Tax and Estate Planning for 2022

The following is an updated outline of proposed major personal tax changes effective for taxable years beginning after December 31, 2021, unless otherwise noted.

Tax Changes

Individual Tax

The top marginal rate would be increased from 37% to 39.6% for taxable income over $452,700 for single taxpayers, $481,000 for head of household, $509,300 for married filing jointly, and $254,650 for married filing separately (indexed annually for inflation).

Capital Gains and Qualified Dividends

Effective as of April 28, 2021, long-term capital gains and qualified dividends would be taxed at ordinary income tax rates for taxpayers with adjusted gross income exceeding $1 million (indexed annually for inflation).

Wealth Transfers

Transfers of appreciated property by gift, including transfers to irrevocable trusts and partnerships, would be considered a realization event subject to income tax on appreciation (above a $1 million per person threshold). This would significantly reduce the benefit of using intentionally defective grantor trusts for large transfers after 2021, as there would be a realization event.

Step-Up in Basis

Transfers of appreciated property upon the death of the owner for deaths after 2021 would be considered a realization event with the decedent recognizing capital gain on appreciation (above a $1 million per person threshold). There are a few exceptions, including transfers to a surviving spouse or to charity. Contact us to learn more about what other exceptions might be available.

Assets Held for Long Periods in Trust

A trust or partnership that owns appreciated property would be subject to a recognition event subject to tax if the property has not otherwise been subject to a recognition event within the prior 90 years.
The start date for the 90-year window is January 1, 1940. Therefore, the operation of this proposal would be effective December 31, 2030.

Sunset of Existing Transfer Taxes

Noticeably absent from the most recent proposals are any changes to the estate tax that the President mentioned during his campaign. The 2021 exemption is $11.7 million per person, or $23.4 million for married persons. It is important to note that even if other proposed changes to transfer taxes do not become part of any approved law, the current exemptions could be lowered by other legislation and will automatically expire at the end of 2025. At that time, the exemption reverts to a base of $5,000,000 per person; indexed for inflation to around $6,400,000 per person today.

Planning Considerations

Chuck Bean III, CLU, CHFC, Founder and CEO with Kevin Webber, CFP, Wealth Manager

Considering the current high Federal exemption and potential for new tax laws, high net worth households could consider the following strategies with their estate, tax, and wealth management advisors:

Annual Gifts

An individual can make an annual tax-free gift of $15,000 per recipient that does not count against your lifetime gift tax exclusion. Any amount you give annually above $15,000 to one person counts toward your lifetime gift tax exclusion. If you are able and have sufficient cash flow, consider giving gifts sooner rather than later to help keep future appreciation and subsequent income out of your estate.

Tuition and Medical Expenses

There are some limited exceptions to the rule for $15,000 annual exclusions per donee. Tuition and medical expenses you pay for someone else are not taxable gifts, provided the payments are made directly to the billing institution and not to the individual.

Intentionally Defective Grantor Trust (“IDGT”)

An IDGT is a type of irrevocable trust that allows you to transfer assets in trust for the benefit of your family during your lifetime, thus removing those assets from your taxable estate. An IDGT is structured for the trust income to be taxed as a “grantor trust,” so that the income is taxed to you rather than to the trust beneficiaries. This tax payment further increases the ultimate value of the transfer because your beneficiaries avoid income tax. This allows the principal of the trust to grow without reduction by income taxes, while your payment of the income taxes further reduces the value of your taxable estate.

Spousal Lifetime Access Trust (“SLAT”)

A SLAT is an irrevocable trust created by you for the benefit of your spouse as well as to provide benefits for your children or other descendants during your spouse’s lifetime. A SLAT is designed so that assets gifted to the trust and appreciation will not be includable as part of either your or your spouse’s estate, to pass on greater wealth to children or other heirs. A SLAT is most often structured as an IDGT, so the potential income tax benefits of the grantor trust setup may be realized with a SLAT as well.

Grantor Retained Annuity Trust (“GRAT”)

A GRAT is an irrevocable trust that you create and fund with assets that are expected to appreciate. You retain the right to receive an annuity from the GRAT for a term of years, based on a rate set by the IRS. At the end of the GRAT term, the remaining assets will pass to your family members for their benefit. If the contributed property appreciates or produces income that exceeds the stated IRS interest rate, that appreciation will pass to those family members free of transfer tax. This strategy is appealing during low interest rate periods such as today.

What Should You Do?

At Heritage Financial, we’re working closely with our clients now to review potential income and estate tax strategies should taxes indeed go up for wealthy individuals. A key part of our approach is to collaborate closely with their tax and estate professionals, to collectively weigh the pros and cons of various strategies. If you are interested in hearing our Financial Planning Team’s thoughts on your current financial plan, contact us to discuss our signature Three Meeting Process where you can test drive working with us before formally becoming a client.

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