Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
The U.S. political winds are changing in the run up to the November 2024 general election. High-net worth (HNW) Americans need to be prepared for every contingency, including Democrats winning a trifecta of POTUS and majorities in both houses of Congress.
If that happens, wealthy Americans will be facing several proposed “tax the rich” changes to tax policies. Advisors must propose changes to their client’s planning to negate or minimize the impact of such changes. This is analogous to how homeowners react when living in a wildfire zone. Wealthy Americans should use fire prevention strategies to avoid a catastrophic impact on their fiscal house.
In addition, they should explore the “premium” (i.e., cost) of acquiring “fire insurance” consisting of a back-up citizenship or residence and developing an effective “fire escape plan” or expatriation tax plan in the U.S. The acquisition of fire insurance and a fire escape plan does not mean that one must use them. Rather, it provides “optionality” should a devastating tax wildfire arrive at your doorstep.
When someone tells you who they are… believe them
In March 2023, President Biden released his budget recommendations in the Treasury "Green Book.” A number of these proposals affect estate and gift tax-related issues. Here are a few key items regarding those proposals.
Billionaire minimum tax
The headline of the 2023 Green Book was the billionaire minimum tax. This is a tax based on wealth, but it is not technically a wealth tax because it is computed as a percentage of a taxpayer’s total wealth. The Biden proposal would only apply to individuals meeting a threshold level of wealth and would impose a minimum income tax rate on income, capital gains and unrealized gains.
Under the 2023 Green Book, a taxpayer with more than $200 million in net assets would have an annual income tax liability of at least 20% of all taxable income and unrealized gains. There are provisions phasing in the tax for those taxpayers over $100 million but under $200 million in net assets. The tax liability for the initial year could be paid in nine annual instalments, while future-year liabilities could be paid over five years.
Higher income tax rates
Another proposal are income-tax-rate increases for “higher income” individuals. This increases the top marginal rate for ordinary income to 39.6% for single taxpayers earning more than $400,000 and married taxpayers filing jointly with income above $450,000; it increases the rate on long-term capital gains and qualified dividends to 37% for taxpayers with incomes in excess of $1 million (40.8% including the net investment income tax).
Treat transfers of appreciated property by gift or at death as realization events
The Green Book includes sweeping capital-gain recognition proposals. Transfers of appreciated property by gift or at death would be treated as recognition events. Limited exclusions from gain recognition would be available, including a $5 million exclusion per taxpayer and exclusions for transfers to a U.S. spouse or charity.
Modifying the tax rules for grantor trusts and GRATs
The Green Book would cause transactions between a trust creator (settlor) and a grantor trust that are disregarded for income tax purposes under current law to be potential gain recognition events. A settlor’s payment of the income taxes of an irrevocable trust would be treated as a taxable gift. The Green Book would thereby curtail the effectiveness of GRATs.
Ending the perpetually GST exempt trust
In prior years, Democrats have sought to curtail the use of so-called “dynasty trusts” that can exist perpetually and are never subject to a generation-skipping tax (GST). The Green Book proposed that the GST tax-exempt status of a trust would only apply to beneficiaries no more than two generations below the transferor.
Self-adjusting lifetime gift/estate tax exemption amount in 2026
Unless Congress takes affirmative action to change the current but interim very high lifetime gift/estate tax exemption amounts (now $12.92 million), beginning in 2026 the amounts will revert to the 2017 law amount, adjusted for inflation since 2017. The adjusted amount in 2026 could be as low as $7 to $8 million.
How to prepare should these proposals become law
Many of the provisions highlighted in this article might attract enough support with moderate Democrats joining their more progressive members to be enacted. Coupled with the self-adjusting lifetime gift/estate tax exemption amount beginning in 2026, a fire-prevention strategy alone consisting of proactive domestic planning such as GRATs may no longer be sufficient or even viable.
Wealthy Americans should take a closer look at the fire insurance of a second citizenship (and possibly residence). The premium/cost of this fire insurance will vary significantly based on family circumstances and will range from zero for those naturalized Americans who retain their prior citizenship….to relatively inexpensive for those with a claim to a lineage citizenship…to $150,000 or more for those who need to acquire a citizenship by investment.
The cost of designing a fire escape plan in coordination with the acquisition of fire insurance is relatively small. When designing the fire escape plan, the cost of implementing it – which is to avoid or minimize the U.S. exit tax (IRC s. 877A) and possible U.S. inheritance tax for U.S. heirs (IRC s.2801) – must be calculated. This information will define an objective benchmark on which to suggest the triggering of this plan in comparison to the additional tax burden of an approaching tax law.
When should you start acquiring fire insurance and a fire escape plan?
Unless a wealthy American already possesses a second passport in a jurisdiction where they and their family can live tax efficiently and comfortably, the acquisition of second citizenships and residences takes time. Ignoring on-line sales hype to the contrary, the fastest citizenship by investment now takes a minimum of eight months to process. Residence by investment takes just as long. Even with lineage citizenships, it is not as easy as calling an embassy and making an appointment to pick up a passport. Lineage citizenships take a minimum of ten months to year to process. Moreover, pre-expatriation U.S. exit and inheritance tax planning is normally a multi-year process.
Given that the November 2024 election is only about a year and a half away, wealthy Americans should act now. This involves looking at fire prevention techniques such as using their gift exemptions and triggering capital gains. At the same time, they should engage fire insurance and fire escape plan experts to work out a coordinated plan to give them maximum “optionality” no matter what the outcome is of the election.
Failure to plan…is planning to fail!
David Lesperance, JD, is a managing partner at Lesperance & Associates, and is one of the world’s leading international tax and immigration adviso
More Insurance & Annuities Topics >
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.