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Now that Joe Biden has been sworn in as President and a 50/50 split in the Senate with the Democrats holding the tying vote, many of my clients are concerned about future adverse tax legislation.  The most mentioned tax legislation proposed by President Biden includes the reduction of the current estate tax exemption of $11,580.00 to $5,000,000, an increase of the capital gain rate which will tax long-term capital gains at higher rates than ordinary income rates for high income tax filers, and the elimination of the stepped-up tax basis rules that apply to certain property received from a decedent[1].  Many high income and high net worth individuals will be adversely impacted if any of these tax proposals are enacted into law.

Many of my clients want to know if they should act now before any tax legislation is passed or even introduced to avoid foreclosing an opportunity that is available under current favorable law.  At the present time, no tax legislation has been introduced and it is likely that any tax legislation will be delayed until the President and Congress address the COVID pandemic. 

All tax legislation must first come from the House Ways and Means Committee and then passed by the House of Representatives before going to the Senate.  Once a tax bill is with the Senate, the Senate Finance Committee must approve any bill before going to the full Senate for approval.  If there is a difference between the House and Senate tax bill, then the bill goes to a House and Senate Conference committee to work through any differences in the two bills.  If the two competing tax bills are resolved, then the compromised legislation goes to the House and then the Senate for a final vote.  If passed by both the House and Senate, then the tax bill goes to the President to sign or veto.

Given this long process, the question is whether Congress can enact retroactive tax legislation. Congress has many reasons to quickly move to enact tax legislation, for example, numerous provisions of the 2017 Jobs Tax Cut and Jobs Act are scheduled to sunset at the end of 2025. Due to the massive COVID relief bills, the government needs more and new sources of revenue.  A new administration usually wants to encourage certain behavior and discourage other behavior.  This carrot and stick approach can be achieved by tax incentives and penalties.

History teaches us that the fastest a tax bill will pass is one that has bipartisan support, introduced at the beginning of the year and then passed in August.  There are always exceptions to this time line and specific targeted tax legislation can be inserted in an unrelated bill.   If tax legislation is enacted in August 2021, could it have retroactive effect to transactions completed at any time in 2021?  The taking clause of the Fifth Amendment to the Constitution does not prohibit the government’s taxing power and that taxing power does not prohibit retroactive application. The Supreme Court has ruled on multiple occasion that there is no absolute constitutional bar to retroactive tax legislation[2]. However, Congress does not have unlimited authority to implement retroactive tax legislation.  The Supreme Court has limited retroactive legislation to periods of less than twelve months[3]

A study completed by the National Law Review[4] on the history of retroactive tax legislation passed since 1997 found that legislation that was applied retroactively for the most part only involved tax rate decreases.  Obviously, tax decreases are easier to implement on a retroactive basis from a political standpoint. Generally, rate increases have been scheduled to go into effect after the legislation has passed.  The most recent tax legislation, the Tax Cut and Jobs Act passed in 2017, applied solely to prospective tax years and was first made applicable for calendar year 2018 even though there were tax decreases for some taxpayers.

Like you, I read all of the articles and news stories that speculate on the coming draconian tax law changes that will adversely impact people of wealth and higher income earners. Many of these articles implore their readers to take immediate steps before it is too late. My many years of experience has taught me that trying to anticipate what Congress does or does not do is a lesson in futility. Most tax planning requires some form of an irrevocable transfer of control of property by gift or to a trust that is controlled by an unrelated third party or selling assets to recognize gain that is believed to be at a lower rate.  History has taught me to be cautious before recommending tax planning advice based upon conjecture and rumor before tax legislation is actually passed into law If an irrevocable transfer of control of property is made or property is sold and tax paid in anticipation of tax legislation that never occurs, then unwinding the process may be impossible or, at the least, extremely difficult and expensive.

We have all heard the saying that the only two certainties in life are death and taxes.  Our life expectancy is marginally predictable.  My belief is that the tax implications of a transaction should be known at the time it is implemented.  It is always possible that tax legislation passed in 2021 and 2022 may not follow history and is applied retroactively.   When tax bills are introduced, I will post more information and references to the provisions that apply to most high net worth and high-income individual taxpayers.  My advice now is to sit tight and not speculate on future legislation.

Certain tax planning opportunities should be considered at this time since many of the tax provisions of the 2017 Tax Cuts and Jobs Act will sunset at the end of 2025.   I will outline several tax plans that I believe have the best likelihood of potential tax savings with the least amount of risk based upon current law. Stay Tuned.

[1] See Tax Policy Center (TPC) Understanding Joe Biden's 2020 Tax Plan.

[2] U.S. v. Darusmont, 449 U.S. 292, 297 (1981).

[3] Cohan v. C.I.R., 39 F.2d 540, 545 (2d Cir. 1930).

[4] National Law Review, Capital Gain Rates, Historical Perspective on “Retroactive” Changes, January 24, 2021, Vol. XI, No. 21.

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