Tax considerations for family offices under the Biden administration


Authored by RSM US LLP

The day before President Joe Biden’s inauguration, it became clear that his ambitious tax plan is lower on the administration’s to-do list than alleviating the public health crisis and stabilizing the economic recovery. Biden’s nominee for secretary of the Treasury Department, Janet Yellen, told the Senate Finance Committee: “The focus right now is on providing relief, and on helping families keep a roof over their heads, and food on the table—and not on raising taxes.”

However, Yellen went on to say that Biden remains intent on repealing “parts of the 2017 tax cuts that benefited the highest income-earning Americans and large companies.” That effort, Yellen indicated, simply will wait until the pandemic has waned and the economy is stronger.

For family offices, then, the pertinent questions are: When will rates increase, and in what form?

Given the 50-50 split in the Senate, potential tax changes will still be subject to political maneuvering. Moderates will have a relatively strong influence on policy, while Vice President Kamala Harris is positioned to cast the tiebreaking vote in favor of the administration’s agenda. Although most legislation debated in the Senate requires the support of 60 senators to advance to a vote, it is possible that Democrats will pursue tax law changes through a process known as budget reconciliation, which requires the support of only a simple majority. In fact, Republicans passed the Tax Cuts and Jobs Act (TCJA) in 2017 through the reconciliation process.

Based on our knowledge of political dynamics and given what the Biden administration has indicated in the face of uncertainty surrounding the public health and economic crises, here are four crucial considerations for family offices. Keep in mind, of course, the situation is fluid and subject to change.

1. Individual tax rates

Laws at the start of Biden’s term: The top individual income tax rate is 37%, but the qualifying business deduction for individuals can lower their effective rate to 29.6%. Meanwhile, the long-term capital gains rate ranges up to 20%.

What we know about Biden’s plan: He has proposed increasing the ordinary income tax rate from 37% to 39.6% for individuals with an annual taxable income above $400,000.

He also has proposed taxing long-term capital gains at 39.6%, up from the current 20%, for taxpayers with over $1 million in income. He also hopes to repeal the step-up in basis at death, which means that heirs may incur a capital gains tax on pre-death value appreciation. It is worth noting the existing 3.8% net investment income tax, which could combine with Biden’s proposed long-term capital gains rate hike to produce an effective rate of 43.4%.

Biden has proposed to phase out the qualifying business deduction for individuals with taxable income above $400,000, which would further increase taxes for high-income earners with operating businesses that are pass-through entities. Also, he has proposed capping the tax benefit of itemized deductions to 28% of value for those earning more than $400,000.

Family offices should consider: The potential increase in the long-term capital gains tax rate could significantly affect investments owned by family offices and private equity enterprises by reducing the after-tax rate of return on capital asset sales. A family office may want to consider generating gains before the enactment of any law changes that increase rates. Additionally, family offices with investments that are eligible to qualify for the small business stock provisions under section 1202 should consider structuring them as such at formation in order to minimize taxation upon disposition of the corporate shares. There are many planning opportunities involving qualified small business stock.

Also, a potential increase in the individual income tax rate reintroduces the question of entity choice to family offices. A family office should be mindful of its short- and long-term objectives when analyzing whether a corporate or pass-through entity is preferable in the context of governance, flexibility, regulatory and tax policies.

2. Corporate taxes

Laws at the start of Biden’s term: The corporate income tax rate is 21%, reduced from 35% by the Tax Cuts and Jobs Act of 2017 (TCJA). That transformative law also repealed the corporate alternative minimum tax.

What we know about Biden’s plan: He has proposed raising the statutory corporate tax rate to 28%. Biden stated in a September TV interview: “I’d make the changes on the corporate taxes on day one.” As it turned out, though, that determination yielded to concerns about the pandemic and economy. Still, at Yellen’s confirmation hearing on Jan. 19, she was clear about the administration’s outlook on taxes. “It’s very important that corporations and wealthy individuals pay their fair share,” she said.

Yellen also said the administration looks forward to addressing taxes on multinational corporations by working with other countries through the Organization for Economic Cooperation and Development. The Biden administration wants “to stop what has been a destructive, global race to the bottom on corporate taxation,” she said. “In that context, we would assure the competitiveness of American corporations even with a somewhat higher corporate tax.”

Biden also has proposed a 15% minimum tax on book income for corporations earning $100 million or more annually.

Family offices should consider: The potential increase in the corporate income tax rate should be part of any entity choice analysis into whether to structure as a pass-through enterprise or a C corporation. There is no easy answer due to myriad considerations, so family offices should consult with their advisors to assess their unique circumstances in order to identify the optimal solution for their situation.

One such consideration could be the impact of potential legislation regarding the taxation of carried interests. Under the TCJA, carried interest that normally would be taxed as long-term capital gains is reclassified as short-term capital gains and taxed at ordinary rates if the underlying asset was held less than three years. Given that there is some uncertainty about whether this rule applies in a family office context, this requires an analysis of the facts and circumstances of the particular family office. Family offices holding these types of interests may want to reconsider the entity holding them if preferential tax treatment is no longer valid.

3. Estate planning and gifts

Laws at the start of Biden’s term: The TCJA contains a number of provisions that have been favorable to many family offices. Estate, gift and generation-skipping transfer (GST) tax exemptions are $11.7 million per person and $23.4 million per married couple in 2021 (indexed for inflation). These increased exemptions are scheduled to sunset Dec. 31, 2025, and return to their pre-2018 levels of approximately $6 million per person. Meanwhile, estate, gift and GST tax rates are 40%.

Also, the basis of assets acquired from a decedent is adjusted to fair market value determined at the date of death. Valuation discounts and other wealth transfer tools remain widely available; however, the Treasury Department could issue regulations that negate the ability to utilize certain tools and valuation discounts, and those regulations would not require congressional support.

What we know about Biden’s plan: The former vice president has publicized few specifics about amending laws governing estate and gift planning, but the 2020 Democratic Party platform states: “Estate taxes should also be raised back to the historical norm.” Now that Democrats control the White House and both bodies of Congress—albeit by virtue of a tiebreaker in the Senate—estate, gift and GST tax rates could increase, the step-up to a mark-to-market basis on appreciated assets upon the death of the owner could be repealed, and favorable valuation discounts and other wealth transfer tools could be curtailed.

Statements by Biden and proposals made during the Obama administration suggest that estate, gift and GST tax exemptions would be reduced to rates that predate the TCJA. The estate-tax exemption was $3.5 million in 2009, and that apparently is Biden’s target. In the written question-and-answer portion of Yellen’s confirmation hearing, she was asked about Biden’s proposal to reduce the exemption to $3.5 million, and she did not dispute the assertion. “On the president’s estate tax proposal, in particular,” she wrote, “it may be helpful to note that only about the wealthiest six out of every thousand estates would face any tax—less than 1%—and every couple with assets under $7 million would be fully exempt from the estate tax.”

Without a publicized detailed plan from Biden, a few items from President Obama’s proposed budget plans in the mid-2010s are worth keeping in mind. (The items were proposed in multiple editions of the annual Green Book but never enacted.) Grantor retained annuity trusts (GRATs) would have been required to have a minimum trust term of 10 years and would have required gift tax to be paid at the time the trust was created. Dynasty trusts would have been subject to tax after the trust had been in existence for 90 years. In addition, grantor trusts would have been subject to gift tax for any distributions made out of the trust; any value in the trust would have been included in the estate upon the grantor’s death. Recently, there have been discussions of possibly limiting the number of $15,000 annual gift exclusions for use by a single donor. Today, there is no such limit.

Family offices should consider: As part of a comprehensive multigenerational review of all estate and gift plans, a family office should immediately determine how much lifetime estate and gift exclusion members of the family have utilized, and whether the exclusions should be utilized early in 2021—before the introduction or issuance of unfavorable legislation or regulations. Maximizing the annual gifting exclusions can facilitate the transfer of wealth. Also, the timing is right for family offices to review their investment portfolios to determine if a GRAT or other estate planning strategies make sense. Charitable lead annuity trusts (CLATs) and other interest rate-sensitive planning tools, such as sales to grantor trusts, should be considered. Leveraged transactions at current low interest rates, coupled with the utilization of grantor trusts, could prove to provide substantial savings over the long term.

As a rule of thumb, estate planning should be undertaken with a holistic approach in which multiple generations of the family consider each other’s objectives and plans. Educate the younger generations about wealth preservation and responsibility, as a number of wealth advisors have indicated younger generations generally are anxious, to some extent, about acquiring such great wealth.

4. State and local considerations

Laws at the start of Biden’s term: Estimates for collective state budget shortfalls due to the public health and economic crises exceed $200 billion over the next two fiscal years. Most states have constitutional requirements for balanced budgets, so proposals to increase revenue through new taxes, higher rates and federal decoupling are surfacing throughout state 2021 legislative sessions, particularly in states feeling economic pain caused by the pandemic.

What we know about Biden’s plan: The Biden administration in late January proposed a $1.9 trillion relief package that includes $350 billion for state and local governments. Allocating federal money to the state level could further stress federal deficits, which ultimately must be funded. That said, the numerous state-level proposals to increase revenue through new taxes and higher rates would likely have greater and more immediate effects on taxpayers.

Family offices should consider: There are significant tax implications to families’ personal state of residence and the situs of the family trusts. This is worth reiterating, given how many people have relocated during the pandemic. Family members who have changed residences during the pandemic may have also changed the state taxation of trusts for which they serve as trustee. This is because some states look to the residence of a trustee when determining the state taxability of a trust. Knowing the budget dynamics of respective states and collaborating with advisors can help family offices plan for potential state tax increases.

In addition, at the state level, we are already seeing an increase in so-called “pass-through entity workaround” proposals. This type of workaround basically shifts the deduction for state taxes to the pass-through entity (where there is no cap on the deduction). However, these proposals and existing workarounds are complex and need to be analyzed. Family offices need to undergo a comprehensive analysis when considering whether the workaround is a good strategy to reduce the impact of the federal cap on state and local tax deductions, because electing into a workaround may ultimately increase the family’s state tax liability.

The takeaway

Given the probability of various significant tax increases, family offices could benefit from analyzing how their multigenerational objectives align with potential policy changes and plan accordingly.

That said, uncertainty about potential tax increases under a unified Democratic government amounts to short-term noise. Family offices must remain focused on the big picture. Initiatives such as integrating technology solutions, digital transformation, adapting to remote work, outsourced financial and accounting services, managed IT services, cybersecurity and data privacy, and long-term family governance and education are crucial to a family office’s long-term success.

For more family office insights from RSM, download our free e-book and visit our Family Office homepage. For insights about tax policy, visit our Tax Policy Resource Center.