Proposed tax changes focus on the rich

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So how do you define who is rich?

The last tax changes proposed by the House Ways and Means Committee basically say that a wealthy individual is someone who earns $ 400,000 a year or a couple with an annual income of $ 450,000.

“Rich is just the term we use to describe people who have more than us when we think they don’t deserve it,” said Brad Klontz, financial psychologist in Boulder, Colorado. “The definition of rich is entirely subjective,” adding that “$ 400,000 is just an arbitrary number – it could make you ‘rich’ in Central America but middle class on the shores. “

Four years ago, when the latest Internal Revenue Code changes were made, the focus was on a lower tax rate for corporations and for very wealthy individuals, especially those who owned property. real estate and could benefit from a very specific tax deferral strategy. on the property.

This time around, companies won’t pay much higher taxes, at least not as high as some progressives wanted. Instead, the tax law focuses on increasing the incomes of the rich.

“All of this legislation is people-centered and raises the ante for the rich,” said Michael Kosnitzky, partner at Pillsbury Winthrop Shaw Pittman law firm. “Raising the corporate tax rate does not benefit the rich because corporate taxes are paid by shareholders, who receive less dividends, employees who receive less wages, and the consumer, who pays more for goods and services. These proposals fall under personal income tax.

The proposed top tax rate of 39.6% is similar to the old top rate of 39.6% in 2017. It is set at $ 400,000 in income for an individual and $ 450,000 for a couple. which is slightly lower than income level in 2017. Currently the highest tax bracket, To 37 percent, starts at $ 523,600 for an individual and $ 628,300 for a couple.

But those affected by the new rate would also pay more because there are fewer deductions than there were in the tax code before the 2017 changes.

“You have to look at the effective rate,” said Pam Lucina, director of trust and head of trust and advisory services at financial services firm Northern Trust. “We have a lot less deductions, so the 39.6% rate is a much higher rate. “

One that affected many people was the loss of the Full State and Local Tax Deduction, or SALT. In the 2017 changes, the deduction was capped at $ 10,000 and primarily affected people who lived in Democratic-controlled states of the Northeast and West Coast, where property taxes and state property taxes are high.

Limiting it brought more money to the US Treasury. In 2017, the cost of the unlimited deduction the federal government approximately $ 122.5 billion; the cap reduced that number to $ 24.4 billion the following year.

Details of the tax proposal are still being negotiated, and lawmakers representing affected states have said they hope they can reinstate more of the SALT deduction. A proposal would double the deduction to $ 20,000, not a wholesale return to what it had been.

The tax that defined this year’s discussion was capital gains. The proposed legislation – raising the rate to 25%, from 20%, for people earning over $ 400,000 – has been a relief for two groups of taxpayers: the very rich and anyone who could inherit property.

The Biden administration began the year by talking about raising the capital gains rate to the ordinary income tax rate for high earners and rejecting a provision that allows people to inherit property without gains in capital.

The administration’s initial proposal called for a maximum capital gain rate of 43.4% – the highest tax rate plus the 3.8% surtax on investment income that pays for Obamacare – for individuals earning over a million dollars. But most of the attention has been drawn to President Biden’s proposal to end the so-called base increase on death – which wipes out all taxable gains on assets passed on to heirs. repeal that reportedly brought in $ 11 billion in additional tax revenue per year.

This proposal has since been abandoned.

“No loss from the base increase is a big win for wealthy families,” said Edward Renn, partner in the Private Clients and Taxation group at the law firm Withersworldwide.

But this change was not made to save wealthy families. This was done because the change could harm smaller families who had property to pass on to their children.

“The provision benefits very wealthy people who have started businesses,” said Justin Miller, national director of wealth planning at Evercore Wealth Management. “But it also benefits anyone who inherits a home from their parents and grandparents that might have hundreds of thousands of dollars that might be subject to capital gains tax. It would have impacted a lot of people, not just the top 1% or top 0.1%. It would not have been a popular strategy.

Taxes affecting estates and large gifts have long been ripe for tax changes. A change would bring the inheritance tax exemption back to its level under the Obama administration. But it probably won’t increase the incomes of megamillionaires and billionaires. While the proposed exemption would drop to around $ 6 million per person from $ 11.7 million, the estate tax rate would remain at 40%. This is what matters for the larger estates.

“If we want to prevent dynasties, the most important thing is the highest tax rate,” said Harland Levinson, a chartered accountant in Beverly Hills, California. “The amount of the exemption is important but not really important. It is the maximum tax rate that affects the largest estates.

A host of other proposals, however, seek to clamp down on areas that have allowed the wealthiest and most sophisticated Americans to pass substantial wealth on to their heirs tax-free. One is to shut off access to various types of grantor trusts which provide huge wealth transfer opportunities for the very wealthy.

A popular type allows someone to put an asset, like shares of a private company about to go public, in a short-term assignee trust and pass all the appreciation on to a franchise heir. tax. Or a person could use another type of transferor trust to pay all of the taxes on the investment in the trust, allowing that investment to grow tax free.

“Grantor trusts have been the bread and butter of estate planning,” Miller said. “This proposal threatens to eliminate grantor trusts on the date the bill is passed.”

The tax proposals also target loopholes that have favored higher incomes in certain industries, such as one that would eliminate the preferential tax treatment on deferred interest, which is used by high incomes in the private equity world.

Another proposal aims to reduce the preferential treatment of shares that start-up founders and first-time employees receive, known as the share limitation of qualified small businesses.

As it is, the first $ 10 million of those shares when the company goes public may be exempt from tax. The proposal would reduce that amount from $ 10 million to $ 5 million.

This would help reduce the impact when people find ways to take the deduction multiple times.

“The founders were using the provision to bring equity into trusts and then stack those $ 10 million exclusions on top of each other,” Tara Thompson Popernik, research director for the wealth strategies group at Bernstein Private Wealth Management. “They could fund multiple trusts. There was an almost unlimited amount that could be excluded. Fifty percent is still a pretty huge advantage.

And for anyone who misses, there is an additional 3% tax for people earning more than $ 5 million a year, and a cap on individual retirement accounts set at $ 10 million (which was in effect. response to a ProPublica article which revealed that Silicon Valley investor Peter Thiel had a tax-free retirement account worth $ 5 billion.)

Any discussion of taxes revolves around paying your fair share, but fairness is in the eye of the person being taxed. But Mr Klontz, the financial psychologist, said his research has shown that most people think taxes are right when someone else pays them.

“At the end of the day, we all want to feel it’s fair, but no one wants to be taxed more,” he said. “If you think the rich are greedy and selfish, you may feel justified in taking more away from them. But in this political climate, there is a good chance that all these tax changes will be reversed in the next election.


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