Sweeping income, capital gains, and estate tax changes are creating confusion and uncertainty for family businesses, such as farms and restaurants. Fortunately, there are tools at your fingertips that can protect your financial-well being and lifestyle.
Even in the most stable economy, family businesses struggle with effective estate and succession planning challenges. In many cases family businesses are much more than just a means to make money - they’re lifestyles and identities. Families put in long hours, sacrifice their personal time, and face disproportionate risk to see their business succeed.
This is especially true for farms and agricultural businesses. Family farms face natural threats, such as fires and droughts, as well as increased pressure to compete with large “factory farms.”
But they also face another challenge: Operating profitably in a difficult tax environment.
Although there is talk of many changes, we have to consider that many of these changes are still at the “proposal” stage. The current Administration may not have the votes or influence to enact any significant tax changes.
Predictions are always difficult, as we’ve seen from pollsters’ accuracy in the past two presidential elections.
Still, it’s important to address this issue now - on September 13, the House Ways and Means Committee released its tax change proposal, with the majority of its provisions set to take effect on January 1, 2022.
We’ll look at the changes relevant to family businesses later in this article. Here are some of the key points of the House proposal.
- Raising the maximum tax rate for individuals to 39.6%
- Raising the maximum capital gain rate to 25%
- Imposing a 3% additional tax for individuals with $5 million in adjusted gross annual income
- Reduction of estate and gift tax exemptions
- Amendments to Grantor Trust treatment
The House proposal is one of many to surface in recent months. Others include the STEP Act and the American Families Plan.
Increased Marginal Rates for Capital Gains and Income (Proposed)
Raising the top tax rate from 37% to 39.6%, as suggested in one proposal, could impact the profitability of family businesses. In addition, state tax rates are rising in many areas of the country. In California, for example, the 13.3% marginal tax rate, coupled with the federal tax rate, would be greater than 50%. Similarly, New York residents shoulder an 8.82% marginal tax rate, which results in an overall tax rate above 48%. If they live in NYC, there’s another 3.816% tax, for a whopping total combined rate of 52.296
New York State residents pay 8.82% state income tax for a combined rate of 48.42%. A resident of the city of New York will pay an additional 3.816% for a combined rate of 52.296%.
The House proposal raises the top capital gains tax rate to 25%. Biden also proposed that capital gains be taxed at the maximum 39.6% rate.
Discontinuation of the Stretch IRA (Implemented)
Thanks to the Secure Act, signed by then-President Trump and enacted on January 1, 2020, it will be easier to reach $1 million in annual income. The “Stretch tax” eliminated under this Act permitted planners to stretch retirement account taxation for multiple generations. With only a few exceptions, the Secure Act places a 10 year limit for a beneficiary to drain an inherited IRA, leading to higher tax bills.
RMDs for High-Value IRAs (Proposed)
The House bill seems to require the commencement of minimum distributions on high-value or “large” IRA accounts holding more than $10 million at the end of the previous tax year. Distributions from these IRAs would be subject to ordinary income tax.
Discontinuation of the Basis Step-Up (Proposed)
The “step-up basis” - an essential provision for inheritors, may be eliminated under the current administration. Today, taxable gains on property sold are calculated by deducting the “basis,” or cost, from the purchase price. The “basis” is elevated to the fair market value on the decedent’s death date when a property is inherited. This could dramatically increase taxation for properties held over multiple generations, especially if the properties increase in value. The American Families Plan proposes limiting the step-up basis.
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