Déjà Vu All Over Again: President Biden’s 2025 Budget Proposals

President Biden has released his budget blueprint for fiscal year 2025. This is a summary of some of the changes likely to impact high-net-worth and ultra-high-net-worth individuals. Obviously, we haven’t included here all of the provisions set forth in the budget blueprint.  

You may notice that most of these proposals are a repeat from President Biden’s 2024 budget blueprint. The proposals were also part of the Inflation Reduction Act of 2022 (though they didn’t make it into the final package) and some were even proposed previously by President Obama. These proposals would have significant tax impact on individual income, estates, gifts and GST (i.e., generation-skipping tax). Many of the currently used wealth transfer strategies would be substantially hindered and the planned outcome and flexibility of some existing structures could be altered. These proposals may not get much attention in a divided Congress and are mostly for political positioning heading into the Presidential election. However, the proposals don’t seem to be going away, and at some point there may be agreement to utilize some of them to raise revenue for the federal government.  

Business-related taxation

• Raise C corporate tax rate. As with prior versions, this budget proposes to increase the corporate income tax rate from 21% to 28%—effective for the 2024 taxable year.
• Apply net investment income tax (NIIT) or self-employment tax to all pass-through income. All pass-through business income would be subject to either NIIT or self-employment tax—effectively closing the loopholes for limited partners and S-Corps for payment of self-employment tax. This proposal would apply to married taxpayers with adjusted gross income of more than $400,000.
• Increase the NIIT and Medicare tax rate by 1.2% to 5%. For those making more than $400,000, the tax rate for Medicare tax and NIIT would be 5% beginning in 2024. Presumably, this increased Medicare rate for wage earners would be split between the employee and the employer. However, for self-employed and NIIT, it would be paid solely by the taxpayer.  

Personal taxation

• Top marginal tax rate increase to 39.6%. The top marginal tax rate would become 39.6% for individuals with taxable income over $400,000, and for married couples with taxable income over $450,000. These amounts would index for inflation after 2024.
• Increased tax rate on capital gains and qualified dividends if taxable income is over $1million. For those with taxable income above $1 million, capital gains and qualified dividends would be taxed at the ordinary income tax rates. This would apply only to the extent that income exceeds $1 million, and would be effective for gains and dividends received on or after the date of enactment.
• Capital gain realized on the transfer of an asset. Taxpayers would recognize gains on the transfer of an appreciated asset upon gift or death, including transfers of appreciated assets into—and distributions from—non-grantor trusts, partnerships or non-corporate entities (if considered a gift). Assets transferred to a spouse or charity would be excluded from gain realization. Each person would have a $5 million exclusion from the recognition of gains on property gifted during life or at death (which is portable between spouses). Gains recognized at death would be deductible against the estate tax. The exclusion for gain on the sale of a residence and 1202 stock (i.e., stock from qualified small businesses) would remain. The effective date would be for gifts and estates after December 31, 2024.
• Capital gains realized on assets in trust or partnership. Assets in a trust or partnership would be marked to market every 90 years beginning from January 1, 1994. So, potential gains would begin to be recognized starting in 2034, if they haven’t recognized gain in the prior 90 years. 
  
• Minimum tax of 25% on total income. If one’s net worth is in excess of $100 million, the minimum income tax would be 25% of total income, including unrealized capital gains. Tax payments will be treated as prepayment of subsequent taxes on realized capital gains to avoid double taxation. The first-year tax could be paid over nine years and tax in future years over five years. There would be mandatory annual reporting of net worth for subjected taxpayers.
• Mandatory distribution from large IRAs. If the combined balance of retirement accounts exceeds $10 million, the owner must distribute 50% of the excess amount over $10million. If the combined balance of retirement accounts exceeds $20 million, then the entire excess must be distributed first from a Roth account and other accounts. Of course, this provision only applies to married couples with an adjusted gross income over $450,000. The distribution would be treated like an RMD and not subject to early distribution penalties.
• “Back door” Roth conversions. Married couples making over $450,000 would no longer be able to convert an IRA or an employer-sponsored plan to a Roth.  

Estate, gift and GST tax proposals

• Revision to annual exclusion gifts. The proposal would replace the $18,000 annual gift exclusion per done with an annual gift exclusion of $50,000 per donor, so a donor would need to allocate the $50,000 among his or her intended beneficiaries.
• Certain trusts required to report asset values. If a trust has an estimated value in excess of $300,000 or gross income over $10,000, the trust will report its asset value to the IRS.
• Revisions to grantor trust rules. Targeting sales to grantor trusts, the proposal would treat a sale of assets to a grantor trust as a gain recognition event. Moreover, the grantor’s payment of the trust’s income taxes would be a taxable gift to the extent that the grantor trust does not reimburse the grantor for the taxes paid. The gift would not qualify for marital or charitable deduction or the annual exclusion amount. Existing grantor retained annuity trusts (GRATs) and grantor trusts would be exempt from these new requirements, but future sales to a trust would be subject to the proposal.
• Revisions to GRATs. The proposal would require the gift on the creation of the GRAT to be the greater of $500,000 (or value transferred, if less), or 25% of the value of assets transferred to the GRAT, effectively eliminating zeroed-out GRATs. The minimum term of GRATs would be 10 years (increasing the mortality risk) and the grantor would not be allowed to swap assets with the GRAT.
• Limitations on GST tax exemption. The GST exemption would be limited to direct skips and taxable distributions to beneficiaries no more than two generations below the transferor—unless the beneficiary was alive at the time of the creation of the trust. A pre-enactment trust would be deemed to have been created on the date of enactment, effectively preventing the use of dynasty trusts. So, effectively, the GST exemption would only last for the transferor’s grandchildren or other family members who were alive at the creation of the trust.
• Modification of GST exemption for trust transactions. If a GST trust purchases property from a non-GST trust, the exempt status of the trust may be modified, taking into account the non-exempt status of the acquired assets. Or, in other words, the GST trust’s exemption would be diluted if it acquires assets that are not GST exempt. A loan made to a trust beneficiary will be treated as a distribution and carry out trust income to the beneficiary, and also be deemed a distribution for GST purposes. Additionally, if the grantor has borrowed from the grantor trust, the repayment of the loan by a grantor would be considered a new contribution to the trust for GST purposes.
• Loans to trust beneficiaries. The proposal would treat a loan by a trust to a beneficiary as a distribution for tax purposes—carrying out the trust’s distributable net income and also treating the deemed distribution as a GST direct skip or distribution.
• Modification of valuation rules. For families that collectively own more than 25% of a non-publicly traded asset, the valuation principles would be based on the family’s collective ownership and any passive assets held within the non-publicly traded entity would be valued as owned by a single individual.
• Change to charitable lead annuity trusts (CLAT). Similar to charitable remainder trusts, the proposal would require that a CLAT have a remainder of at least 10% of the value of the property transferred to the trust—effectively creating a gift of 10% of the value transferred to a CLAT and eliminating the ability to zero-out a CLAT.  .  

Other notable provisions

• Carried interest would be taxable as ordinary income. Partners in an investment partnership making in excess of $400,000 would pay ordinary income tax rates on their share of partnership income. Additionally, the income would be subject to self-employment taxes.
• Like-kind exchange limitation. Like-kind exchanges have been limited to real estate transactions. The proposal would limit like-kind exchange treatment to $500,000 per taxpayer and $1 million per couple for each taxable year.
• 100% real estate depreciation recapture. Generally, accumulated depreciation on the sale of real estate would be fully recaptured to the extent of the gain recognized for those couples with gross income over $400,000. Historically, the recapture was limited to the amount of depreciation in excess of straight-line depreciation. This recaptured depreciation is subject to ordinary income tax rates.
• Limit use of donor-advised funds to avoid private foundation payout. A private foundation must annually distribute 5% of their non-charitable assets to charitable purposes and reasonable administrative expenses. This proposal would disallow such distribution to be made to a donor-advised fund unless this fund makes a qualifying distribution by the end of the following year. Additionally, administrative expenses paid to a disqualified person (family member of a substantial contributor) will not count as a qualifying distribution.

You can find a full summary of the proposed budget package in the so-called “Green Book¹,” which provides the Treasury Department’s explanation of the specific proposals. For more information on these potential changes and how they may impact you, speak to your Corient Wealth Advisor.

¹ https://home.treasury.gov/system/files/131/General-Explanations-FY2025.pdf

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