The U.S. in general, and New Jersey in particular, face some significant challenges when it comes to concerns like crumbling infrastructure and educational racial equality. Experts and activists who have called for government solutions to these issues have been cheered by President Joe Biden’s moves since he’s been in the White House. But is the country prepared to foot the bill?
These kinds of issues have a sizeable local impact. The Garden State’s deteriorating roads, bridges and other components impede “New Jersey’s ability to compete in an increasingly global marketplace,” according to a 2021 “report card” issued by the American Society of Civil Engineers. And the racial gap in the state’s educational system means that the state’s ranked in the bottom nine nationally, according to a June 2020 WalletHub study.
After taking a victory lap following the passage of his $1.9 trillion American Rescue Plan, on March 31 Biden outlined a $2 trillion infrastructure plan that, if approved by Congress, will be paid for, in part, by hiking the federal corporate income tax to 28%, up from the current 21%. It would also increase taxes on the wealthy, which Biden appears to define as households with an income of more than $400,000 a year.
The problem is that $400,000 a year may be a lot for a family in so-called flyover states like Kentucky or West Virginia, but in high-cost regions like the metro New York area, or in cities like Boston and San Francisco, some financial advisors say that $400,000 a year basically funds an upper-middle-income lifestyle.
That means Biden’s tax increase could lead to unintended consequences. “The concern is that a lot of the proposals focus on a $400,000 threshold,” said Richard Bloom, a partner at the audit, tax and advisory organization Mazars USA LLP, whose focus includes trusts and estates. “Federal numbers like these are often not that rare in high-cost states in the Northeast, but they’re never tied to the local cost of living.”
Two of the significant potential federal changes under Biden “could be an increased income tax rate and a reduction in the estate tax’s lifetime exemption,” he added. “The income tax rate for single and for joint married filers with income above $400,000 may go up to 39.6% — it’s currently 37%; while the amount of the lifetime exemption from the estate tax could fall from the current $11.7 million per person — or $23.4 million for most married couples — to as low as $3.5 million per person, or $7 million for a married couple.”
Making it personal
Some politicians aren’t opposed to changes that would step up certain effective tax rates. In March, U.S. Sen. Cory Booker supported a separate, proposed Sensible Taxation and Equity Promotion (STEP) Act that would eliminate the so-called step-up in basis, which lets donor assets pass on to heirs at current market prices, instead of the owner’s original cost. The current tax minimization process may reduce a beneficiary’s liability for capital gains tax.
Biden revealed some of his plans on March 31, though his proposals still have to go through Congress, where they may be modified. But “[w]e’re already engaged with our clients in a lot of gift and estate tax planning that will let them utilize the current exemptions,” Bloom said. “Flexible planning is key, because at this point we don’t know when any changes may kick in. The effective date could be the date they’re enacted, or a prospective future date — like Jan. 1, 2022 — or they could even be retroactive to a specific date, although that’s not likely.”
Trusts are a big part of the planning. “One popular structure is a SLAT, or spousal lifetime access trust,” he said. “The donor spouse funds the irrevocable trust, typically on behalf of his or her non-donor spouse and other family members, like children and grandchildren.”
SLATs are popular because although the donor spouse is not a beneficiary, the trustee could make distributions to the non-donor spouse during the non-donor’s spouse’s lifetime. That’s often done to maintain the couple’s standard of living, which of course may indirectly benefit the donor spouse.
“The key to planning is flexibility,” Bloom explained. “We know that these exemptions are good now, but what if the changes are retroactive? In that case clients may need a way to unwind their gifts. We can accommodate that with a disclaimer provision within the documents that basically allow the doner, or recipient, to disclaim the gift and it would return to the donor.”
Matthew Rheingold — a partner at the law firm of Einhorn Barbarito, Frost & Botwinick PC, where his focus includes wills, trusts and estates, and taxation — said he’s working with many clients “to prepare basic documents like trust agreements now, although we’ll wait to fund them once the details of the president’s tax plans get ironed out.”
He’s concerned though, that owners of certain businesses, including ones structured as sole proprietorships, partnerships or other “pass-through” entities — where profits and losses generally flow through to owners or members and are taxed at their individual income tax rate — may be in for a bigger tax bill.
“If President Biden follows through on his planned repeal of the QBI deduction [which currently enables certain small-business owners and others to deduct up to 20% of their qualified business income from being taxed at the federal level] for people with taxable income in excess of $400,000, it could be a big hit,” he said.
But the news isn’t all bad. Residents of New Jersey and certain other high-tax states could get a “huge” break if Biden is able to eliminate the $10,000 cap on state and local tax deductions from the 2017 Tax Cuts and Jobs Act, he added.
Prepare, don’t react
For estates, flexibility is crucial, advises Claire Toth, managing principal and senior wealth strategist at Peapack Private Wealth Management. “If you can delay making irrevocable decisions until all the facts are known, that’s ideal. Techniques like disclaimer trusts and flexible QTIP [qualified terminable interest property trust] elections can defer decisions about which spouse owns which assets until after the first death. A spousal limited access trust can move assets out of the estate while keeping them available to the donors.”
“The biggest possible estate tax change may be what happens to unrealized appreciation at death,” she added. “Under current law, most assets get a new tax basis equal to then fair market value. One possible change is no basis adjustment. Another is to tax all that appreciation at death. Either would roil the entire estate planning landscape. “
And “what happens to the basis of non-publicly traded assets like private businesses, real estate, and family farms?” she asked. “Creating a taxable event at death would require a new level of estate planning. It’s far better to prepare than react.”