Capital gains tax rate increase effective date

Congress debated numerous proposals to significantly change the tax code since the Biden Administration took office in 2021. While most of these proposals have yet to become law, some notable tax changes are included in the Inflation Reduction Act. The Act gained Congressional approval in August, and shortly thereafter, President Biden signed the Act into law.

Other potential rule changes not included in the Inflation Reduction Act are outlined by the U.S. Department of the Treasury in a document commonly referred to as “The Green Book.” The revenue proposals reflected in the Green Book are before Congress, though no action is anticipated for the rest of the year. Additional tax legislation that may match or differ from some of the Green Book proposals may be developed and reviewed as well by Congress in the months to come.

It’s always important to be prepared for potential changes that could affect your tax liability. The primary focus of this article is to provide a summary of the tax provisions in the Inflation Reduction Act and key proposals from the administration’s “Green Book.” This article also highlights current tax laws that are scheduled to sunset after Dec. 31, 2025, resulting in changes that may impact your future tax liability.

Tax and other provisions of the Inflation Reduction Act

The Inflation Reduction Act includes provisions designed to address climate change, health care and corporate taxation. Within those measures are new provisions that may affect your tax bill and personal finances. They include the following:

Clean energy tax credits for homeowners

Tax credits are extended to 2032 incentivizing homeowners to add solar or wind power systems. Eligible homeowners could qualify for a 30% tax credit. After 2032, a 26% tax credit would apply until 2034. Tax incentives are also included for the purchase of energy-efficient water heaters, heat pumps and HVAC systems. Rebates for these items can add up to as much as $14,000. These rebates take effect immediately.

Rebates for electric vehicle purchases

Existing tax credits for the purchase of a new electric vehicle are extended through December 2032. The credit applies to any “clean” vehicle, including hydrogen fuel cell cars within price limits. To qualify, vehicles must be assembled in North America and be priced under $80,000 for trucks and SUVs and under $55,000 for all other types of cars. Qualified buyers of new vehicles receive a $7,500 credit, applied at the point of sale. A new $4,000 tax credit would also apply for the purchase of qualified used electric vehicles. The credit is available to married couples filing a joint return with income less than $300,000 per year and single tax filers with income under $150,000. The credits are effective immediately, but starting in 2024, qualifying vehicles must meet other requirements for American-made components, including batteries.

The Inflation Reduction Act includes provisions designed to address climate change, health care and corporate taxation. Within those measures are new provisions that may affect your tax bill and personal finances.

Affordable Care Act premium subsidies

Subsidies for health insurance under the Affordable Care Act were expanded in the wake of the COVID-19 pandemic, but scheduled to expire at the end of 2022. The Inflation Reduction Act extends those subsidies through 2025. This is expected to benefit up to 13 million Americans who purchase health insurance under the Affordable Care Act.

Managing prescription drug prices for seniors

The new law opens the door for Medicare to negotiate drug prices. Beginning in 2023, this will involve only 10 specific drugs, but the list will eventually be expanded to 20. This is designed to lower the cost of medications to Medicare beneficiaries.

Another provision caps Medicare beneficiaries’ drug costs to $2,000 per year beginning in 2025, with some reduced costs taking effect in 2024. Drug manufacturers will be required to pay a rebate if they increase prices faster than Medicare’s rate of inflation, a law that takes effect in 2023. In addition, the Inflation Reduction Act provides seniors with free vaccinations beginning in 2023.

Expanded IRS Enforcement

The legislation provides an additional $80 billion in funding over ten years designed to allow the IRS to pursue more tax enforcement. The purpose is to boost tax collections through increased audits and other enforcement actions. The expanded funding begins immediately.

15% corporate minimum tax

A critical provision applies to most U.S. corporations that earn more than $1 billion in profits. While under current law, these firms are subject to a 21% corporate tax rate, many pay less or no federal tax. Under this change, a new minimum 15% tax would apply based on annual income posted in a corporation’s financial statement, rather than the corporation’s taxable income, effective on January 1, 2023. Corporations will still have the ability to claim certain credits to reduce their tax liability. A special carve-out provision in this law applies to subsidiaries of private equity firms that amass more than $1 billion in profits annually. Private equity firms that own various subsidiaries with profits totaling more than $1 billion are exempt from the 15% minimum tax.

Tax on stock buybacks

Corporations have commonly repurchased their own stock as a way to boost the value of its shares. The Inflation Reduction Act adds a 1% tax on the value of stock buybacks corporations choose to execute, effective January 1, 2023.

Existing tax laws that are set to expire

Tax laws change frequently, and in some cases, tax law changes are built into the calendar. Many of the provisions included in the Tax Cut and Jobs Act (TCJA) that passed in 2017 are scheduled to “sunset” (or no longer apply), by Dec. 31, 2025. With that date drawing nearer, planning ahead is critical to leverage current tax laws and to mitigate the potential impact of the changes that are scheduled to occur without further Congressional action.

Key provisions affecting individual taxpayers that are scheduled to expire at the end of 2025 include:

• The top tax bracket that affects individual taxpayers, estates and trust income reverts to 39.6% (from the current 37%).
• The 12%, 22% and 24% individual income tax rates will also move higher.
• The unified estate and gift tax deduction, valued at $12.06 million per individual in 2022 (effectively $24 million for a married couple) will be cut approximately in half.
• The ability to utilize certain lifetime gifting strategies will be limited, because of a reduced lifetime gift tax exemption beginning on Jan. 1, 2026, if not earlier.
• The ability to implement certain estate planning and wealth transfer strategies at death will be greatly limited, because of a reduced estate tax exemption beginning on Jan. 1, 2026, if not earlier.

If you are potentially subject to these tax law changes, be sure to talk with your financial and tax professionals to discuss possible solutions.

Who could be affected by the proposed “Green Book” changes?

The proposals included in the Green Book cover a wide range of tax laws, though the impact will be felt mostly by a narrow group of taxpayers. Nevertheless, the changes may be of concern to you if you meet any of these criteria:

• Have adjusted gross income equal to or exceeding $400,000 for single tax filers, or $450,000 for those who are married and filing a joint return
• Itemize deductions on your federal tax return
• Have current or planned trusts
• Are an owner of a limited partnership, limited liability corporation (LLC), “S” corporation or “C” Corporation

Note that the proposed effective dates of various changes to the law are not consistent. While most would take effect after December 31, 2022, some could become effective at an earlier date. Note the effective dates as you review the provisions below.

This is a summary of key relevant provisions of the administration’s tax proposal, as presented in the Green Book, that may impact you.

Tax rates for individuals

“Surcharges” on certain high-income taxpayers

Current law
The highest tax rate is 37%, which applies to income that exceeds:

• $539,900 for individual tax filers (other than a surviving spouse)
• $647,850 for married couples filing a joint return
• $539,900 for heads of household
• $323,925 for married couples filing a separate return

Proposed changes
The Green Book proposals would raise the top tax bracket to 39.6% from the current 37% level, and reduce the applicable income thresholds to:

• $400,000 for individual tax filers (other than surviving spouses)
• $450,000 for married couples filing a joint return
• $425,000 for heads of household
• $225,000 for married couples filing a separate return

Minimum tax

Current law
There is currently no minimum tax requirement that is applied to individuals.

Proposed changes
A new 20% tax rate on total income, generally inclusive of unrealized capital gains, would apply to taxpayers with total wealth (net of liabilities) exceeding $100 million. Provisions include the ability to pay a minimum tax liability in nine equal installments in the first year. In subsequent years, the minimum tax liability would be payable in five equal installments over the course of the year.

Payments of the minimum tax liability will be treated as a prepayment credit that can be applied towards subsequent capital gains realized in the future to avoid double taxation of capital gains. Because of various factors that go into the calculation of meeting the $100 million threshold, taxpayers should be aware that the minimum tax is fully phased in for taxpayers with wealth in excess of $200 million.

The proposal would be effective for taxable years beginning after December 1, 2022.

Tax changes that could affect investments

Tax rate on long-term capital gains and qualified dividends

Current law
The top tax rate is 20%. In 2022, it applies to long-term capital gains and qualified dividends generated if income exceeds:

• $459,750 for individual tax filers (other than surviving spouses)
• $517,200 for married couples filing a joint return
• $488,500 for heads of household
• $258,600 for married couples filing a separate return

Proposed law
A new top tax rate of 39.6% would apply for high income taxpayers. Combined with the Net Investment Income Tax (NIIT) of 3.8%, the result for those affected by the change would be a federal tax rate on long-term capital gains and qualified dividends of 43.4%. The higher tax rate would apply only to the extent that an individual’s taxable income exceeds the applicable threshold amounts indexed for inflation after 2023:

• $1,000,000 for married couples filing a joint return
• $500,000 for married couples filing separately

If enacted, it is proposed that this change would apply retroactively for gains and dividends received on or after the date of enactment.

Tax changes that could affect estate transfers and gifting

Surtax on estates and trusts

Current law
The current unified gift and estate tax exemption of $12.06 million per person (in 2022) is set to expire at the end of 2025. At that time, the exemption amount will be reduced by roughly half the current level. Previous proposals under consideration would have accelerated the expiration of the higher exemption amount to 2022, but this broad aspect of estate and gift taxation is not addressed by the Green Book. However, a number of other provisions are included.

Proposed changes
Unrealized gains on appreciated assets transferred by gift during life or held at death would be treated as a “realization event” for tax purposes and taxed as if the underlying property was sold. The unrealized gain of property transferred by gift during life or held at death would be subject to a $5 million lifetime exclusion for a single tax filer. Any unused exclusion during life can be applied towards the unrealized gain on property held at death. Also, the proposed exclusion would be portable and may be used by a surviving spouse. This results in an effective aggregate exclusion amount of $10 million that married couples filing a joint return can use towards unrealized gains.

Gains on gifts or bequests to charities would not be required to be recognized. Neither would gains on gifts or bequests to a spouse until the spouse dies or disposes of the asset. However, in both cases, the cost basis would carry over. This tax would apply on property transferred by gift after December 31, 2022, or property owned by individuals who die after December 31, 2022.

In addition, unrealized capital gains in appreciated assets would be taxed if they are transferred into or distributed in kind from an irrevocable trust, partnership or other non-corporate entity if such transfers are effectively a gift to the recipient.

Similarly, unrealized capital gains in appreciated assets held by an irrevocable trust, partnership or other non-corporate entity would be subject to tax if such property had not been recognized for tax purposes within the prior 90 years.

These rules would become effective on transfers, or for property owned by individuals who die after December 31, 2022.

New rules for donor-advised funds

Current law
Private foundations (PF) are generally required to make annual “qualifying distributions” of at least 5% of the aggregate fair market value of all a foundation’s assets that are not used to carry out its exempt purpose. Current law allows a PF to protect foundation assets by directing some of those distributions to donor-advised funds (DAF), where assets can be held for an indefinite period.

Proposed changes
The use of DAFs would be limited to avoid private foundation PF payout requirements by clarifying the definition of a distribution from PFs to DAFs. Such distributions would not be considered a qualifying distribution unless the DAF funds are expended as a qualifying distribution in the following taxable year. In addition to meeting that requirement, the PF must maintain adequate records or other evidence to that effect. This rule would be applicable on the date that it is enacted into law.

Tax laws related to GRATs and other trusts

Overview of current law
The creator of a grantor trust is treated as the owner of the trust assets for income tax purposes. This allows the grantor to manage transactions within the trust without realizing gains and to pay income taxes without it being considered a taxable gift. Several provisions of the new proposals would affect the operation of Grantor Retained Annuity Trusts (GRATs) and other types of trusts.

All changes proposed below could take effect on or after the date of enactment of the new tax law, unless otherwise specified.

Minimum and maximum value requirement for a GRAT

Current law
No minimum values are currently applied to GRATs.

Proposed changes
To fully qualify for favorable tax treatment inside the trust, the remainder interest established at the inception of a GRAT must have a minimum value equal to the greater of 25% of the value of assets transferred into the GRAT or $500,000 (but not more than the value of such assets). The term of the GRAT must also be a minimum of ten years and not exceed the annuitant’s life expectancy plus ten years.

Asset sales in grantor trusts

Current law
A sale that occurs between an irrevocable grantor trust and its deemed owner is not a taxable event.

Proposed changes
The sale of an asset between an irrevocable grantor trust and its deemed owner (grantor or any other person) would require the seller to recognize a gain on any appreciation in the transferred asset for income tax purposes. The buyer of appreciated property would be required to claim a cost basis equal to the value of the asset, which would include the satisfaction of an obligation, such as an annuity payment or note repayment. This rule would not apply to securitized transactions.

Tax treatment of income paid by owner

Current law
If the deemed owner of the trust pays the income tax due from the trust, it is not considered a gift.

Proposed changes
If the deemed owner of the trust pays the income tax due from the trust, it would be considered a gift, unless the trust reimburses the owner for the tax payment in the same year.

Value of promissory notes

Current law
A common estate planning technique is to sell appreciated assets to a grantor trust in return for a promissory note. This creates a significant wealth transfer opportunity by essentially freezing the value of the appreciating asset in the estate.

Proposed changes
Promissory notes that bear sufficient interest to avoid below-market status would require consistent valuation. The discount rate used to value the note for gift and estate tax purposes would be the greater of the actual interest rate of the note or the applicable federal rate (AFR) based on the remaining term of the note. The proposal would apply to valuations as of a valuation date on or after the date of introduction.

Limit to generation-skipping transfer tax exemption

Current law
If sufficient generation-skipping transfer (GST) tax exemption is allocated to a trust, it makes the trust perpetually GST-exempt.

Proposed changes
The GST tax exemption would be limited to direct skips and taxable distributions from a GST trust to beneficiaries who are no more than two generations below the transferor (grandchildren). Those of younger generations would qualify for the same tax treatment if they were alive at the creation of the trust. Taxable terminations of a GST trust that occurs while any of these persons are beneficiaries of the trust would also qualify.

Tax changes that could affect businesses and business owners

Increase in corporate tax rate

Current law
The effective tax rate on C corporations is 21%.

Proposed changes
The new effective tax rate would be 28%, effective for tax years beginning after December 31, 2022. For taxable years that begin after January 1, 2022 and before January 1, 2023, only the portion of the taxable year in 2023 would be subject to the 28% tax rate.

Limits on family partners to shift tax basis

Current law
Family members can use a partnership to shift the tax basis of assets between each other.

Proposed changes
The new law would reduce the ability of family members to use a partnership to shift the tax basis of assets between each other. This would be effective for tax years after December 31, 2022.

Treatment of carried interest

Current law
A “profits” interest in a partnership received in exchange for services is typically not taxable when received. The recipient is taxed based on their share of partnership income and the character of the income at the partnership level.

Proposed changes
Tax-carried profits interests in a partnership, regardless of the character of the income at the partnership level, would be treated as ordinary income and be subject to self-employment taxes. This would apply to partners holding the interest and providing services to the partnership with taxable income exceeding $400,000. The interest would only be treated as a long-term capital gain if there were a three-year holding period. The new law would be effective beginning after December 31, 2022.

Limits on like-kind (1031) exchanges

Current law
Section 1031 exchanges allow taxpayers to defer the full value of the gain when exchanging real property for other real property.

Proposed changes
The deferral of Section 1031 like-kind exchanges of real property would be limited to an aggregate amount of $500,000 for each taxpayer ($1 million for married couples filing a joint return) per year. This would take effect after December 31, 2022.

Limits on conservation easement transactions

Current law
There is significant flexibility to claim a deduction when establishing certain conservation easement transactions.

Proposed changes
The tax deduction for a partner in certain syndicated conservation easement transactions would be limited. A direct or indirect contribution by a partnership that exceeds 2.5 times the sum of each partner’s basis in the partnership would not be treated as a qualified conservation contribution.

There are important exceptions to this proposal. For example, the limit would not apply if a three-year holding period requirement was satisfied. It also would not apply to certain partnerships and other pass-through entities if family members substantially hold all of the interests.

The new law would be effective for contributions made in taxable years after December 23, 2016, or in the case of contributions to preserve a certified historic structure, for contributions made in taxable years beginning after December 31, 2018.

Deductions for business-owned life insurance

Current law
A pro-rate interest expense deduction can be claimed for interest allocable to unborrowed cash values of business-owned life insurance policies covering employees, officers and directors of a corporation can be deducted.

Proposed changes
The deduction disallowance in these circumstances would be expanded to include policies covering employees, officers or directors. An existing exception would continue for a policy covering a business owner with at least a 20% ownership position. This would be effective for policies issued after December 31, 2021.

Previously proposed rule changes not included in the Green Book

The Green Book did not address some key changes to tax code that had been proposed in legislation under consideration in 2021. These include:

• Repeal of the cap on Social Security taxes. The 6.2% tax on Social Security for each employer and employee applies to the first $142,800 of income in 2022. While some expected this cap to be removed, nothing to that effect was included under these proposals.
• Change to gift and estate tax exemptions and tax rates. As indicated above, the current lifetime unified exemption amounts and tax rates for gift and estate remain at their elevated levels, with the current rules phasing out in 2026.
• SALT limitation. There was much discussion of eliminating the maximum $10,000 deduction for state and local (SALT) taxes, but that issue is not addressed in the Green Book.

Start planning for a changing tax environment

The Inflation Reduction Act makes a modest number of specific changes to the tax code that will apply immediately. Other provisions in the Green Book excluded from the Inflation Reduction Act may come under consideration going forward. However, with mid-term elections coming up in November 2022, it becomes less likely that any further major tax legislation will occur this year. If control of either house of Congress changes after the election, that may limit the potential for changes in the next two years. Notwithstanding the uncertainty of proposed tax law changes given the current political environment, there is a high degree of certainty under the current tax laws if Congress does nothing. Therefore, it is important to consider current tax laws and related sunset provisions, along with the new laws incorporated into the Inflation Reduction Act, and plan accordingly. We will closely monitor events in Washington and keep you apprised of the latest proposals impacting your taxes.

Talk with your wealth professional if you have questions about the potential impact on your own situation and financial plan.

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