It is impossible to turn on the television, pick up a paper, or go on the Internet without reading or hearing something about the Democrat’s Budget Reconciliation Bill. In light of the House vote scheduled for Thursday, we thought it important to provide you with both content and context.
Democrat’s Budget Reconciliation Bill: Fact and Fiction
A BIT OF HISTORY
President Biden introduced his “wish list” for legislation outlined in the Green Book issued in May of this year. The estimated cost to adopt his budget proposals was over $6 trillion. That wish list has translated into a pared-down $3.5 trillion 881-page octopus with tenacles touching a vast range of areas from childcare to climate change. In August, the Senate passed a $1 trillion infrastructure bill with bipartisan support. It is currently in the House for a vote. Meanwhile, recognizing there would not be bipartisan support for the additional measures progressive democrats are demanding, many additional items from the wish list have been introduced by House Democrats in a Budget Reconciliation Bill. This was a strategic move since passage of a Reconciliation Bill only requires a simple majority of 51 Senate votes, not the usual 60 votes needed to overcome a filibuster. Despite the crafty strategy, every Democrat in the Senate needs to vote for this $3.5 trillion bill for it to pass. This seems highly unlikely given the vocal opposition from Senators Manchin and Sinema. Plus, it is well understood that there is no Senate Republican support for the bill.
Here’s the rub: both the Senate Infrastructure bill and the House Reconciliation Bill will be voted on at about the same time in the House. The progressives in the House have taken the position that unless the Reconciliation Bill has the needed support in the Senate, they will oppose the infrastructure bill.
Currently, the Reconciliation Bill is in the “markup” process in numerous House committees. This is where changes and eliminations occur. Progress on the details of the bill have has been hampered by the conflicting progressive and centrist factions of the party. The progressives see the $3.5 trillion package as a big drop from what they originally sought. The centrists, including many who could face difficult reelection bids, are concerned that the bill is too big and too expensive.
As introduced, there is “zero chance” of the Reconciliation Bill getting a party-line vote in both the House and the Senate without significant concessions on the price tag and how it is paid for says Donald R. Wolfensberger, a Congress scholar at the Woodrow Wilson International Center for Scholars and the Bipartisan Policy Center.
FUNDING PROPOSALS FOR THE RECONCILIATION BILL
In order to pass a fiscal bill, funding sources must be identified. This is where much of the media attention and alarmist focus has been. Here are some of the funding sources that have dominated the media:
- Individual, Capital Gains and Corporate Income Tax Rate Increases:
- Individual Rates:
- Raise the top individual rate to 39.6% for single filers with taxable income over $400,000 and over $450,000 for joint filers.
- Add a 3% surcharge on modified adjusted gross income above $5 million.
- Prohibit Individual Retirement Account (IRA) contributions when the account balance reaches $10 million and accelerate required minimum distributions for those accounts. This applies to income earners over $400,000 for single filers and $450,000 for joint filers.
- Eliminate Roth conversions for single filers with income over $400,000 million and joint filers over $450,000.
- Capital Gains Rates
- Increase the current top rate of 20% to 25%.
- Net Investment Income Tax Rates:
- Apply Net investment income rates to income derived in the ordinary course of trade or business for single filers with income over $400,000 and over $500,000 for joint filers. This would also apply to trusts and estates.
- Corporate Rates:
- Replace the flat 21% rate with graduated rates of 18% on the first $400,000 of income; 21% on income between $401,000 and $5 million; and 26.5% on income above $5 million. The graduated rates phase out and the top rate applies to corporations with income over $10 million.
II. Lifetime Gift and Estate Tax Exemption Reduction:
- The current lifetime gift and estate tax exemption is $11.7 million per individual ($23.4 million per married couple). This exemption amount is scheduled to “sunset” at the end of 2025 and reduce to $5 million per individual, indexed for inflation. The Reconciliation Bill will accelerate the “sunset” to the end of 2021. This means an exemption beginning in 2022 of approximately $6.2 million per individual.
III. Grantor Trust Changes:
- Grantor trusts are irrevocable trusts used to remove assets from the taxable estate while taxing trust income back to the Grantor at a presumably lower individual tax rate than the trust’s rate. Though the Grantor pays the tax on the trust income, the trust assets are not included in the Grantor’s taxable estate. This bill would require the inclusion of all the Grantor trust assets in the Grantor’s taxable estate at death. Further, trust distributions made during the Grantor’s life would be taxed as gifts made by the Grantor.
No other provision in the Reconciliation Bill has generated more alarmist rhetoric in the planning arena. Many appear to have missed two significant exceptions in the original draft of the bill. Notably if either exception applied, the whole provision did not apply. These are:
- Any estate tax inclusion of trust assets to the Grantor is reduced by the value of any transfer to the trust previously taken into account by the Grantor under Chapter 12 of the Internal Revenue Code which includes taxable gifts, gifts made using the annual gift tax exclusion and gifts made using the lifetime gift and estate tax exclusion.
- Any trust the Secretary determines by regulations or guidance that does not have as a significant purpose the avoidance of taxes.
These exceptions were changed by the House Ways and Means Committee during mark up. The bill currently provides for an exclusion from estate tax inclusion of Grantor trust assets for gifts made to or transfers made from trust under Chapter 12, which includes gifts sheltered from tax by the annual exclusion or by the lifetime credit. So, even after the changes made in the Ways and Means Committee, at the very least, the gifts made pursuant to Chapter 12 will not be brought back into the Grantor’s taxable estate at death. The death knell rung by alarmists for Grantor trust-owned life insurance certainly appears to be pre-mature. Most policy premiums are paid using gifts to the trust that are sheltered from tax by the annual exclusion or the lifetime exemption. What is unclear is whether the assets purchased within the trust using the gifts made under Chapter 12 fall under the exemption or whether the exemption is limited to the gifts made to trust. Of course, there are planning alternatives to avoid Grantor trusts altogether by using an LLC or Partnership to own the policy.
The changes made in Committee indicate how in flux the provisions of the reconciliation bill are. It is important to note that if or when the House votes the bill out, the Senate will certainly make significant changes, so there is no way to predict what the final bill, if there is one, will look like.
WHAT MIGHT HAPPEN NOW?
Congressional Democrats could cut entire specific spending programs or cut many programs by a specific percentage. They could increase the individual and corporate income tax rates even more than currently proposed. As noted earlier, the push-me pull-you within the Democratic party in Congress runs the risk of killing the bill entirely. The moderates believe the bill is too big and too expensive. The progressives do not think it is big enough. Neither side has indicated a willingness to compromise. Most pundits agree that something will be passed but they also agree that it will not look much like what is currently under consideration. One thing is certain, there is no certainty here except the current bill will change.
SO, WHAT TO DO?
Make a point of having conversations with your advisors about the possible impacts of these proposals on your personal and business planning, and discuss your options moving forward. Your PRW team is waiting to help assess any planning challenges and explore your opportunities. There is still time to make an impact on your 2021 circumstances.
NOTICE: The foregoing is not intended nor should be construed as legal advice to any particular client and may not be used to avoid US tax penalties (IRS Circular 230). Clients should always consult their attorney about their individual circumstances.
PRW Wealth Management, LLC is a registered investment advisor (“RIA”) with the U.S. Securities and Exchange Commission (“SEC”). Investment Advisor Representatives offer financial advice through PRW Wealth Management, LLC. Registered Representatives offer securities through Lion Street Financial, LLC; member FINRA/SIPC. PRW Wealth Management, LLC and Lion Street Financial, LLC are not affiliated. PRW Wealth Management, LLC and Lion Street Financial, LLC do not provide legal, accounting, or tax advice and are not Certified Public Accounting (CPA) firms. Consult your attorney or tax professional. Trading instructions sent via email may not be honored. Please contact my office at (617)745-0900 for all buy/sell orders. Please be advised that communications regarding trades in your account are for informational purposes only. You should continue to rely on confirmations and statements received from the custodian(s) of your assets.