer an amount up to the gift tax annual exclusion so the transfer is considered the gift of a present interest and therefore eligible for the gift tax annual exclusion. The extent to which the transfer is a gift of a present interest is determined by the extent of the withdrawal powers conveyed. Under this provision, the extent of withdrawal powers held by individuals would no longer determine how much of the transfer is eligible for the gift tax annual exclusion; it simply provides an overall exclusion for the entity.

Improve tax administration for trusts and estates

Expand definition of executor. The Administration proposes to move the existing definition of executor from IRC Section 2203 to IRC Section 7701 so that it will apply for all tax purposes, authorizing the executor to act on the decedent's behalf "in connection with the decedent's pre-death tax liabilities or other tax obligations that the decedent could have done if still living." The proposal would apply upon enactment, regardless of when a decedent died.

Implications. This proposal is a carryover from President Obama's budget proposals. The proposal would make the definition applicable for all tax purposes, not just estate tax purposes. Currently, it is not clear that an executor can handle tax matters that may have arisen before the death of the taxpayer — e.g., income tax audit, final income/gift tax return.

Increase the limit on the reduction in value of special use property. The proposal would increase to $13 million the cap on the maximum valuation decrease for "qualified real property" elected to be treated as special-use property. This property generally includes real estate used in family farms, ranches and timberland. The proposal would apply to the estates of decedents who died on or after the date of enactment.

Implications. This provision was rumored to have been considered in drafting the BBBA but never made it into the Act. This amount is currently $1.230m. IRC Section 2032A allows real property used in a farm or business to be valued for estate tax purposes based on its actual use, rather than on its best use.

Extend 10-year duration for certain estate and gift tax liens. The proposal would extend the current 10-year duration of the automatic lien and allow it to continue during any deferral or installment period for unpaid estate and gift taxes. This extension would apply to 10-year liens in effect on the date of enactment, as well as to the automatic lien on gifts made and the estates of decedents dying on or after the date of enactment.

Implications. A carryover from President Obama's budget proposals, this proposal would extend the general estate tax lien that applies to all estate tax liabilities under IRC Section 6324 to continue past the normal 10-year period until the deferral period that the decedent's estate has elected under IRC Section 6166 expires. This proposal responds to the Tax Court's decision in Estate of Roski v. Commissioner, 128 T.C. 113 (Apr. 12, 2007), holding that the IRS had abused its discretion by requiring all estates electing to pay estate tax in installments under IRC Section 6166 to provide a bond or lien. The court held that Congress intended the IRS to determine, on a case-by-case basis, whether the government's interest is at risk before requiring security from an estate making an election under IRC Section 6166.

Require reporting of estimated total value of trust assets and other information about the trust. The proposal generally would require certain domestic and foreign trusts administered in the United States to annually report certain information to the IRS. This reporting requirement would apply to trusts with estimated total value on the last day of the tax year exceeding $300,000 (indexed for inflation after 2024) or with gross income for the tax year exceeding $10,000 (indexed for inflation after 2024). Further, any trust, regardless of its value or income, would be required to annually report its inclusion ratio whenever the trust makes a distribution to a non-skip person, along with information regarding any trust modification or transaction with another trust that occurred during that year.

Implications. This provision first appeared in the Sensible Taxation and Equity Promotion Act of 2021 proposed by Senator Chris Van Hollen (D-MD) on March 29, 2021. The reporting would be done on the trust's annual income tax return, or as otherwise provided by Treasury. The trust would have to provide general information, including the name, address and taxpayer identification number of each trustee and grantor, as well as the general nature and estimated total value of the trust's assets.

Change the generation-skipping transfer (GST) tax characterization of certain tax-exempt organizations

The proposal would ignore trust interests held not only by charities described in IRC Section 501(c)(3), as under current law, but also by other tax-exempt organizations for purposes of the GST tax (i.e., other organizations designated as tax-exempt in IRC Section 501(c). As a result, including any tax-exempt organization as a permissible distributee of a trust would not prevent a taxable termination subject to GST tax from occurring. The proposal would apply in all tax years beginning after the date of enactment.

Implications. This provision is new. It would treat tax-exempt entities that are not charities the same as charities for purposes of determining whether the tax-exempt entity has an interest in the trust. The result is they will be ignored for purposes of determining whether a trust has a taxable termination for GST tax purposes.

Modify the definition of a guaranteed annuity from a charitable lead annuity trust (CLAT)

The proposal would require that the annuity payments made to charitable beneficiaries of a CLAT at least annually must be a level, fixed amount over the term of the CLAT and that the value of the remainder interest at the creation of the CLAT must be at least 10% of the value of the property used to fund the CLAT, thereby ensuring a taxable gift on creation of the CLAT. The proposal would apply to all CLATs created after the date of enactment.

Implications. This provision is new. The requirement that the annuity must be level and fixed over the term of the CLAT is meant to prevent having the annuity increase each year by a certain percentage over the previous year. The advantage to this strategy is that the assets in the CLAT may stay in the CLAT for a longer period than if a level, fixed annuity amount increased the likelihood of the success of the CLAT (i.e., more assets transferred to the remainder beneficiaries). Currently, a CLAT can be structured so that the present value of the annuity stream equals the initial FMV of the assets funding the CLAT (i.e., "zeroing out" the CLAT), resulting in no gift tax consequences. The 10% remainder requirement would result in gift tax consequences in creating a CLAT.

Limit duration of GST tax exemption

Under the proposal, the GST tax exemption would only apply to (a) direct skips and taxable distributions to beneficiaries no more than two generations below the transferor and to younger-generation beneficiaries alive at the creation of the trust; and (b) taxable terminations occurring while any person described in (a) is a beneficiary of the trust. As a result of these changes, the benefit of the GST exemption would not last for the entire duration of the trust. "Instead, the GST exemption would only shield the trust assets from GST tax for as long as the life of any trust beneficiary who either is no younger than the transferor's grandchild or is a member of a younger generation who was alive at the creation of the trust," Treasury explains in the Green Book.

The proposal would apply on and after the date of enactment to all trusts subject to the generation-skipping transfer tax, regardless of the trust's inclusion ratio on the date of enactment.

Implications. This provision is new. For purposes of determining the duration of GST exemption, a trust created before the date of enactment (i.e., a grandfathered trust) would be deemed to have been created on the date of enactment. As a result, trust assets would only be exempted from GST tax during the life of any beneficiary who is no younger than the grandchild of the transferor or a beneficiary who is a member of a younger generation who was alive at the creation of the trust. After this period, the inclusion ratio of the trust would increase to one and the entire trust would no longer be exempt from GST tax.

Modify income, estate, gift and GST tax rules for certain trusts

Modify tax rules for grantor trusts. When a remainder interest in a grantor retained annuity trust (GRAT) is created, the proposal would require that interest to have a minimum value for gift tax purposes equal to the greater of 25% of the value of the assets transferred to the GRAT or $500,000. Any decrease in the annuity during the GRAT term would be prohibited; the grantor could not exchange assets held in trust without recognizing gain or loss for tax purposes; GRATs would be required to have a minimum 10-year term and a maximum term of the life expectancy of the annuitant plus 10 years.

Implications. These provisions are a carryover from President Obama's budget proposals, as well as prior legislation. Currently, GRATs may be structured to have no gift tax consequences because the present value of the annuity payments to the grantor equals the FMV of the assets transferred to the GRAT. GRATs are especially useful when the taxpayer has little or no remaining gift tax exemption. The minimum value requirement would eliminate the ability to create a GRAT that does not have gift tax consequences, severely limiting its usefulness in an estate plan.

The prohibition of decreasing annuity payments would eliminate the "front-loading" of GRATs with other assets so that more of the main asset that is the target for using the GRAT is preserved for the remainder beneficiary.

Requiring a minimum term would make a GRAT a riskier planning technique because the transfer-tax benefits of GRATs are typically achieved when the grantor outlives the GRAT term. Requiring a maximum term would prevent 99-year GRATs that some taxpayers have created so that the amount includable in the grantor's estate under IRC Section 2036 is very small.

Adjust a trust's GST inclusion ratio on transactions with other trusts. Under the proposal, a trust's purchase of (1) assets from, or interests in, a trust that is subject to GST tax, or (2) any other property that is subject to GST tax, would be treated as a change in trust principal that would require the purchasing trust's inclusion ratio to be redetermined at the time of purchase.

Implications. This provision is new. Currently, one trust's purchase of another trust's assets at FMV would not require a redetermination of the purchasing trust's inclusion ratio.

Modify the tax treatment of loans from a trust. Loans that a trust makes to a trust beneficiary would be treated as a distribution for both income and GST tax purposes. These rules would apply to loans that trusts make, and to existing loans renegotiated or renewed, after the year of enactment.

Implications. Under this new provision, to the extent a trust has distributable net income in the year a loan is made, the loan would have income tax consequences to the beneficiary. And, to the extent the loan is to a skip person (as such term is defined for GST tax purposes), it would have GST consequences to the beneficiary.

Revise the valuation of partial/fractional interests in certain assets transferred intrafamily

The proposal would replace IRC Section 2704(b), which disregards the effect of liquidation restrictions on FMV, and instead provide that the value of a partial interest in non-publicly traded property (real or personal, tangible or intangible) transferred to or for the benefit of the transferor's family member would equal the interest's pro-rata share of the collective FMV of all interests in that property held by the transferor and the transferor's family members, with that collective FMV being determined as if held by a sole individual. Family members for this purpose would include the transferor, the transferor's ancestors and descendants, and the spouse of each described individual.

In applying this rule to an interest in a trade or business, passive assets would be segregated and valued as separate from the trade or business. Thus, the FMV of the family's collective interest would be the sum of the FMV of the interest allocable to a trade or business (not including its passive assets) and the FMV of the passive assets allocable to the family's collective interest determined as if the passive assets were held directly by a sole individual. Passive assets are assets not actively used in the conduct of the trade or business, and thus would not be discounted as part of the interest in the trade or business.

This valuation rule would apply only to intrafamily transfers of partial interests in property in which the family collectively has an interest of at least 25% of the whole. The proposal would apply to valuations as of a valuation date on or after the date of enactment.

Implications. This provision is new. It is meant to nullify discounts (e.g., lack of marketability, lack of control) that may be associated with transfers of partial interests in property (except an operating trade or business) among family members. Treasury and the IRS have had limited success in the courts in applying IRC Section 2704 to intrafamily transfers.

Limit use of donor advised funds (DAFs) to avoid private foundation payout requirement

Effective on the date of enactment, this proposal would clarify that a private foundation's distribution to a DAF does not constitute a qualifying distribution unless two conditions are met. First, the DAF funds must be expended by the end of the following tax year as a qualifying distribution that does not include a distribution to another DAF. Second, the private foundation must maintain adequate records or other evidence showing that the DAF has made a qualifying distribution within the required time frame.

Implications. The chief aim of the proposal is to prompt private foundations to distribute money to further their exempt purposes, rather than holding onto the money in investments or endowments indefinitely. The proposal would require distributions from private foundations to DAFs to be administered, documented, and redistributed in a manner similar to distributions to other private foundations. Having sufficient documentation to support that a private foundation's expenditures are being made appropriately and with charitable intent can greatly assist these organizations in maintaining their compliance.

Exclude payments to disqualified persons from counting toward private foundation payout requirement

Effective for payments made and expenses reimbursed after the date of enactment, compensation or reimbursement payments a private foundation makes to a disqualified person would not be considered qualifying distributions that satisfy the payout requirement. For these purposes, a disqualified person does not include a foundation manager who is not related to a substantial contributor. The Green Book notes that the "self-dealing rule would not change, so a private foundation could still pay reasonable compensation to a disqualified person for personal services that are reasonable and necessary to carry out the foundation's exempt purposes; these payments would just not count toward the payout requirement."

Implications. Like the DAF proposal, this proposal is aimed at prompting private foundations to distribute money to further their exempt purposes, rather than holding onto the money indefinitely. While reasonable compensation to a disqualified person for certain personal services that are reasonable and necessary to carry out exempt purposes would still be permissible, these payments would not be qualifying distributions. If the proposal were enacted into law, private foundations that normally count such compensation as a qualifying distribution would need to ensure that their other qualifying distributions are sufficient to meet annual minimum distribution requirements and avoid incurring excise tax on underpayment of those required distributions.

Modernize rules for digital assets

Apply wash-sale rules to digital assets and address related-party transactions

Effective for tax years beginning after December 31, 2023, digital assets would be added to the list of assets subject to the wash-sale rules unless the taxpayer is a dealer in stock or securities and the loss is sustained in the ordinary course of its dealer business. The wash-sale rules would also be modified as they apply to all assets with respect to transactions involving related parties, which would include members of a taxpayer's family and tax-favored accounts such as individual retirement accounts controlled by the taxpayer and one or more family members. For example, if assets subject to the wash-sale rules are sold and a related party purchases the same or substantially identical assets within 30 days of the sale, the loss generally would be deferred until the related party sells or otherwise disposes of the asset.

Implications. This proposal is identical to a proposal included in the BBBA and would subject digital assets held as investments or for trading to the same loss recognition rules as would apply for stocks and securities. The change would curtail loss-harvesting strategies involving the sale of digital assets at a loss followed by the immediate repurchase of the same or substantially identical assets.

Amend the mark-to-market rules to include digital assets

Effective for tax years beginning after December 31, 2023, a new third category of assets — actively traded digital assets and derivatives on, or hedges of, those digital assets — would be added to those that a dealer or trader may mark to market. The Green Book notes that a "digital asset would not be treated as a security or commodity for purposes of the mark-to-market rules and would therefore be eligible for mark-to-market treatment only under the rules applicable to the new third category of assets. No inference is intended as to the extent to which a digital asset may be eligible for mark-to-market treatment under current law."

Implications. The mark-to-market rules generally provide a clear reflection of income with respect to assets that are traded in established markets. The proposal would update these rules to reflect the proliferation of different digital assets that are traded in high volumes and may have reliable valuations.


Contact Information
For additional information concerning this Alert, please contact:
Private Client Services
   • Anthony Nitti (
   • Justin Ransome (
   • David Kirk (
Exempt Organization Tax Services
   • Stephen Clarke (
   • Melanie McPeak (

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor