Lots of the big scary tax changes that were predicted to be on the horizon aren't going to happen after all.
Many estate planners jumped on these potential changes many months ago, to scare clients into giving them more business. Once the Biden administration took over, estate planners became fearful of increased taxes on higher-net-worth families and a huge reduction in the estate tax exemption. Estate planners weren't wrong to suggest that their clients should plan ahead. However, I resisted the urge to notify my clients of these potential tax changes until I had more certainty on whether or not they were going to happen.
There are many times when I do have to scare clients into the sad reality of what will happen if they don't have a proper estate plan. I also have to explain how much of a tax there really is on your own death (hint: it can be HUGE!). Even death can't save you from taxes. But I didn't want to scare clients with these potential changes, just to have them spend a lot of money for me to update their documents, only to later find out that many of these changes weren't happening anyway. Well, I'm glad I waited because many of the scariest changes don't appear to be coming to light. There's an excellent article by the National Law Review that gives a bare-bones description of what's in and what's out, as far as tax reform.
Believe me, the originally proposed form of the law included huge taxes on higher-income earners, as well as major cuts in the estate tax exemption. I still wasn't sold on the fact that all these changes would pass through the House of Representatives and the Senate. So far, it looks like they will not pass after all. There were some changes that made it through the version of the law approved by the House of Representatives and now awaiting approval by the Senate, but many of the biggest and scariest changes were cut out of the bill so that it had a better chance of passing.
So, what's out of the bill at this point?
There was a proposal cutting the estate tax exemption in half, which was going to have huge ramifications on higher-net-worth families, but this provision of the bill has been removed. There was also a potential change to the way that trusts are taxed. This change was going to result in major taxes to people that have trusts. Further, it was going to render a lot of our trust techniques basically void. For example, we've used life insurance trusts for years as a way to remove life insurance proceeds from the death tax calculation. The new proposed rule was going to take that loophole away from us, but this part of the bill has been removed. Now, we don't have to worry about our life insurance trusts for the time being and we can still recommend them as an effective tool. Even putting property into a trust was going to be taxed, but those provisions have since been taken out of the bill.
There are some provisions in the new law that did make it through and that are not good news for higher-income earning families.
Some of these changes are only going to hit the top percentage of the highest-earning people in the country that have assets of more than $10 million. But there still are provisions included that are going to hit more of the upper-middle class. The wealthy people that have over $10 million in assets can absorb these taxes easier than a traditional higher-income earning family that's making between $400,000-$500,000 per year. For example, trade or business income earned by taxpayers that make more than $500,000 a year (if filing jointly and $400,000 a year if filing individually) will be subject to what's called the net investment income tax or an NIIT.
The NIIT hits income that is not subject to self-employment tax. So, if you are self-employed or run a business, and are taking a salary through that business, but also taking profit from the company, you could get around the self-employment tax. That’s over and done with now. This new NIIT closes that loophole and self-employed people like me are going to get hit with this additional 3.8% tax.
For someone that does not have $10 million, I can personally say this one is going to hurt and it's going to hurt most of my clients as well.
There will also be some changes to the way we can contribute to IRAs and Roth IRAs. For people with income over $400,000 (for single people and $450,000 for married people), you will be prohibited from doing a Roth conversion starting in 2032.
This means that we are left with the traditional IRA that taxes the money when it's withdrawn as opposed to the Roth IRA, where the growth of those funds is not taxed. Many people prefer the Roth IRA because, while a contribution is not tax-exempt now, what you take out later isn't taxed. Most high-income earners are prohibited from contributing to a Roth IRA during their working lives but could convert standard traditional IRA funds to a Roth down the road, after retirement when their income goes down.
This new tax plan will put the kibosh on that. Under this new bill, these Roth conversions are going to be a thing of the past.
Although some of these taxes still hurt, the newest version of the bill is far better than what was being proposed before. I'm glad I waited before telling all my clients to get rid of their life insurance trusts. Regardless of this bill, the estate tax numbers from the federal government are still going to drop significantly over the next several years, and our threshold in Massachusetts for estate and death taxes is only $1 million. If you are a higher-income-earning, individual or family, or your family has assets, including a home and life insurance proceeds, in excess of a million dollars, your estate plan can help reduce those taxes if it's done right. For more information about how to minimize these taxes and stop giving the government even more money, you can set up a Strategic Planning Session with us.