Wealth Planning Insights


Greenbook Summary

FY 2015 Revenue Proposal

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The Administration’s Fiscal Year 2015 Budget and the Treasury’s 2015 Greenbook – Proposed Tax Treatment of High Income and High Net Worth Taxpayers.

On March 4, the Administration released the “Fiscal Year 2015 Budget of the U.S. Government,” which was accompanied by the “General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals,” the so-called “Greenbook”. The Congressional Budget Act of 1974 requires Congress to write a budget each year and instructs the President to submit a proposal for consideration by the first Monday of February (February 3rd this year). As was the case last year, the release was delayed.

Conversations in Washington regarding the budget and the possibility of tax reform have been ongoing for some time, and are expected to continue for the foreseeable future. The Administration’s proposal comes on the heels of a comprehensive tax-reform proposal entitled the “Tax Reform Act of 2014,” which was released on February 26 by Representative Dave Camp, Chairman of the House Ways and Means Committee.

The common ground in the current proposals is an understanding that access to education and employment are fundamental to the well-being of individuals, communities and the country and that we are a nation where giving back is valued. There also is a degree of shared focus on expanding the tax base through limiting the proliferation of what are commonly referred to as “tax expenditures”. However, whereas the Tax Reform Act of 2014 is a comprehensive tax reform proposal, the Greenbook only address narrow aspects of the current tax code, focusing heavily on the Earned Income Tax Credit.

Following is a high level summary of representative Greenbook proposals of interest to individual taxpayers. Generally, the proposals would be effective in the year following enactment.

INDVIDUAL TAXATION OF HIGHER INCOME INDIVIDUALS Unlike the proposed Tax Reform Act of 2014, the FY 2015 Greenbook only suggests limited modifications to the current income taxation of individuals, including limitations on the value of certain tax expenditures, a “Fair Share Tax,” and modification of some of the complex retirement account provisions under the Internal Revenue Code (Code).

Reduce Value of Certain Tax Expenditures
The Administration’s FY 2015 Budget includes a proposal to limit the tax value of “expenditures,” specific deductions or exclusion from adjusted gross income and all itemized deductions. The proposal seeks to cap the value of these items to 28% for taxpayers in the 33%, 35%, and 39.6% tax brackets.

The proposal seeks to impose the 28% limit on tax-exempt state and local bond interest, employer-sponsored health insurance paid for by employers or with before-tax employee dollars, health insurance costs of self-employed individuals, employee contributions to defined contribution retirement plans and individual retirement arrangements, the deduction for income attributable to domestic production activities, certain trade or business deductions of employees, moving expenses, contributions to health savings accounts and Archer MSAs, and interest on education loans.

Fair Share Tax
Again this year, the Administration’s budget also includes the “Buffett Rule,” imposing a Fair Share Tax (FST) on high‐income taxpayers. The FST is 30% of adjusted gross income, with a credit for charitable contributions. The threshold for the FST is $1 million of adjusted gross income ($500,000 for married filing separately) and the FST is fully phased in at $2 million ($1 million for married filing separately), with each level being indexed for inflation beginning after 2015.

Carried (Profits) Interests
Changing the income taxation of carried (profits) interests of partners in investment partnerships is again suggested in the Administration’s proposal. Under current law a partner may receive an interest in future profits of a partnership in exchange for services. Part or all of the associated income may be characterized as capital gain and taxed to the partner accordingly. Under the proposal, a partner’s share of income from an “investment services partnership interest” (ISPI) in an “investment partnership” would be taxed as ordinary income, even if its character at the partnership level is capital gain. Ordinary income tax rates would apply and the income would be subject to self‐employment tax.

Retirement Accounts
The Administration proposes a number of modifications to the tax treatment of retirement savings. In order to promote retirement savings, the proposal would require employers in business for at least two years that have more than ten employees to offer an automatic IRA contribution option to employees. Regular contributions would be made using payroll-deductions.

In an effort to discourage what is perceived as excess tax deferred retirement account accumulations, the proposal would prohibit additional contributions to tax-favored retirement accounts in excess of an amount determined to be necessary to support an adequate annuity level payout. The maximum for an individual age 62 would currently be approximately $3.2 million. The proposal would be effective for contributions and accruals for taxable years after the effective date.

The required minimum distribution rules would be modified to eliminate required distributions for aggregate IRA and tax-favored retirement account balances of $100,000 or less. Alternatively, Roth accounts and Roth IRAs, which are not presently subject to the required minimum distribution rules, would be subject to required distribution requirements for taxpayers after age 70-1/2.

Gift, Estate and Generation-Skipping Transfer Tax Provisions
The Administration proposes a number of modifications to the current gift, estate and generation-skipping transfer taxes. Many of the proposals have appeared in prior years’ budgets and Greenbooks. However, there are some 2016 budget modifications and new developments of significance to taxpayers.

Restore the Tax Parameters in Effect in 2009
Currently, the estate, gift, and generation-skipping transfer (GST) taxes are “permanently” unified, while maintaining portability of a spouse’s unused exclusion amount at death. The highest marginal transfer tax rate is 40% and the applicable exclusion and exemption amounts for gift, estate and GST tax purposes remains unified at $5 million, adjusted annually for inflation from 2011 ($5.34 million in 2014).

The Administration seeks, beginning in 2018, to make permanent the estate, GST and gift tax parameters as they applied in 2009. If enacted, the proposal would make the top marginal tax rate 45%, and the exclusion and exemption amount would be $3.5 million for estate and GST taxes and $1 million for gift tax purposes, without indexing for inflation. For a decedent electing portability, although the decedent’s unused estate and gift tax exclusion would be available in full on the surviving spouse’s death, gifts during the survivor’s life would be limited to gifts the decedent could have made during his or her year of death.

Require Consistency in Value for Transfer and Income Tax Purposes
Gift and estate taxes are determined based on the fair market value of the property transferred. Although the determination of the basis of the property received by the donee or beneficiary differs depending on whether the transfer was by gift during life or at death (and if a gift, whether or not the property is appreciated and whether or not the donee pays any part of the gift tax), in all circumstances determination of fair market value is necessary. While the same valuation standards apply to donors and estates when the transfers are reported for gift and estate tax purposes and for donees and beneficiaries in determining their basis in the property received, there is currently no explicit consistency and associated reporting requirement. Therefore, the potential exists that the respective values will be reported differently by donors and estates as well as by donees and beneficiaries. In order to avoid any irregularities, the proposal requires consistency in valuation and reporting of valuation by donors and estates to donees, beneficiaries and the Internal Revenue Service.

Require a Minimum and Maximum Term for Grantor Retained Annuity Trusts (GRATS)
The proposal requires the minimum term for a GRAT to be ten years and the maximum term to be the life expectancy of the annuitant plus ten years. This proposal has appeared in a number of prior proposed budgets, but has yet to progress through Congress. Thus, planning with GRATs remains an effective strategy at present in the right circumstances, particularly in light of the inflation‐ adjusted increases to the applicable exclusion amount – $90,000 in 2014 (the increase from $5.25 million in 2013 to $5.34 million in 2014), $180,000 for a married couple.

Limit Duration of GST Tax Exemption
Many states currently allow trusts created subject to the law of those jurisdictions to continue in perpetuity. As a result, the transfer tax shield provided by the GST exemption effectively has been expanded from trusts funded with $1 million (the exemption at the time of enactment of the GST law) and a maximum duration specified by law, to trusts funded with $5.34 million and continuing (and growing) in perpetuity.

Again this year, the Administration’s proposal regarding limiting the GST exemption provides that, on the 90th anniversary of the creation of a trust, the GST exclusion allocated to the trust would terminate. The proposal provides an exception intended to permit an incapacitated beneficiary’s distribution to continue to be held in trust without incurring GST tax on distributions to the beneficiary as long as the trust is to be used for the sole benefit of the beneficiary and any trust balance remaining on the beneficiary’s death will be included in the beneficiary’s gross estate for Federal estate tax purposes. The other rules regarding the taxation of multiple skips would continue to apply, and would be relevant in determining when a taxable distribution or taxable termination occurs after the 90th anniversary of the trust.

Coordinate Certain Income and Transfer Tax Rules Applicable to Grantor Trusts
The grantor trust income tax rules are separate and independent from the gift, estate and GST tax rules, but may be used under current law to establish what is commonly referred to as an “intentionally defective grantor trust,” treated as owned by the grantor for income tax purposes, but considered a completed gift for gift, estate and GST tax purposes. Transactions between the trust and the deemed owner are ordinarily ignored for income tax purposes.

The proposal applies generally to any person who is deemed to be an owner of the trust and who engages in a sale, exchange, or comparable transaction with the trust that would have been subject to capital gains tax if the person had not been a deemed owner of the trust. The portion of the trust attributable to the property received by the trust in the transaction will be subject to estate tax as part of the gross estate of the deemed owner, will be subject to gift tax during life when the deemed owner status is terminated, and will be treated as a gift to the extent of a distribution to another person during the deemed owner’s lifetime, subject to reductions for consideration received and any prior taxable gift treatment.

Modify GST Tax Treatment of Health and Education Exclusion Trusts
Under the Code, certain payments made directly by a donor to a qualified medical provider or educational institution on behalf of another are not subject to gift or GST tax. Thus, for example, a grandparent may make medical expense or tuition payments directly to qualified providers or educational institutions for a grandchild free of gift or GST tax. Health and Education Exclusion Trusts (HEETS) have been used to place property in trust in order to fund the medical and tuition expenses of younger generations. Amounts contributed to HEETS have the potential to appreciate in value, while avoiding estate, gift, and GST taxation when distributions are made for qualified medical or tuition expenses. The proposal seeks to make the exclusion from the GST tax applicable only to a payment by a living donor directly to the medical provider or to a school for tuition – not to trust distributions, even if distributions are used for those same purposes. Whereas the 2014 Greenbook characterized the HEET provision as a clarification, the 2015 Greenbook acknowledges that this proposal is a change from existing law.

Simplify Gift Tax Exclusion for Annual Gifts
This year for the first time, the Administration’s budget includes a new proposal to eliminate the present interest requirement for gifts that qualify for the annual gift tax exclusion and to place an aggregate per donor limitation on certain types of annual exclusion gifts. Currently, in order to qualify for the annual exclusion ($14,000 per donor per donee in 2014), a gift must be of a present, not a future, interest. Generally, a contribution to a trust on behalf of a donee is considered a future interest. However, short-term withdrawal rights included in a trust, known as “Crummey powers” are considered present interests eligible for the annual gift tax exclusion as long as they are not illusory, meaning the donee has an actual legal right to the withdrawal.

First, the proposal would eliminate the present interest requirement for gifts to qualify for the annual gift tax exclusion. The proposal further seeks to impose an annual limit of $50,000 per donor on gifts that would qualify for the annual gift tax exclusion to a new category of transfers. Included in the new category are certain transfers in trust, transfers of interests in passthrough entities, transfers of interests subject to a prohibition on sale, and other transfers of property that, without regard to withdrawal, put, or other such rights in the donee, cannot immediately be liquidated by the donee. Therefore, even if individual gifts do not exceed the annual exclusion ($14,000 per donor per donee in 2014), a donor’s collective gifts within the new category in excess of $50,000 in a single year will be taxable.

Expand Applicability of Definition of Executor
Currently, under the Code the definition of executor applies only for purposes of the estate tax. As a result, an executor does not have authority to act on behalf of a decedent regarding a tax liability which arose prior to a decedent’s death. With the increase of reporting requirements, including those pertaining to foreign assets, the proposal seeks to extend the authority to one party to act on all tax matters relating to a decedent, including tax liabilities incurred prior to death. Anticipating that such a rule may give rise to conflicts among multiple executors, the proposal will also grant regulatory authority to enact rules to resolve issues.

Summary of Estate, Gift and Generation-Skipping Transfer Tax Provisions

Tax reform and simplification have been topics of ongoing discussion in Washington for years. With the proposed Tax Reform Act of 2014 from the House Ways and Means Committee and the Administration’s FY 2015 budget proposal and the related Greenbook, we have a clearer framework for the continuing debate. What remains to be seen is what, if any, real reform will occur in furtherance of common ends of opportunity and growth.

Wealth Planning Advisory Services at Northern Trust includes financial planning, family education and governance, philanthropic advisory services, business owner consulting, tax strategy and wealth transfer services.

If you’d like to learn more, contact a Northern Trust professional at a location near you or visit us at northerntrust.com.

Special thanks to Amanda C. Andrews for her contributions to this piece.

Northern Trust Wealth Planning Advisory Services include financial planning, family education and governance, philanthropic advisory services, tax strategy and wealth transfer services.
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LEGAL, INVESTMENT AND TAX NOTICE: This information is not intended to be and should not be treated as legal advice, investment advice or tax advice. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel.