Now that U.S. tax changes are more real, what should you do?

There’s been a lot of talk about Congress wanting to revise the tax law to target the wealthy. Federal lawmakers continue to take steps to make some much-discussed changes a reality. A new law might be adopted, if at all, as early as late November but possibly well into December.

Here, we offer you some ideas as to how you might best respond with actions that can support you reaching your financial goals depending to some extent on what Congress ultimately does, or doesn’t, do.

But first we’re going to let you know what lawmakers have put on the table so far, and what they have not; what has survived two rounds of edits, and what has not.¹ We’ll then provide you with a potential to-do list: nine actions that might suit you to take by December 31 or in the near future. (Of course, you should always consult your own tax advisor before taking any action, as we do not provide tax or legal advice.)

Key tax changes proposed

On September 13, the House Ways and Means Committee released parts of a bill that, had it been enacted, would have reshaped the U.S. tax landscape and collected more from wealthier taxpayers. On October 28, many tax-related provisions were modified substantially; six days later, lawmakers made a few, generally more modest, revisions. And regardless of what passes the House, it is expected that the Senate will make still more revisions.

This third bill would, if enacted unchanged:

Individual income taxes—generally

• Impose a 5% surtax on individual or married taxpayers to the extent their modified adjusted gross income (AGI) exceeds $10 million, and an additional 3% surtax (for a total of 8%) to the extent their modified AGI exceeds $25 million.
• Impose a 5% surtax on non-grantor trusts to the extent their modified AGI exceeds $200,000 and an additional 3% surtax (for a total of 8%) to the extent their modified AGI exceeds $500,000.
• Subject digital assets (including cryptocurrencies), commodities and foreign currency to expanded constructive and wash-sale rules that suspend losses taken when a taxpayer buys a "substantially identical" security within 30 days of taking the loss.
• Prohibit additions to traditional IRAs with account balances in excess of $10 million, and increase required minimum distributions from large IRAs, both traditional and Roth.
• Increase the cap on the deduction for state and local taxes (SALT) paid from $10,000 to $80,000, through the end of 2030. The cap would revert to $10,000 starting in 2031.

Individual income taxes—specific to business owners

• Subject profits from businesses to the 3.8% net investment income tax, which currently is only applicable to interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer.
• Permanently disallow an annual deduction for business losses (those greater than business income) in excess of $500,000 (with minor exceptions).
• Limit the qualified small business stock (QSBS) exclusion to 50% for individual or married taxpayers with income greater than $400,000, and for all non-grantor trusts.

Corporate taxes

• Impose a 1% tax on stock buybacks by publicly traded companies.
• Impose a 15% minimum tax on the profits of publicly traded companies that report more than $1 billion in profits.

Not currently proposed or removed from earlier versions of the bill

Importantly, the latest bill does not currently contain provisions:

• Increasing the top ordinary income tax rate (now 37%) or the top long-term capital gains tax rate (now 20%).
• Eliminating the basis adjustment (step-up in basis) at death rule.
• Deeming death a realization event, thereby triggering a capital gain on any unrealized growth; or imposing some type of annual tax (what is sometimes referred to as a wealth tax), such as a mark-to-market imputed tax event, on the appreciation of taxpayer wealth.
• Increasing the holding period for capital gains treatment for carried interests to five years (under current law, the holding period is three years); this had been proposed in the September 13 bill.
• Prohibiting IRAs from investing in assets available only to accredited investors (such as many alternative investment funds); this, too, had been proposed in the September 13 bill.
• Reducing, as proposed in the September 13 bill, the gift and estate tax exclusion amount from $11.7 million to $6.03 million effective January 1, 2022; instead, those exclusions would sunset, as scheduled under current law, on January 1, 2026.
• Regarding irrevocable grantor trusts (IGTs) and grantor-retained annuity trusts (GRATs), as proposed in the September 13 bill. Those provisions, if enacted, would have substantially reduced, if not altogether eliminated, the tax benefits of those planning techniques.
• Increasing the corporate income tax rate from 21% to 26.5%, as proposed in the September 13 bill.

Our tax to-do list: nine actions you might take

Keep top of mind that it is unclear whether any tax law will be enacted during this session of Congress and, if any is, what that law’s precise terms may be.

Still, there are some actions we think you may be well-advised to consider taking.

We urge you to speak with your estate planning lawyer, accountant and other advisors, including your J.P. Morgan team, to determine which of these steps may be right for you and the rest of your family. 

And, as always, we advise against letting the tax tail wag the dog: Any and all of your decisions should be made in the context of your goals and with this perspective: Tax law will likely continue to change over time—as it has for many decades.

That said, here are our top nine actions to consider:

1. Accelerate income into 2021 particularly if your 2022 income is expected to be above $10 million, or $25 million, as your total rate increase might be as much as 8% ( 5% on modified AGI from $10 million to $25 million, and another 3% on modified AGI over $25 million). If you have retirement accounts, now may be a good time to consider a Roth conversion.  Further, exercising stock options or realizing capital gains in 2021 may make sense, assuming doing so would otherwise make sense in the context of your overall net worth and goals with respect to your wealth.
2. Taxpayers who are able to spread the receipt of income that in the aggregate would exceed $10 million over multiple years, perhaps from the sale of a business or large concentrated positions or through earned compensation, should consider whether it is worth the interest rate, market, creditor, and other risks to take that income over multiple years, thereby potentially avoiding imposition of the surtax(es) in each year, whereas receipt of a single amount in a single year could trigger the 5% or even 8% surtax in that year.
3. Because the surtaxes (of 5% and 3%) apply to modified AGI and not to taxable income—the latter being the amount against which charitable and other “below-the-line” deductions are applied—deferring those deductions (principally charitable donations) would not prove to be economically beneficial. Consequently, for those taxpayers who anticipate being affected by the proposed surtax(es), focus should be placed on transactions that reduce modified AGI. Among those “above-the-line” actions are taking tax losses from the sale of capital assets, incurring investment interest expenses, and, for business owners, implementing the state and local tax (“SALT”) cap workarounds that many states have enacted statutes to permit.
4. If feasible, divide a large non-grantor trust (with roughly $10 million or more) that benefits multiple beneficiaries into smaller trusts, each for the benefit of a single beneficiary. The 5% surtax on high-income taxpayers is proposed to apply to trusts whose AGI (after deductions for distributions to beneficiaries) is greater than $200,000 (for individual taxpayers, that figure is, as noted above, $10 million). An additional 3% surtax would apply to non-grantor trusts with income in excess of $500,000, making this approach even more powerful.  As the bill is written now, separate non-grantor trusts would each be allowed $200,000 of income before the surtax would apply.
5. Trustees or others holding powers with respect to existing non-grantor trusts (such as to modify their administrative terms) the income of which may be subject to the 5% and 3% surtaxes may want to amend those trusts, or otherwise exercise those powers, to have those trusts considered grantor trusts for income tax purposes, thereby perhaps avoiding imposition of those surtaxes.  In determining whether any of those powers should be exercised, the powerholders should consider, among other factors, any fiduciary duties they owe to all of the trust’s beneficiaries in both the short term and the longer term, as well as the costs associated with such an amendment.  If a trust instrument is silent as to discretionary powers, powerholders may want to add or exercise grantor trust powers and then move the trust to a jurisdiction, such as Delaware, that has a legal infrastructure (including courts) familiar with the use, exercise, and modification of a trust’s administrative powers.
6. Take losses on the sale of cryptocurrencies and other property that starting in 2022 might be subject to the wash sale rule.
7. For individuals who would be subject to the 5% and/or 3% surtaxes, invest some of your liquid assets in an insurance policy that invests in insurance-dedicated funds. Assets invested by an insurance company on behalf of a policyholder—through a properly designed and managed contract—appreciate free of income tax. The benefits of this tax deferral and in many instances tax forgiveness feature increases when tax rates are higher.
8. If you can afford to do so, and doing so would comport with your values, use up the balance of your soon-to-be $12.06 million exclusion against gift tax, preferably by funding irrevocable grantor trusts that can last in perpetuity. As long as asset values continue to appreciate over time, transferring “excess” capital to (or in trust for the benefit of) future generations remains a powerful technique to preserve family wealth. 
9. Review the tax classification of operating businesses, comparing flow-through forms (such as partnerships or Subchapter S corporation) versus the C corporate form that considers both shareholder and entity level taxation under the current and proposed law changes to determine the most tax efficient classification within the context of your business model. The differences to your ultimate take-home can be substantial—especially as the BBB Act currently proposes that high-income taxpayers would not able to avail themselves of the 100% exclusion from capital gains tax of a significant portion of their qualified small business stock (QSBS)—but would still benefit from the 20% deduction for owners of businesses operating as flow-through entities (such as partnerships) for income tax purposes, potentially making the conversion to a pass through more appealing. The 20% deduction was effectively eliminated in the original bill but was restored (via removal) in the revised and latest bills.

How we can help you

We do not advise our clients on which tax moves may be best for them. However, we can provide you, your tax advisors and your estate planning attorneys with our financial modeling of your assets and insights into markets, wealth planning and trusts, as well as observations on other similar transactions we have participated in —all of which can help inform your decisions.

¹ As of November 2021.

² All wealth transfer actions outlined here are recommended only for those who have both the capacity and the desire to make such gifts.

³ Under the current proposal, minimum distributions from a taxpayer’s aggregated retirement accounts that are worth over $10,000,000 at the end of the prior tax year would be increased by 50% of the difference between the aggregate value and $10 million. Additional minimum distributions would be required from Roth IRAs if the total retirement account balances were over $20,000,000