President Barack Obama is proposing to close what he calls “the trust fund loophole” in the capital gains tax. The changes would curtail the step-up in basis on estates of the wealthy.
The proposals are significant enough to spur insurance and financial professionals to send out alerts to their high-net-worth clients and others who could be affected or might be interested.
If adopted as proposed, the changes may require revisions of certain financial and estate plans or perhaps repositioning of financial assets.
The administration this weekend posted a summary of Obama’s plan in a fact sheet on the White House website. The fact sheet spells out the full package of proposals that the President intends to introduce to the nation in his Jan. 20 State of the Union address.
Using what the administration calls “middle-class economics,” the proposals aim to eliminate loopholes that - in the administration’s words - “let the wealthiest and big corporations avoid paying their fair share in taxes, and invest those savings to help middle-class families strengthen their standing in the 21st-century economy.”
The proposals would generate tax revenues that the administration intends to deploy into middle-class-friendly initiatives. These initiatives would impact retirement savings programs, second-earner credits for married couples, child care tax credits and tax incentives for education.
It is a modern variation of a take-from-the-rich-and-give-to-the-poor agenda. It has many interlocking fingers but curtailing the existing tax law concerning the stepped-up basis appears to be the central theme.
The proposal would close what the administration calls the “trust fund loophole” or the “single largest capital gains tax loophole” in current tax law. This refers to the part of the tax code that allows people to pass appreciated assets on to heirs free of capital gains tax.
Specifically, the proposal calls for treating bequests and gifts — other than to charitable organizations — as “realization events, like other cases where assets change hands,” according to the fact sheet.
The President’s proposals also would increase the total top capital gains and dividend rate to 28 percent. It is currently 23.8 percent. The top rate applies to wealthy couples who have incomes over about $500,000, the White House said.
To protect middle-class families, the proposal includes the following:
- For couples, no tax would be due until death of the second spouse.
- Capital gains of up to $200,000 per couple ($100,000 per individual) could still be bequeathed free of tax, an exemption that the administration said “would allow couples to bequeath more than $200,000 without owing taxes.”
- Couples would have an additional $500,000 exemption for personal residences ($250,000 per individual).
- Tangible personal property would be tax-exempt. The exceptions would be “expensive art” and similar collectibles.
- No tax would be due on inherited small, family-owned and operated businesses, unless and until the business is sold.
- Any closely-held business would have the option to pay tax on gains over 15 years.
Here are some things that insurance and financial advisors may want to explore with colleagues as well as clients.
Not a done deal: As with all presidential proposals to Congress, this package is but an opening salvo to a discussion about new tax reforms. The proposals may go nowhere, since both Senate and House are now controlled by Republicans, who will not want to endorse programs of a Democratic president.
Still, clients may wonder what the impact would be if the proposal to remove the stepped-up basis on capital gains picks up steam anyway. This is the time for advisors to start thinking this through, so they will be ready to provide clients with cogent feedback.
Wealth-market issues: Wealthy clients and their advisors will want to stay abreast of any movement on the stepped-up basis part of the proposals. It is safe to say, the current tax plans do not account for heirs having to pay capital gains tax on those inherited assets, so any change in this area would impact existing plans.
Middle-market issues: The bread-and-butter accounts of many insurance agents and brokers are middle-market families and small business owners. Many if not most of these clients would not feel the impact of the proposal, at least not in the current environment.
That is because many such clients likely do not have enough capital-gains-generating assets to put them into that tax zone. As noted above, the administration proposal includes “protections” for this market. The proposals would exempt capital gains of up to $200,000 per couple or $100,000 per individual, exempt personal residences ($500,000 for couples, $100.000 for individuals), and provide certain tax protections for those who inherit small businesses.
For this reason, advisors probably will not need to make changes in existing financial or estate plans for many middle-market families.
Some advisors who only serve the middle market may even be tempted to ignore the proposals. However, that could be risky. The financial situation of certain clients, especially those on the upper-end of the middle market, could improve to the point that their estates may hit the proposed threshold triggering capital gains tax. If the new proposals ever do become law, advisors with upper-end middle-market clients may want to start monitoring those clients’ capital gains exposure in a new way.
Could that create a new need for life insurance or other financial plans for such clients? Possibly, but there are so many unknowns right now that speculation in this area is probably not productive.
Charitable exemption. The proposal’s exemption of gifts to charitable organizations from the proposed change to stepped-up rules could be of interest to insurance and financial advisors who are active in charitable organizations and/or in the charitable giving market.
The exemption, if enacted, could be a point of discussion with wealthy clients about making bequests to such groups, particularly if the exemption would impact the overall tax picture for the client’s remaining estate. Certainly the charities would welcome any such boost to their resources.
In sum, the Obama proposals have yet to meet the tests from the opposition and from vested interests with deep knowledge of tax law and tax implications. That could be the main message advisors might want to send to clients right now.
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