This is The End[i]
I have dreaded the year end for as long as I can remember. As a teenager and then as a young adult I associated the final quarter of the year, and especially the period beginning on Thanksgiving and ending on New Year’s Eve, with completing final exams and papers.[ii] After graduating from law school, but being inexperienced with the business of business, I naively hoped that the blues and the anxiety that I had experienced every year during that time of year were finally behind me. Not so.
As every transactional attorney quickly learns, the end of the calendar year may be among the most trying and challenging of times as many clients insist upon completing transactions before the year’s end. In some cases, and these are often the most vexing for an attorney, the client’s determination to consummate a deal may cause them to make concessions that, under different circumstances, they would never have considered. The pressure to close a transaction may be especially great where the client is eager to capture a particular tax benefit before its expiration or sunset at the end of the year.
Why am I sharing these not-so-fond memories of holidays past? Because we are approaching what may turn out to be, at least from a tax perspective, the most consequential Presidential and Congressional elections in decades. The legislative aftermath may very well push transactional attorneys to their limits.
Ghost of the Future
Of course, the fact that the year end is also a time of celebration for most folks tends to aggravate what is already an unpleasant situation.
“I wish to be left alone,” said Scrooge. “Since you ask me what I wish, gentlemen, that is my answer. I don’t make merry myself at Christmas, and I can’t afford to make idle people merry.”[iii]
Of late, I have been channeling – figuratively speaking and, one might say, in the spirit of the season[iv] – the ghost of future amendments to the Code. No, I am not writing this post under the influence of spiked eggnog or X-mas cheer. Hear me out.
“Ghost of the Future! I fear you more than any spectre I have seen.
But as I know your purpose is to do me good, and as I hope to live to be another man from what I was, I am prepared to bear you company, and do it with a thankful heart.
Will you not speak to me?”[v]
Over the last several weeks, observers of the federal tax scene have been reminding taxpayers that many of the taxpayer-friendly provisions enacted by the 2017 Tax Cuts and Jobs Act (the “TCJA”)[vi] are set to expire after December 31, 2025. Among the most significant and impactful of these taxpayer-friendly provisions[vii] was the enhanced unified gift and estate tax basic exclusion amount.[viii]
The TCJA doubled the basic exclusion from $5 million per individual taxpayer to $10 million. Adjusted for inflation, the exclusion will increase from $12.92 million per individual taxpayer for 2023 to $13.61 million for decedents dying and for transfers made on or after January 1, 2024. In other words, a married couple will be able to transfer up to $27.22 million of property in the aggregate over their lifetimes and at their demise without incurring gift or estate tax.[ix]
However, for decedents dying and for transfers made on or after January 1, 2026, the basic exclusion will revert to its pre-TCJA level of $5 million. When adjusted for inflation through 2025, this amount should be just over $7 million per individual taxpayer, or approximately $14 million per married couple.
Planning for the Sunset?
Based on the foregoing, it is likely that many business owners and investors will start planning in 2024 and into 2025 for gifts and sales of properties to members of their families or to trusts for the benefit of such family members.[x]
Of course, the means or the vehicles by which these transfers are effectuated will depend in no small part upon the interest rate environment. For example, an installment sale[xi] in a lower rate environment will shift more appreciation to the purchaser without adverse federal transfer tax consequences. Similarly, the use of a grantor retained annuity trust (GRAT)[xii] in such an environment will shift more appreciation to the remainder interest holders free of such transfer taxes.[xiii]
That said, the Federal Reserve last week decided to hold rates at between 5.25 percent and 5.5 percent, though it also indicated there would be rate cuts next year, depending upon the direction of inflation and the state of the economy.
There are other taxpayers of means who plan to await the outcome of the 2024 federal elections before committing to a plan for the immediate transfer of some portion of their properties. The thinking underlying this strategy is that a Republican victory may ensure the extension of the enhanced basic exclusion amount and provide more time for the disposition of their assets.
Of course, if the election results are other than what these folks hope, they will still have the last two months of 2024 plus all of 2025 to get their affairs in order.
Which brings me back to the ghost of future amendments to the Code that has been haunting my dreams.[xiv]
Whither the Congress?
After the 2022 midterm elections, the Democrats ceded their House majority to the GOP, though it is a very slim majority.
As of the end of last week, 15 members of the House have announced they will run for other office, 14 have announced their retirement, and 3 have resigned (including former Speaker McCarthy). It’s possible that more members are reconsidering their plans.
Query what this will mean for control of the House after 2024.
The Senate has 48 Democrats, three Independents[xv] who vote with the Democrats, and 49 Republicans. The Veep is a Democrat.[xvi] Of the 34 seats that will be up for reelection in 2024, 26 belong to Democrats, including Sinema. Another of those Democrats is Joe Manchin, who has decided not to seek reelection.
Query what this will mean for control of the Senate after 2024.
It is worth reminding folks that but for Manchin’s and Sinema’s opposition, the first version of the President’s Build Back Better (“BBB”) bill would have been enacted into law at the end of 2021. You will recall that among the changes to the Code proposed by the Administration were the following:
- an increased individual income tax rate for ordinary income from 37 percent to 39.6 percent;
- an increased rate for long-term capital gains recognized by individuals from 20 percent to 39.6 percent;
- an increased rate for qualified dividends from 20 percent to 39.6 percent;[xvii]
- the taxation of a carried interest as ordinary income;
- the taxation of property passing from a decedent as if it had been sold; and
- elimination of the basis step-up at death in situations not covered by the deemed sale at death.[xviii]
One should also recall that the Democrat-controlled Senate Finance Committee had its own tax proposals in 2021:
- mark-to-market rules that would have required wealthier individuals to pay income tax on the unrealized gain (i.e., appreciation) of their assets every year;[xix]
- limits on the size of qualified, tax-advantaged retirement accounts; limits on the use of GRATs, which probably would have included elimination of the “zeroed-out,” short-term GRAT;
- limits on the use of “intentionally defective” grantor trusts, which would probably have targeted sales to such trusts in exchange for promissory notes; and
- the reintroduction of regulations that would have limited the use of discounts for valuing interests in closely held businesses for estate and gift tax purposes.[xx]
What May Be
“Lead on. The night is waning fast, and it is precious time to me, I know. Lead on, Spirit.”[xxi]
What does the situation in Congress portend for the 2024 election and beyond? It’s difficult to say.
Of course, much will depend upon which Party wins the White House,[xxii] especially when one considers that the President, whoever that may be, will likely be able to veto whatever bill is sent to their desk without fear of being overridden.[xxiii]
Given all the uncertainty, indulge me for a moment if I posit a not impossible outcome: a trifecta for the Democrats, with the Party taking the White House and a majority in each Chamber. What may follow?
As in 2021, the House passes a bill in 2025 that includes many of the provisions set out in the Build Back Better plan.[xxiv]
Next, the Senate uses the budget reconciliation process, which is not subject to the filibuster and which requires only a simple majority, to pass a very similar bill.[xxv]
The President signs the bill into law. Query the effective date, especially if the law is enacted early in the year. You may recall the discussions during the spring of 2021 of a retroactive effective date for the BBB, to the beginning of that year.
The consequences are obvious and, from the perspective of many business owners, they would not be good.
What to Do?
“[A]nswer me one question. Are these the shadows of the things that Will be, or are they shadows of things that May be, only? . . . Men’s courses will foreshadow certain ends, to which, if persevered in, they must lead,” . . . [b]ut if the courses be departed from, the ends will change. Say it is thus with what you show me.”[xxvi]
At the moment, the hypothetical election results suggested above are just that. However, they can easily turn into reality, as may the legislative tax agenda that was embodied in the current Administration’s BBB plan.
That is unless the owners of closely held businesses, including anyone who aspires to become a business owner, as well as those who have sold or transitioned their business to others, can convince enough of the electorate that government should be fostering a business environment that encourages long-term investment and growth – not a tax regime that dissuades or punishes such planning.
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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[i] “The End” by The Doors may be fitting given the current national malaise.
[ii] “The school is not quite deserted,” said the Ghost. . . The Spirit touched him on the arm, and pointed to his younger self, intent upon his reading.” Stave 2: “The First of the Three Spirits,” A Christmas Carol, by Charles Dickens.
[iii] Stave 1: “Marley’s Ghost,” A Christmas Carol.
[v] As spoken by Scrooge in Stave 4: “The Last of the Spirits,” A Christmas Carol.
[vi] Pub. L. 115-97.
[vii] Other expiring provisions: the top rate for personal income taxes will return to 39.6% from 37%; the qualified business income deduction for pass-through entities under IRC Sec. 199A will disappear; the Pease limitation on itemized deductions will be reinstated.
[viii] IRC Sec. 2505 and Sec. 2010. The generation-skipping transfer tax exemption is also tied to this amount. IRC Sec. 2631. Both Sec. 2505 and 2631 refer to Sec. 2010.
[ix] The basic exclusion amount will also be adjusted for inflation for transfers made in 2025.
[x] I assume these are rational individuals and that the properties in question are “disposable” – the transferring taxpayers can afford to give up ownership and control over the properties in question.
[xi] Usually to a trust that is treated as a grantor trust for income tax purposes. IRC Sec. 671. The IRS has announced regulations projects aimed at such sales.
[xii] IRC Sec. 2702.
[xiii] For some individuals, the transfer of highly appreciated assets to a charitable remainder trust may be appropriate. IRC Sec. 664.
[xiv] “Dark have been my dreams of late,” as Theoden said. The Lord of the Rings.
[xv] King, Sanders, and Sinema.
[xvi] Her highest and best use? Break ties in the Senate.
[xvii] Don’t forget the 3.8% surtax on net investment income under IRC Sec. 1411.
[xviii] Other proposed changes included: elimination of the tax-deferred like kind exchange of real property, an increased corporate income tax rate (from 21 percent to 28 percent), the expansion of the employment and net investment income taxes.
[xix] Sen. Wyden’s wealth tax.
[xx] The Finance Committee also called for additional limitations on the ability of a corporation to deduct executive compensation.
[xxi] Scrooge to the Ghost of the Future At the start of their journey.
[xxii] The current President is non compus mentis, and no one with half a brain on either side of the aisle could possibly support Veep Harris.
The former President is despised by the media, academia, and the Washington establishment, and faces many legal issues.
[xxiii] You’ll recall that Congress may override a veto by a two-thirds vote of each Chamber. U.S. Constitution, Art. I, Sec. 7, Cl. 2. It is doubtful either Party will enjoy such a majority.
[xxiv] Worse yet, what if the estate and gift tax rate is reduced to the pre-2010rate of 45%? What if the estate and gift tax exclusion amounts are also reduced to their pre-2010 level \s or $3.5 million and $1.5 million, respectively?
[xxv] It is unlikely that the Dems would have a large enough majority in the Senate to eliminate the filibuster (which requires the vote of at least 60 Senators to end debate on a bill before bringing it to a vote on the floor.
[xxvi] Scrooge to the Ghost of the Future, in the graveyard.