Major changes in the tax law generally are not enacted when a President is in his last year in office, or when the President and the Congressional majority belong to opposing parties. However, one can never be certain what Congress will do this session. The most recent estimates from the Congressional Budget Office (CBO) show that in recent years federal tax revenue has risen strongly, while expenditures have fallen. The accompanying chart shows how the federal government budget deficit has shrunk from 9.8 percent of Gross Domestic Product (GPD) in 2009 to 2.8 percent in 2014. Recent forecasts from the CBO state that the deficit, as a percent of GDP, will remain at or below 2.8 percent for the next five years.
Under these circumstances, it is unlikely that any significant change in federal income or transfer tax laws shall be enacted until after the 2016 Presidential and Congressional elections have occurred. Nonetheless, a host of tax-related proposals have been introduced in the 114th Congress and referred to the House and Senate tax-writing committees or included in President Obama’s FY2016 budget proposal and some of these may ultimately result in enacted changes in tax laws.
Among proposed changes in federal income and transfer tax laws are provisions that would:
- Increase the highest long-term capital gain and qualified dividend tax rate from 20 percent to 24.2 percent (or, for taxpayers who are subject to the 3.8 percent net investment tax, from 23.8 percent to 28 percent).
- Impose a 30 percent minimum tax on the income of individuals or couples with income in excess of $1 million who have large deductions and other tax preferences.
- Eliminate the exclusion from income of pre-tax contributions to dependent care flexible spending accounts.
- Limit the value of most itemized tax deductions to 28 percent for certain higher income taxpayers.
- Limit the amount that individuals can accumulate in tax-deferred retirement accounts and plans to $3.4 million.
- Subject to self-employment taxes all business income derived by owners of interests in pass-through entities who actively participate in those entities.
- Classify as ordinary income the net income derived from, and gain derived on the disposition of, the so-called “carried interest” in private equity, investment services, real estate, and certain other partnerships and limited liability companies which are classified as partnerships under federal tax entity classification rules.
- Tax gain realized on the sale or exchange of an interest in an entity classified as partnership for federal income tax purposes on a look-through basis.
- Require that, in computing gain or loss on the disposition of stock, average cost basis be used and eliminate the ability to use specific share or lot identification.
- Prohibit use of minority discounts in valuing interests in family-controlled entities, such as partnerships, limited liability companies, and corporations, when such interests are transferred between family members.
- Increase the top federal estate tax rate to 45 percent (from 40 percent), reduce to $1 million the unified gift and estate tax exemption (which, indexed for inflation, is $5,430,000 in 2015), and reduce to $1 million the generation-skipping tax exemption (which, indexed for inflation, is $5,430,000 in 2015).
- Increase the minimum term imposed on grantor retained annuity trusts (GRATs) to 10 years (from two years).
- Limit the duration of the generation-skipping tax (GST) exemption so that the GST exclusion that is allocated to a trust would terminate 90 years after the date on which the trust is created.
- Eliminate the extended tax deferral now available to non-spouse beneficiaries of IRAs and 401(k) qualified retirement plans by requiring that assets of such inherited plans be fully distributed over a period of not more than five years.
- Eliminate the ability of individuals who are not eligible to make direct ROTH IRA contributions, because their incomes are too high to make back-door ROTH IRA contributions through the conversion of their traditional IRAs to ROTH IRAs.
- Impose, on a donor or deceased owner of appreciated property, tax on capital gain at the time property is gifted or at the death of such owner, and thereby eliminate the income tax free step-up in basis of assets acquired by gift, bequest or inheritance, with exclusions for property given or bequeathed to a spouse or to charity and a $100,000 per person exclusion, an exemption of up to $250,000 per individual (or $500,000 for a couple) for a home, and special provisions for interests in small, family-owned and operated businesses.
- Raise oil and gas taxes on businesses that develop oil, gas and geothermal wells by eliminating deductions for intangible drilling costs and percentage depletion and by increasing minimum amortization periods.
- Reduce to 28 percent the maximum U.S. corporate income tax rate, with a maximum effective rate of 25 percent for domestic manufacturing corporations.
- Strengthen existing rules directed at combatting “earnings stripping” by further limiting the ability of U.S. companies to deduct interest on indebtedness they owe to foreign subsidiaries.
- Impose a per-country 19 percent minimum tax on the foreign income of domestic companies and their controlled foreign corporations.
- Impose, as part of the transition to the 19 percent minimum tax, a one-time 14 percent tax, payable ratably over a period of five years, on U.S. corporations’ current accumulated foreign earnings not previously taxed in the United States, with generally a 40 percent credit allowable for the associated foreign taxes paid.
- Close so-called “loopholes” under existing tax laws (Subpart F) pertaining to U.S. taxation of income of U.S.- controlled foreign corporations, create a new category of Subpart F income for income derived from transactions involving digital goods or services, and make certain additional changes to the Subpart F rules.
- Eliminate certain U.S. tax benefits that under current tax laws may be achieved through the use of hybrid entities, hybrid instruments, and hybrid transfers in ways that create “stateless income” or enable taxpayers to claim deductions in the U.S. without a corresponding inclusion of income in the payee’s tax jurisdiction or to claim multiple deductions for the same payment under U.S. tax laws and under the tax laws of one or more other countries, and eliminate U.S. tax benefits which currently may be obtained through the use of so-called reverse hybrid entities (i.e., entities treated as corporations for U.S. tax purposes but as transparent in foreign jurisdictions).
- Exempt foreign pension funds from the application of the Foreign Investment in Real Property Act (FIRPTA) provisions.
- Modify the worldwide interest allocation rules for members of an affiliated group of U.S. corporations.
- Broaden the applicability of rules that limit the ability of a domestic corporation or partnership to expatriate through so-called inversion transactions, in which the domestic entity is replaced with a foreign corporation as the parent company of a multinational affiliated group of companies, by expanding the definition of an inversion transaction.
Whether federal tax legislation to limit or eliminate valuation discounts for family-controlled entities is enacted, those who own interests in such entities should keep abreast of current developments. The Internal Revenue Service and Treasury Department are close to finalizing tax regulations addressing restrictions on valuation discounts. The forthcoming guidance may significantly reduce the availability of valuation discounts for transfers of interests in family-controlled entities.
We encourage you to consider the effect that such proposals, if enacted, would have on your income and transfer tax obligations and the tax-efficiency of your financial and estate planning arrangements. You may want to take advantage of available tax-saving opportunities that may be eliminated if the proposed changes are enacted. If you want to discuss those opportunities or are interested in determining how your existing estate and financial planning arrangements would be affected if these proposed tax law changes are enacted, contact your Marcum LLP advisor.