Tag: assets

The Biden Administration Proposes Mark-to-Market Minimum Tax on Individuals With More than $100 Million in Assets

Summary and Background.  On March 28, 2022, the Biden Administration proposed a 20% minimum tax on individuals who have more than $100 million in assets.  The minimum tax would be based on all economic income (which the proposal refers to as “total income”), including unrealized gain.  The tax would be effective for taxable years beginning after December 31, 2022.  The minimum tax would be fully phased in for taxpayers with assets of $200 million or more.

Under the proposal, an individual’s 2023 minimum tax liability would be payable in nine equal annual installments (e.g., in 2024-2032).  For 2024 and thereafter, the minimum tax liability would be payable in five annual installments.  The tax may be avoided by giving away assets to section 501(c)(3) organizations (including private foundations or donor-advised funds) or 501(c)(4) organizations before the effective date of the legislation so as to avoid the $100 million threshold.

The Biden proposal is an attempt to appeal to Senator Joe Manchin (D-W.Va.) and address some criticisms of Senator Ron Wyden’s (D-Or.) mark-to-market proposal.  Senator Manchin has expressed support for a minimum 15% tax on individuals, and this support was apparently an impetus for the proposal.  Senator Manchin has not, however, expressed support for a mark-to-market minimum tax, and the Biden Administration does not appear to have received any support from Senator Manchin before releasing its proposal.

The five-year payment period is an attempt to address concerns that Wyden’s proposal might overtax volatile assets, and to “smooth” taxpayers’ cash flows without the need for the IRS to issue refunds.  Under the Biden Administration’s proposal, installment payments of the minimum tax may be reduced to the extent of unrealized losses.

The minimum tax is being described as a “prepayment” that may be credited against subsequent taxes on realized income.  This description provides a backup argument on constitutionality: the minimum tax isn’t a tax on unrealized income but is merely a prepayment of tax on realized income.

Operation of the Minimum Tax.  The minimum tax would apply to taxpayers with wealth (assets less liabilities) in excess of $100 million.  The proposal does not define liabilities, and does not indicate whether a taxpayer would be deemed to own the assets of his or her children, or trusts.  Therefore it is unclear as to whether a taxpayer who is close to the $100 million threshold may avoid the tax by giving away assets to children.  As mentioned above, a taxpayer can give assets to section 501(c)(3) or 501(c)(4) organizations to avoid the threshold, and so, if the minimum tax is enacted, donations to charity would be expected to dramatically increase.

The proposal phases in for taxpayers with wealth between $100 million and $200 million.  The phase in is achieved mechanically by reducing the tax liability to the extent that the sum of (w) the minimum tax liability, and (x) the uncredited prepayments exceeds two times (y) the minimum tax rate, times (z) the amount by which the taxpayer’s wealth exceeds $100 million.  Thus, for a taxpayer with $150 million of wealth and a zero basis and no prior prepayments, the $30 million of minimum tax liability would be reduced by $10 million to equal $20 million.  ($10 million is amount by which (x) $30 million exceeds (y) $20 million, which is 40% [two times the minimum tax rate] times $50 million [the amount by which the taxpayer’s wealth exceeds $100 million].)

A taxpayer subject to the minimum tax would make two calculations:  Their “normal” tax liability under our current realization system, and the “minimum” tax under the proposal. Tax would be paid on the greater of the two.

For purposes of the 20% minimum tax, the taxpayer would include all unrealized gain on “tradeable assets.”  The proposal does not define tradeable assets.  Tradeable assets would be valued using end-of-year market prices.  The taxpayer would also include all unrealized gain on “non-tradeable assets.”  Non-tradeable assets would be valued using the greater of (i) the original or adjusted cost basis, (ii) the last valuation event from investment (i.e., a round of equity financing), (iii) borrowing (i.e., a lender’s appraisal), (iv) financial statements, or (v) other methods approved by the IRS.  Original or adjusted cost basis would be deemed to increase at a rate equal to the five-year Treasury rate plus two percentage points.  The five-year Treasury rate is currently 2.76% and so, at today’s rates, non-traded assets without a valuation event would deemed to increase in value at a 4.76% annual rate.  The proposal would not require valuations of non-tradeable assets.

While a taxpayer would be subject to the minimum tax if it exceeds the normal tax, as mentioned above, payment of the minimum tax would be made in equal annual installments (nine for the first year of minimum tax liability and five thereafter).

So, assume that a taxpayer purchases an equity interest in a non-traded C corporation on January 1, 2023 for $200 million.  The taxpayer has no realized income and no other assets.  The taxpayer would have zero “normal” tax.  Assume that the five-year Treasury rate is 2.76%.  The investment would be deemed to increase in value by 4.76% (to $209.5 million).  The minimum tax would be 20% of $9.5 million, or $1.9 million.  If this was the taxpayer’s first year subject to the minimum tax, the minimum tax liability would be $211,111 in each of years 2024-32, subject to the “illiquid exception” described below.  If the taxpayer subsequently sells the C corporation, it would credit the minimum tax prepayments against his or her income tax liability.

Payments of the minimum tax would be treated as a prepayment available to be credited against subsequent taxes on realized gains.

The Biden Administration has separately proposed that death would give rise to a realization event.  If a taxpayer’s prepayments in excess of tax liability exceed gains at death, the taxpayer would be entitled to a refund.  The refund would be included in a single decedent’s gross estate for estate tax purposes.  Net uncredited used prepayments of a married decedent would be transferred to the surviving spouse (or as otherwise provided in regulations).

In contrast to Senator Wyden’s proposal, which does not require that tax be paid on unrealized gain for non-traded assets, and instead imposes a deferral charge upon realization, the Biden Administration’s proposal generally requires that minimum tax be calculated with respect to all unrealized gain, including deemed appreciation on non-traded assets, subject to an “illiquid exception.”  If tradeable assets held directly or indirectly make up less than 20% of a taxpayer’s wealth, the taxpayer may elect to include only unrealized gain in tradeable assets in the calculation of their minimum tax liability.  A taxpayer that makes this election would be subject to a deferral charge upon realization to the extent of gain, but the deferral charge would not exceed 10% of unrealized gain.  The proposal does not indicate the rate of the deferral charge.

This aspect of the Biden Administration’s proposal provides a meaningful benefit to “illiquid” taxpayers and encourages taxpayers to become “illiquid” to qualify for the exception.  The proposal provides that tradeable assets held “indirectly” are treated as owned by the taxpayer for this purpose and therefore it is unclear whether and to what extent taxpayers can contribute tradeable assets into nontradeable vehicles to qualify for the illiquid exception.  The proposal would provide the IRS with specific authority to issue rules to prevent taxpayers from inappropriately converting tradeable assets to non-tradeable assets.

Estimated tax payments would not be required for minimum tax liability, and the minimum tax payments would be excluded from the prior year’s tax liability for purposes of computing estimated tax required to avoid the penalty for underpayment of estimated taxes.

The tax is expected to affect 20,000 taxpayers (in contrast to roughly 700 under Wyden’s plan) but to generate approximately the same amount of revenue as Wyden’s proposal: $360 billion over ten years as estimated by the Treasury Department (which is expected to be around $550 billion over 10 years under the Joint Committee on Taxation’s “scoring” methodology).

Article By Robert Gaut, Martin T Hamilton, and Colleen Hart at Proskauer Rose LLP

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© 2022 Proskauer Rose LLP.

In Estate Planning, Where There's a Will There's a Way

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An August 15, 2014 article, by Robert Wood, in Forbes.com, told how many large companies, such as GM and Merck, pay zero taxes. It told how Apple avoided $9 billion in US taxes in 2012, according to a US Senate Report issued in 2013.

In the estate world, billionaires such as George Steinbrenner, the Yankees owner who died in 2010, avoided an estimated $500 million in US estate tax. But that was because he died in 2010, the one year when there was no estate tax. In 2014, US citizens can protect $5 million from estate tax, and that amount is indexed for inflation, so the current figure is $5,340,000. Thus, $10,680,000 protects most American married couples from paying federal estate tax upon the second of their deaths. Married couples fortunate enough to have more than $10,680,000, will pay federal tax at 40%.

Even wealthy families with assets exceeding $10,680,000 (or a single person exceeding $5,340,000) can take advantage of gifting strategies and charitable planning to avoid or reduce estate tax. These strategies include techniques known as “GRATS,” “IDGT’s,” “CRT’s” and “CLT’s,” which mean nothing except to the tax professionals who implement them, and the wealthy who benefit from them. Although Congress has threatened to curtail or eliminate many of these strategies, they currently remain legal options for US citizens upon their deaths to leave more to their families and less to the IRS.

Whether it is multi-national public companies with billions of income, or wealthy US families with millions of assets, when it comes to avoiding taxes, be it income or estate, where there’s a will there’s a way.

ARTICLE BY

John P. Dedon
OF
Odin, Feldman & Pittleman, P.C.

Planning for Disabled Beneficiaries in Ontario

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Whether you own Cross-Border assets or not, when dealing with the transfer of assets to a disabled beneficiary who is resident in Ontario, special planning may be needed to preserve your disabled beneficiary’s entitlement to certain benefits he or she may be receiving, or may be entitled to receive in future.

The Ontario Disability Support Program (“ODSP”) is a provincial program offering income and employment support to adults with physical and/or mental disabilities.

An eligible applicant must show financial need, which is determined by calculating the assets held by such applicant. A single adult is entitled to hold up to $5,000 worth of assets. If he or she has a spouse (whether married or common-law), the limit rises to $7,500. The limit increases by $500 for each dependent child living with the disabled beneficiary.

Certain assets are exempt from counting toward the asset limit, including, but not limited to, an interest in a principal residence, a car and a prepaid funeral. Other assets may be exempt up to certain limits or as determined by specified rules.

For instance, an interest in a second property, such as a cottage or vacation property in Florida, may be exempt if it can be shown that the property is an asset necessary for the health and well-being of the ODSP applicant. If the second property is not exempt, the owner may not be eligible for ODSP benefits. Where this is so, the property will be exempt for only 6-months, during which time the property would be expected to be sold. If reasonable efforts to sell the property fail to produce a bona fide purchaser, the property may remain exempt until such time as the property is sold, provided that reasonable efforts to sell are maintained. Following the sale, attention must be paid to structuring the holding of the proceeds of sale in order to ensure such proceeds do not put the ODSP recipient offside of the asset limitations.

The ODSP regulations are complex, with many restrictions, of which the consequence of breaking may be ineligibility or permanent loss of ODSP income benefits. Some of the notable restrictions include limitations on ownership of assets above the thresholds outlined above as well as asset class. For instance, an ODSP recipient is restricted from owning more than $100,000, in aggregate, of life insurance (cash value), segregated funds (similar to a mutual fund but offered only by insurance companies) and any inheritance, whether received outright or held in trust for the recipient’s benefit.

You might ask why go through the trouble of trying to protect such income benefits when you plan to leave your disabled beneficiary much more than what he or she would receive from ODSP? Although ODSP provides financial benefit to your disabled beneficiary, there are also social programs, such as employment assistance, that may be lost. Such programs can be valuable to disabled persons of all financial backgrounds.

A special type of trust, referred to as a “Henson Trust” (named after the precedent-setting Ontario Court of Appeal case: The Director of the Income Maintenance Branch of the Ministry of Community and Social Services v. Henson, 36 Estates and Trusts Reporter 192, and also referred to as an absolute discretionary trust), may alleviate many of the foregoing issues.

Where drafted appropriately, a Henson Trust provides a means to leave unlimited assets to a disabled beneficiary without jeopardizing the benefits he or she may receive from ODSP or other government sources, both financial and otherwise. In other words, your disabled beneficiary can benefit from the substantial inheritance you may leave in such Henson Trust for his or her benefit, while continuing to collect the financial (and other) benefits available pursuant to the ODSP.

Whether a Henson Trust is an appropriate structure requires some fact gathering and analysis, coupled with a consideration of whether the beneficiary is disabled but has capacity, versus disabled but does not have capacity. In the case of the former, a trust structure may not be ideal where the beneficiary manages or is involved in managing his or her own finances. Further, where a Henson Trust is implemented, selection of one or more trustees to administer the trust is critical as there is a greater potential for abuse than in non-Henson Trusts.

Consideration should also be given to whether to utilize the federal government’s Registered Disability Savings Plan (“RDSP”), a registered matched savings plan for people with disabilities. An RDSP may be used in conjunction with a Henson Trust or on its own.

Article by:

Heela Donsky

Of:

Altro Levy LLP