The Tax Cuts and Jobs Act, otherwise known as TCJA, has proven to have many implications for domestic corporate and individual income tax, as well as federal gift, estate and GST tax, fiduciary income tax, and international tax. Since the TCJA’s enactment, various technical corrections have been issued, as has the Internal Revenue Service’s (IRS) guidance on certain aspects of the new taxing philosophy, however it is still in a position to have an outsized impact.
In light of the TCJA and recent IRS guidance, it is important to review existing estate plans, consider future planning to take advantage of the increased exemption amounts, and maintain flexibility to allow for future strategic planning. Some of the most significant changes and recent guidance are addressed below.
The TCJA increases the percentage limitation on cash contributions to public charities from 50 percent of the donor’s contribution base (generally, the donor’s adjusted gross income) to 60 percent. This 60 percent limitation applies if only cash gifts are made to public charities. The deduction limitations remain the same for donations of other assets, such as stock, real estate, and tangible property.
The TCJA reduced the top corporate income tax rate to 21 percent. To decrease the discrepancy in the tax rates between C corporations and pass-through entities, the TCJA also addressed the taxation of pass-through entities (partnerships, limited liability companies, S corporations, or sole proprietorships) that would typically be taxed at the rate of the individual owners. Generally, new Section 199A provides a deduction for the individual owner of 20 percent of the owner’s qualified business income (QBI). This deduction has the effect of reducing the effective income tax rate for an owner in the highest tax bracket from 37 percent to 29.6 percent. The deduction is subject to numerous limitations and exceptions. Notably, the deduction may be limited for taxpayers over a certain taxable income threshold ($326,000 for married taxpayers filing jointly, and $163,300 for other taxpayers, to be adjusted for inflation in future years).
Gift exemptions and estate exemptions
The TCJA retained the federal estate, gift, and GST tax rates at a top rate of 40 percent, as well as the marked-to-market income tax basis for assets includible in a decedent’s taxable estate at death.
While the federal gift, estate, and GST taxes were not repealed by the TCJA, fewer taxpayers will be subject to these transfer taxes due to the TCJA’s increase of the related exemption amounts. Under the TCJA, the base federal gift, estate, and GST tax exemptions doubled from $5 million per person to $10 million per person, indexed for inflation. As noted above, the relevant exemption amount for 2021 is $11.7 million per person, resulting in a married couple’s ability to pass $23.4 million worth of assets free of federal estate, gift, and GST taxes. These amounts will increase each year until the end of 2025, with inflation adjustments to be determined by the chained Consumer Price Index (CPI) (which will lead to smaller increases in the relevant exemption amounts in future years than would have resulted from the previously used traditional CPI). The exemption amount in 2022 will be $12,060,000 per individual. Without further legislative action, the increased exemption amounts will sunset, and the prior exemption amounts (indexed for inflation, using the chained CPI figure) will be restored beginning in 2026.
It is also important to note that each year individuals are entitled to make gifts using the “Annual Exclusion Amount” without incurring gift tax or using any of their lifetime applicable exclusion amount against the estate and gift tax. The Annual Exclusion Amount is $15,000 per donee in 2021. Thus, this year a married couple together can gift $30,000 to each donee without gift tax consequences. In 2022, the annual exclusion for gifts will rise to $16,000. The limitation on tax-free annual gifts made to noncitizen spouses will increase from $159,000 in 2021 to $164,000 in 2022.
The new Federal Income Tax Rates
The TCJA provides for seven individual income tax brackets, with a maximum rate of 37 percent. The 37 percent tax rate will affect single taxpayers whose income exceeds $518,400 (indexed for inflation, and $539,600 in 2022) and married taxpayers filing jointly whose income exceeds $622,050 (indexed for inflation and $647,850 in 2022). Estates and trusts will reach the maximum rate with taxable income of more than $12,950 (indexed for inflation, and $13,450 in 2022).
A zero percent capital gains rate applies for single filers with income up to $40,000 (indexed for inflation, and $41,675 for 2022) or married taxpayers filing jointly with income up to $80,000 (indexed for inflation, and $83,350 in 2022). A 15 percent capital gains rate applies for income above this threshold up to $441,450 for single taxpayers (indexed for inflation, and $459,750 in 2022) and $496,600 for married taxpayers filing jointly (indexed for inflation, and $517,200 in 2022). The 20 percent capital gains rate applies above these thresholds.
Additionally, the standard deduction was increased to $24,800 (indexed for inflation, and $25,900 in 2022) for married individuals.
Also important: The Corporate Transparency Act (CTA)
On January 1, 2021, the CTA was enacted into law as part of the National Defense Authorization Act for Fiscal Year 2021. The purpose of the CTA is to prevent the use of United States entities for criminal activities, such as money laundering. The CTA requires corporations, limited liability companies, and other similar entities that are formed within the United States and foreign entities that are registered to do business within the United States to disclose information regarding an entity’s beneficial owners to the Financial Crimes Enforcement Network (FinCEN). Required to be reported to FinCEN are the full legal name, current residential or business street address, date of birth, and identification number of each applicable beneficial owner.
Exempt from such reporting requirements are:
- Entities that are already closely regulated (for example entities regulated by the SEC)
- Publicly traded companies
- Companies that are “dormant” as defined within the CTA
- Tax-exempt entities
- Taxable entities that have (i) more than 20 full-time United States employees, (ii) a physical office in the United States, and (iii) more than $5 million in gross receipts or sales
- Any entity owned or controlled, directly or indirectly, by an exempt entity
- Additional entities that FinCEN may determine on an ongoing basis.
While the information collected would not be accessible by the general public, the information would be available to governmental bodies and federal agencies for certain limited uses including law enforcement, national security, and intelligence purposes.
The impact of the Tax Cuts and Jobs Act cannot be understated. For a more in-depth understanding of how this and other 2022 rule changes can impact your estate, schedule a time to talk to the Hartmann Law team.