The Biden administration is waging and all-out war on wealth. We already know about the plans to:
- Raise the top individual income tax rate to 39.6 percent 43.4 percent if the 3.8 percent tax on net investment income is included,
- Raise the top corporate tax rate to 28 percent,
- Tax capital gains and dividend income as if they were ordinary income (above a certain percentage) and,
- Eliminate the stepped-up basis accorded to assets transferred to heirs upon the death of the owner, something that will (effectively) bring many more people into the death tax, and subject others to a double death tax.
What hasn’t been discussed is a provision that’s buried in the 114-page document released by the U.S. Treasury in May. The document, General Explanations of the Administration’s Fiscal year 2022 Revenue Proposals (the so-called Green Book), broadly explains President Biden’s plan to confiscate vast amounts of wealth from citizens.
I’m referring to the use of trusts as vehicles to preserve family wealth over generations.
That portion of the plan was not discussed at all by Biden during his campaign, nor was it mentioned when he released his plans to “tax the rich” in April. If this element of the plan becomes law, there will be a great deal of consternation among people who have used an estate-planning strategy regularly for many generations — and not just by the richest 1 percent.
A Primer on Trusts
A trust is an entity created by a contract between the grantor (the person setting up the trust) and the trustee (the person who controls the income and assets of the trust). The trustee controls the trust’s assets for the benefit of beneficiaries, the people who ultimately receive the income and assets from the trust.
Trusts are used in estate planning as a means of putting the assets into the hands of a holder who is, so to speak, immortal. Families often put investment assets into trust to avoid probate, thus allowing the assets to continue to work and grow without the need to liquidate them upon the death of the owner.
Because trusts don’t “die” (or, to put it more technically, enjoy perpetuity of life, like a corporation), future generations can realize the benefits of income generated by trust assets but without the heavy hand of estate and gift taxes carving their way through the assets themselves.
For these reasons, trusts can be a very effective part of a comprehensive estate plan. Indeed, American families have used trusts for over 100 years to preserve and grow assets, which in turn generate substantial income for future generations. A core element of the American Dream is that parents who acquire wealth legally and peacefully might pass that wealth to their children and grandchildren so future generations have a better life than their ancestors.
But Biden’s team wants to confiscate that wealth. In doing so, they wish to prevent you and your family from enjoying your basic constitutional right to contract (U.S. Const. Art 1, § 10) in the creation of such a trust to preserve the wealth you created for your descendants.
Understanding “Stepped-up Basis”
As we know, Biden intends to eliminate the stepped-up-basis rule for assets transferred to beneficiaries upon death. Under the plan, beneficiaries will assume the same basis in inherited assets as that of the decedent. In the case of a family home, for example, children may inherit a home with a fair market value of $500,000, but which was purchased by the decedent for a small fraction of that and held for decades.
For example, suppose the home was purchased for $50,000 and $25,000 in capital improvements (e.g., new garage; finished basement) were added over time. In that case, the decedent’s basis is $75,000. Under current law, the beneficiaries inherit the asset with a basis equal to the fair market value of the property — $500,000. If they sell at that price, there is no capital gain.
Biden’s plan will eliminate this so-called “stepped-up basis.” That means the beneficiaries will inherit the property at a basis equal to that of the decedent’s — in this example, $75,000. When they sell the property at fair market value ($500,000), they are taxed on capital gain of $425,000.
The result is that wealth is transferred not from parents to children, as it should be, but rather is divided among children and the government, as part of a deliberate plan to destroy the concentration of capital in the hands of private citizens.
The Attack on Trusts
Under current law, trusts can avoid this outcome for a number of reasons. Chief amount them is that trusts don’t necessarily “die.” But Biden’s plan — undisclosed to the public until now — will attack the trust structure directly in two ways.
First, trusts that own property which has “not been the subject of a recognition event [an event that would trigger a tax liability] within the prior 90 years” will be forced to pay taxes on all gain not recognized for tax purposes during that period. This will directly confiscate a portion of the capital assets of the trust equal to the capital gain tax rate in effect at the time of the assessment.
For example, suppose a person creates a trust and transfers 1,000 shares of stock into the trust in 1940. The stock was worth $0.50 per share when transferred to the trust. Today, the stock is worth $200 per share and produces substantial dividend income. The income is distributed to the trust’s beneficiaries, and they pay taxes on the distribution. However, the stock has accumulated substantial capital value that has not been taxed since before the transfer in 1940.
In this case, Biden’s plan will impose a capital gains tax on the value of the stock at $199.50 per share. Of course, the tax will be assessed at the then-applicable capital-gains rates, which Biden also intends to increase.
Second, the proposals provide that “transfers of property into” either a “trust, partnership, or other non-corporate entity” would constitute a taxable event. That is to say, the mere act of transferring property out of one’s personal name and into any estate-planning device (trust, family limited partnership, LLC, etc.) would be treated as a “sale” of the asset.
For example, suppose one owns stock with current fair market value of $200 per share that was acquired at $50 per share. If the owner were to transfer the stock to a trust (as opposed to holding it until death), the transfer would be considered a sale and the owner would be liable for capital gain tax on the “profit” of $150 per share. Needless to say, as is the case with all capital-gains liabilities, no credit would be given for the fact the way that inflation, particularly on an asset that has been held for years, may well have eaten away at a substantial part of the real gain.
Certain Exclusions Would Apply
The proposal includes several exclusions, summarized as follows:
- Transfers to a surviving spouse would carry the decedent’s basis to the spouse and would not be taxed until the spouse disposes of the property;
- Appreciated property transferred to charity would not generate a capital gain;
- The exclusion of $250,000 under current law for capital gain on the sale of a principal residence would continue to apply, and the exclusion would be “portable to the decedent’s surviving spouse, making the exclusion effectively $500,000 per couple”;
- The proposal excludes all personal property such as household furnishings and person effects, but NOT collectibles; and
- The proposal includes a $1 million per-person exclusion from recognition of unrealized capital gains. The exclusion would be indexed for inflation beginning in 2022, and would be portable to the decedent’s surviving spouse, effectively creating a $2 million exclusion for married couples. So the exclusion itself is indexed, but the gain itself would not be.
Decimation of Family Businesses
This proposal, if enacted, would create major difficulties for family businesses. Imagine the tax liability created as a result of the death of a patriarch of a family-owned business. This will certainly mark the return to the days when the heirs of such a business were forced to sell business assets, or the entire business itself, just to pay the taxes.
And, of course, the Biden administration knows this. Thus, the Green Book discusses a “deferral” scheme that is apparently intended to take the sting out of this insofar as family businesses are concerned. It operates in two ways.
First, the tax on family-owned and operated businesses (not defined by the plan) “would not be due until the interest in the business is sold or the business ceases to be family-owned and operated.” Second, the law would allow “a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death.” The payment plan would not apply to “liquid assets such as publicly traded financial assets.”
The 15-year deferral comes at a cost, and not just in the form in interest. The plan calls for the deferral to be “secured.” Consider this:
The Internal Revenue Service (IRS) would be authorized to require security at any time when there is a reasonable need for security to continue this deferral. That security may be provided from any person, and in any form, deemed acceptable by the IRS.
Where the IRS is concerned, the word “security” means one thing only: a federal tax lien. The federal tax lien is all-encompassing, attaching to all “property and rights to property” owned by the taxpayer at the time the lien is filed, including all property acquired after the lien is filed. See: Internal Revenue Code § 6321.
A Blizzard of Regulations
Not surprisingly, there are few details spelled out in the Green Book. The Biden administration didn’t even talk about this plan in the early days of its reign, never mind give us the gory specifics about exactly how the attack on private capital will operate. We know the details are mostly a matter of legislation to be worked about by Congress. That’s not reassuring.
Further, assuming legislation is enacted, many details will be subject to IRS regulations. In this regard, the proposal states:
The Secretary would be granted authority to issue any regulations necessary or appropriate to implement the proposal, including rules and safe harbors for determining the basis of assets in cases where complete records are unavailable, reporting requirements for all transfers of appreciated property including value and basis information, and rules where reporting could be permitted on the decedent’s final income tax return.
I expect a blizzard of regulations designed to implement what threatens to be a broad, sweeping change designed to enable the federal government to confiscate the fruits of a lifetime of hard work. The consequences of that do not need to be spelled out.