Pres. Obama’s Proposed Tax Increases on the “Rich”

In connection with his 2015 State of the Union Address, Pres. Obama proposed to increase taxes again on the “rich” in order to give new tax credits to the “middle class.”  Taxes would increase an estimated $320 billion over 10 years.

Increasing the Top Tax Rate on Qualified Dividends and Long-Term Capital Gains 

·       The current top income tax rate on qualified dividends and long-term capital gains is 20% for taxpayers with income above $413,200 (single) or $464,850 (joint).  In addition, a 3.8% net investment income tax (NIIT) created under Obamacare applies.

·       The President proposes to increase the top tax rate on qualified dividends and long-term capital gains to 28% for couples with income over about $500,000.   The February 2nd budget proposal clarifies that the 28% rate includes the 3.8% net investment income tax.

Treating Transfers of Property by Inheritance and Gifts as Taxable Events 

·       Under current law, most assets receive a new basis at death equal to the date of death value.  This allows heirs to sell inherited assets without a capital gain.  On the other hand, in the case of a gift, the donor generally does not realize any gain, and the donee generally takes a carryover basis, meaning the donee pays the capital gain tax when the asset is sold. 

·       The President describes the current law as “perhaps the largest single loophole in the entire individual income tax code.” 

·       The proposal treats bequests and gifts other than to charitable organizations as realization events.  A realization event means the property is treated as if it had been sold for its fair market value at the date of death or at the date of gift.  Treating death as a realization event is harsher than prior proposals to deny an increase in basis at death (carryover basis).  Under a carryover basis regime, the beneficiaries can defer the tax until they sell the appreciated assets.  It is unclear who would pay the capital gain tax upon a gift, but it would probably be the person making the gift.

·       Administration officials indicate that the capital gains tax paid at death may be deducted for estate tax purposes.  The combined estate, capital gain, and Utah taxes on appreciated property would amount to as much as 60%.

·       A spouse could inherit from a deceased spouse without immediate tax.  The tax would not be due until the death of the surviving spouse. 

·       There would be an exemption from capital gains tax at death of up to $100,000 per individual ($200,000 per couple).  Note that these figures are “gains” and not the fair market value of the asset.  Any unused exemption of one spouse would “port” to the surviving spouse.

·       In addition, capital gains of up to $250,000 per individual ($500,000 per couple) for a personal residence would be exempt.  This additional exemption would also be portable between spouses. 

·       Tangible personal property other than expensive art and similar collectibles would be exempt. 

·       No tax would be due on inherited small family-owned and operated business unless and until the business was sold.  A small family-owned business was not defined.

·       Any closely-held business would have the option to pay the tax over 15 years on gains.  A closely-held business was not defined.

Limiting Retirement Plan Contributions

·       The President proposes to prohibit contributions to and accrual of additional benefits to IRAs, 401(k)s, and pension plans when balances are sufficient to produce an annual distribution of $210,000 in retirement.

·       Under current assumptions, the permitted balance would be about $3.4 million.

Withdrawn:  Treating Section 529 College Savings Plan Distributions as Taxable.

·       Under current law, earnings on Section 529 college savings plans withdrawn to pay for qualifying college expenses are not taxable.

·       Last week Pres. Obama proposed to tax the earnings on new contributions even when spent on qualifying college expenses.  This proposal received a lot of push back, including from members of his political party.  Administration officials indicated on January 27, 2015 that this proposal is withdrawn.

The New Utah Unitrust Act Can Help Trust Beneficiaries in a Period of Low Investment Yield

With historically low interest rates, income beneficiaries of traditional trusts have been suffering low distributions.  A trust often has different classes of beneficiaries, those who receive income distributions as the trust earns income, and those who receive the remaining principal of the trust after some event has occurred or some time period has elapsed.  A trustee is in a difficult position where investment decisions must be made to benefit the two classes of beneficiaries who have opposing interests.  The income beneficiaries will want a high allocation to income generating investments at the expense of capital growth investments favored by the remainder beneficiaries.  An example of such a situation is a trust established by a deceased husband for his second wife who is to receive the trust income, with the children of his first wife waiting to receive the principal until after the second wife passes away.

The Utah Unitrust Act became effective July 1, 2013.  The Act permits a trustee, or a beneficiary who petitions the trustee, to convert the traditional income trust into a Total Return Unitrust.  The word “unitrust” means a distributable amount computed as a fixed percentage of the fair market value (FMV) of trust assets as determined annually.  The Act permits a unitrust of at least 3% but not more than 5% of FMV.  The trustee can then invest the trust assets for total return as a prudent investor would do, without worrying whether the investment selection will disadvantage one class of beneficiaries in favor of the other.  There are important variables that must be agreed to by all of the parties when converting to a unitrust such as:

·       Setting the unitrust percentage

·       Determining how much capital gain is to be taxed to the income beneficiaries as part of the unitrust

·       The method for determining FMV

·       How expenses are to be accounted for between the beneficiaries

Converting a traditional income trust to a Unitrust may very well benefit both classes of beneficiaries as the trustee then can invest to grow the trust assets as a whole which will both increase the unitrust payout to the income beneficiaries and provide capital appreciation for the remainder beneficiaries.

Utah Partnerships with Resident Individual Partners May Have a Utah Tax Return Filing Requirement

In the past, partnerships owned 100% by Utah resident individual partners have not been required to file a Utah partnership tax return.  Beginning with the 2011 form instructions, the Tax Commission clarified that a partnership that is a pass-through entity taxpayer is required to file a Utah partnership tax return, even if all its partners are Utah resident individuals.

A pass-through entity is an entity whose items of income, deductions, and credits flow through to the tax returns of its owners via Schedule K-1 (partnerships, limited liability companies taxed as partnerships, S corporations, trusts, and estates).  A pass-through entity taxpayer is an entity that is an owner in another pass-through entity.  For example, Partnership B is a partner in Partnership A.  Partnership B is referred to as a “second tier partnership” and is classified as a pass-through entity taxpayer.  Partnership B is now required to file a partnership tax return even though all its partners may be Utah resident individuals.  This is true regardless of whether Partnership A withheld any Utah tax on the income allocated to Partnership B.