What became law, however, contained none of the game-changing provisions that were part of the Sept. 13 proposal. Instead, the Infrastructure Investment and Jobs Act signed into law by President Biden on Nov. 15 contained few tax provisions and the ones in the bill had very specific and narrow targets. So what planning should a business consider?
First, close attention should be paid to the “Build Back Better” legislation making its way through Congress. Of import, as proposed the BBB legislation includes an increase in the state and local tax deduction (SALT) cap from $10,000 to $80,000. If the cap is increased, New Jersey businesses that are pass-through entities (partnerships, LLCs and S corporations) will need to take a long look at the interplay between taking the SALT on individual returns or taking advantage of New Jersey’s recently enacted Pass-through Business Alternative Income Tax (BAIT).
BAIT is a SALT workaround. A pass-through entity can pay the tax due on behalf of its owners at the entity level, and the owners can claim a credit for the payment on their New Jersey return. The effect is a tax deduction for the pass-through entity and a reduction in Federal taxes:
Example: Assume ABC LLC has $1,000,000 of taxable income. The entity could elect to take the BAIT, pay $63,087 of New Jersey taxes for its members, and receive a tax deduction for that, thus reducing its taxable income to $936,913. At 37%, that saves $23,342 in Federal taxes.
There is a slight “upcharge” paid to New Jersey for taking the BAIT — the BAIT tax rate is slightly higher than the pure individual tax rate. However, it is well worth the toll charge if the owners are subject to a $10,000 limit on their own SALT deductions. On the other hand, if the cap goes to $80,000, then if ABC has two 50% owners, they can pay the approximate $30,000 in New Jersey tax themselves, and unless their property taxes and other state taxes exceed $50,000, receive a full benefit from the SALT deduction.
Keep three points in mind. First, as seen from the above the analysis will be very fact-specific. Second, the IRS has indicated its acceptance of this workaround. Third, if the taxpayer has a single member entity that is treated as a disregarded entity, and if taking the BAIT makes sense, thought should be given to becoming a two-member, true pass-through entity (no longer disregarded) to take advantage of the New Jersey law.
What other planning should be considered? Attention should be paid to provisions of the Sept. 13 proposed legislation that has not made it into the Infrastructure Investment and Jobs Act or the Build Back Better proposed bill. One focus might be on the reduction in an individual’s lifetime exemption from $11.7 million to a much lower number, as well as proposals to eliminate discounts on gifts of non-business assets held by family partnerships.
The lifetime exemption is the amount that can be either gifted or left to a business owner’s heirs gift and estate tax free. That amount is currently $11.7 million, which is scheduled to be reduced in 2026 back to $5 million plus inflation adjustments regardless of whether there is a law change.
Business owners contemplating a succession plan should look hard at using their lifetime exemption now, rather than waiting, for a number of reasons:
The sooner the transfer is made, the more appreciation that leaves the estate;
Snapping the exemption back is an easy revenue raiser, and a change passed in 2022 could be retroactive to Jan. 1, 2022;
Flexible structures are available to “mitigate” but not overcome the loss of the assets; and
Appropriate thought is needed to adopt a structure that combines the desire for continued control with the gifting plan.
The benefit of taking action sooner can be demonstrated.
Example: Karen and Cliff have a $50 million estate; they have used none of their lifetime exemptions, so they have $23.4 million available. Gifting now (Dec. 31, 2021) at 5% assets out of the estate on Dec. 31, 2025 are $28.4 million, allowing an additional $4 million to avoid estate taxes.
There are other potential planning opportunities in advance of the change in the law. For example, with rates increasing the use of private placement life insurance will become more popular, especially if proposals to eliminate the value of grantor trusts resurface. But as with all planning, the devil is in the details, and the proper plan requires careful consideration of tax, financial, and emotional issues.
Bryan Bloom is a partner at Faegre Drinker in Florham Park. He is a tax authority who provides personalized and comprehensive estate planning for family offices and tax and transactional advice for investment funds and investors. [/vc_column_text][/vc_column][/vc_row]