The long-term effects of tax proposals in the Treasury Department's recently released Green Book would cut across a huge swathe of the economy, revolutionize transfers of wealth, transform partnership taxation and produce big business winners and small business losers.
“Nothing will happen for a while,” said Tom Wheelwright, CEO of accounting firm WealthAbility. “Right now, it’s just a series of proposals in the budget for the fiscal year beginning Oct 1, 2021.”
Naturally, many of the proposals in the Green Book, which reflect the Biden administration's plan for the next fiscal year, are politically motivated, according to Wheelwright: “There are massive new entitlements, including the extension of the Child Tax Credit and Dependent Care Credit, and a proposal to extend pre-K to younger children. And then there’s the energy proposals, which are really intended to eliminate oil and gas production in the U.S.”
“By deducting intangible drilling costs and using percentage depletion, you can effectively write off 100% of investment in the first and second year of drilling,” he said. “Expenses other than those would likely be for equipment subject to bonus depreciation, which they’re not taking away. On the flip side they’re adding credits, extending the solar credit back to 30%, and expanding charging station credits. Interestingly, they even have a credit for existing nuclear energy facilities. It could be the first time that nuclear energy has been classified as clean energy, since it’s the least intrusive into the environment.”
There are some subtle and some not-so-subtle provisions that disfavor small business, according to Wheelwright: “There’s an interesting provision to subject S corporation earnings to the [Net Investment Income Tax] whether they are distributed or not, unlike C corporations, that only pay on distributed earnings.”
There’s also a disparity in the treatment of transfers of property, according to Wheelwright. “Transfers of property into a partnership or a trust other than a grantor trust would be subject to capital gains taxes. But a transfer to a corporation under Code Section 351 would still be tax-free. This is a winner for big companies, and a loser for small businesses. It would produce a big-business economy — we’ll do more business as C corporations and less as S corporations.”
While the proposed changes may favor big corporations, there are still provisions intended to create wealth by encouraging small business, according to Elizabeth Sevilla, a partner at Top 100 Firm Seiler LLP. “For example, the provision on qualified small business stock [Code Section 1202] is an incentive to wealth creation by starting new businesses and generating jobs,” she said. “This is in recognition of the fact that the majority of employers are small-business owners.”
The proposals affecting high-net-worth individuals would constitute a full employment act for trust and estate professionals, Sevilla believes. “There’s a trifecta of aging baby boomers facing their mortality, the value of most assets — businesses, homes, real estate and stocks — is all up, and there are impending tax law changes,” she said. “They need to figure out the best way to configure their estate plans.”
But it’s important not to have the tax tail wag the planning dog, according to Sevilla. "When you’re engaged in comprehensive planning, it’s important to address the goals and desires and vision of the trustor, who created the wealth, as to how they want to gift or leave a legacy,” she said. “Tax law changes should be more of an impetus to make the planning happen sooner rather than later, but when you construct a plan just because of proposed tax law changes, there’s a chance of buyer’s remorse when the proposed changes don’t happen.”
‘A wish list’
“The Green Book is primarily a wish list,” said Ed Renn, senior equity partner at Withers. “Most of the proposals were from positions he’s taken since 2019 on the campaign trail. No one was surprised by the personal income tax hike, or the corporate hike changes to income of offshoring.”
“Section 1031 exchanges are limited to $500,000 per year. If you have a series of transactions, you have a lot of gains. That would effectively curtail the Section 1031 industry, knowing that you can’t defer bigger gains than half a million,” he pointed out.
“The proposal would effectively eliminate the economics of carried interest, since if you’re paying the ordinary income rate you’re not getting a tax preference. If capital gain and dividends are taxed at 39.6%, there’s no longer an economic incentive to carry, but just in case the rates get lowered in the future, the proposal affirmatively makes it a tax preference item again,” he continued. “So, it’s not only economically impossible to get the benefit for more than $1 million, they also make it impossible to restore the benefit simply by lowering the rates. They would have to affirmatively change the code to bring it back.”
There were some surprises as to what is not in the proposals, according to Renn: “Biden’s campaign proposed to take the estate tax exemption down to $3.5 million. That was supposed to be in the American Family Plan, but at the last minute it came out. Also, an estate tax increase was left out, and the $10,000 SALT cap was left alone.”
“There would be no step-up in basis as we know it,” Renn added. “If you give an appreciated asset to the kids or a trust or die holding the asset, those will be recognition events. Also, transfers of appreciated property to partners would be recognition events. If I have a gas station and you are a mechanic and contribute and run the garage, placing the real estate in a partnership would trigger capital gains. I don’t think they meant it to have that consequence, but that concept would revolutionize partnership taxation.”
Glenn DiBenedetto, director of tax planning at New England Investment & Retirement Group, believes that the top capital gains rate proposed for those who earn more than $1 million will affect many who would not otherwise be considered to be wealthy. “If a business owner wants to sell the business he started decades ago and wants to cash in on the benefits of a lifetime of work, they would be over the $1 million mark in the year they sell and will effectively pay twice the tax,” he said.
DiBenedetto suggested a carve out to aid those who wish to reap the benefit of a once-in-a-lifetime transaction such as the sale of a closely held business. “Biden proposed that anyone making less than $400,000 a year would not be affected. But you could be making that amount and have one of these events that push you over the threshold,” he said.
“For planning purposes, you have to look at the Green Book proposals and decide where your client will fit in,” said Roger Harris, president of Padgett Business Services. “The stepped-up basis elimination is one of those things that will get more complicated and could be problematic for a lot of people who have historically benefited from it. It’s been a good way to clean up a messy history. For example, if a property was transferred three times within a family over time as it moves from one family member to another, stepped-up basis allows you to assign value as of a particular date. You can clean up records where no one knows what the value was.”
Politics will play an important role in shaping any legislation, Harris suggested: “Senator Joe Manchin, (D-West Virginia), has said he will not kill the filibuster, which makes passing the proposals more difficult. And he won’t support the voting rights bill, which will likely be part of the infrastructure deal, so there has to be something that at least ten Senate Republicans support.”
