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New Tax Law Changes Coming? Part 2

In my post last week I talked about recent draft legislation which would make changes to federal income, gift and estate tax laws.  Many of our clients have called asking what they should do and I must remind callers that nothing has changed yet.  We are at the beginning of what is usually a lengthy legislative process as we just saw with the passage last week of the $1 trillion infrastructure package.

Nevertheless, what is contained in the current draft will affect certain taxpayers and not others.  It is targeted more towards wealthy – high income and net worth – Americans.  It is not likely to affect a majority of our clients, again, as far as what is currently on the table.

For example, the federal estate and gift tax exemption – the amount that each person can pass free of estate and gift tax during and/or at death – would be cut in half.  It is currently $10 million per person indexed for inflation ($11.7 million for 2021) and it would drop to $5 million.  With the inflation index the exemption would be a shade over $6 million in 2022.  For a married couple that would be up to $12 million they could pass on to heirs tax free using estate tax planning trusts.  Only a small number of taxpayers would be affected by this change.

The current proposal would also eliminate many of the tax benefits of using what are called “grantor trusts”.  These are irrevocable trusts that allow the grantor (person establishing the trust) to own the trust assets for income tax purposes but treat the assets as outside of his/her estate for estate tax purposes.  If this proposal becomes law the assets of a grantor trust would be included in the estate, eliminating this estate tax minimization strategy.  (While we use grantor trusts in long term care asset protection plans to permit income to be taxed at individual rather than the higher trust income tax rates, these clients typically do not have to worry about estate taxes so this change would have no effect on them.)

There are also several proposed changes to retirement accounts.  High income earners ($400,000 for single filers and $450,000 for joint filers) with combined retirement account balances exceeding $10 million would be required to withdraw 50% of the balance over $10 million.  If retirement account balances exceed $20 million then 100% of the excess over that amount would have to be withdrawn and any tax paid.  Additionally, further contributions would be barred as long as balances exceed $10 million.  This would apply to traditional IRAs, Roth IRAs and defined contribution retirement accounts such as 401ks.  

Another proposal concerning Roth IRA conversions, could potentially affect more people than the other changes detailed above.  It would prevent high income earners from converting pre tax qualified retirement plan contributions and pre tax IRAs to Roth IRAs.  It also would prevent everyone regardless of income from converting after tax contributions to qualified retirement accounts and IRAs into Roth IRAs.

Until we see how the back and forth of the legislation making process changes these initial proposals or adds to them, there is nothing that most of our clients need to do but wait and see and be sure to check back on our blog.  We’ll add more as things develop.