Originally published on Forbes.com.
So the Senate Finance Committee has scheduled for markup (whatever that means exactly) a different version of the Tax Cuts and Jobs Act. The difference between the Senate bill and the House bill illustrates the difference between House members and senators. According to this report by Ballotpedia, the average net worth of a House member is about $7 million and the average net worth of a Senator is $14 million (2011 numbers in both cases).
The picture in my mind is that House Republicans are mere millionaires bought and paid for by the billionaires who own them. Republican senators, on the other hand, are themselves multi-millionaires. Also, the Senate cannot be gerrymandered, beyond the original gerrymandering the founders did having the Senate represent land as much as people.
Back in the day, it was easier to buy Senators, when it was the state legislatures rather than the people directly who selected Senators. Have to wonder if the Convention of States will revisit the 17th Amendment. The irony is that the Senate bill better represents the interests of mere millionaires than the House bill. The House members have their demanding billionaire bosses to take care of.
What’s A Mere Millionaire?
When I was a kid, there was a TV show called The Millionaire
This fabulously wealthy guy sent his minion, who narrated the show, out to various people to hand them a check for a million bucks, and then we follow along with how that worked out for them. Don’t get me wrong. A check for a million bucks would be a transforming event for many people, but not for as many as you might think if you are struggling. Someone who remains consistently well employed for three decades is not improvident and does not have really bad breaks, should have a net worth over a million when they are in their sixties. Most typically the net worth will be in the form of a paid-off residence and a retirement account.
When you throw in social security, medicare, and all those senior citizen discounts, it is a really sweet deal. Trust me I know. Nonetheless, the lives of people like that do not appear that different from that of their non-millionaire neighbors. If you gave one of them a million bucks, they would be pleased, but most likely it would just make them feel a bit more secure.
To become a really legit multi-millionaire – say $10 million and up – you have to be more than a steady Eddie if you don’t have the previous generation helping you along. A lot of that crowd will also not be that visible to the naked eye. Check out Thomas Stanley’s The Millionaire Next Door and you will see what I mean.
The Senate bill caters to those two classes and to some extent their poorer brothers and sisters and cousins. The House bill is directed to the ultra-high net worth – Business Insider puts them at $50 million-plus and indicates there are fewer than 55,000 of them in the United States.
The Estate And Generation-Skipping Tax
Both the House and Senate Bill double the exemption from estate, gift and generation-skipping tax from $5 million to $10 million (indexed for inflation from 2011). To the lower class of mere millionaires, this does not mean much except for the cockeyed optimists. I can kind of imagine my ship coming in and getting me close to five and a half million, but it would have to be a really big ship, like maybe a cruiser. To get up around the $10 million mark would take a carrier battle fleet. Doubling the exemption is quite significant to people with Senate level net worth.
Even if your net worth is $20 million, two million or so in estate tax savings is a big deal and if you leverage the exemption with a discounted gift, it can cover a lot more. To people high up in the ultra-high net worth group, the increased exemption is pretty insignificant.
The House bill totally repeals the estate and generation-skipping taxes after 2023. That is huge for billionaires, like our President for example. Just saying. And the timing is interesting. It looks to me like they picked 2024, betting that there is a second Trump term, but a good chance that the Democrats might finally come back in 2024. The GST has not been producing much in the way of revenue, but that is because it has a long fuse. To keep it simple just consider children and grandchildren and great-grandchildren etc. as heirs. The children are non-skip beneficiaries. Anybody further down is a skip beneficiary. The tax which is essentially equal to the estate tax, but is on top of it is triggered with a direct skip – an outright gift beyond the exemption and exclusion to a grandchild, a distribution from a nonexempt trust to a skip beneficiary or a termination.
Normal estate planning, not just for tax purposes, calls for significant wealth to be left to trusts. Someone who dies this year with $100 million in net worth will leave five and a half million to an exempt trust and $94.5 million to a non-exempt trust. The reasonable way for a trustee to act is to make distributions from the non-exempt trust to the children (non-skip) and let them take care of the little skippers (grandchildren and beyond). That game ends when the children all pass away. This probably has not happened yet in a really big way, because trusts formed before 1986 are grandfathered and even trusts that are subject to the rule against perpetuities can last a really long time. Many of the children of people dying in the nineties are probably passing away now, which I am thinking should have trustees sweating about this big time. I have not however been able to find any evidence of that.
I spoke with Richard Baum of Anchin Block & Anchin Accountants and Advisors who practices in this area and has written on it. He agreed with the analysis that that trusts that have run out of non-skip beneficiaries are facing a problem, but he has not heard much rumbling in the estate planning community about the issue. Lauren Detzel of Dean Mead thinks the scoring on the value of the repeal of GST is low
I totally agree that there are lots of nonexempt trusts with substantial assets that will benefit from the repeal of GST that probably haven’t been factored in. By adding in a non skip person as a beneficiary of an otherwise GST trust planners could kick the tax bite down the road to the death of the non skip person. Lots of baby boomers are non skip beneficiaries of nonexempt trusts. If they die after 2023 big tax savings.
Howard Medwed of Burns and Levinson who is the person I would think would know if there is concern in the estate planning community about the passing of non-skippers. He has not heard anything either. He was pretty dismissive of my notion that there is a conspiracy going on – a bevy of billionaire grandchildren out begging in the street after having exhausted their exempt trust. He thinks it unlikely that Congress is thinking that far ahead. Of course, if I was a real conspiracy junkie, I could use the lack of evidence as conclusive evidence, since it shows that they are all keeping mum about it.
Relief For Flow-Through Entities
The House bill does nothing for people making less than $260,000 (joint returns, lower thresholds) when it comes to business income. And above that, it discriminates against people who actually work in the businesses and many service providers who don’t require a lot of capital.
The Senate bill is much more generous to those further down the food chain. The Senate bill is probably a little simpler than the House bill. Rather than creating a special maximum rate on a certain class of income (25%), it allows a deduction of 17.4% on pass-through income. Arguably that is equivalent to a rate of around 33% on top bracket people, but it benefits everybody who has flow-through income. Even the service providers like doctors and accountants get the break if their taxable income is below $150,000 ($75,000) for singles.
And it seems that the Senate is taking the jobs part of the act seriously. Individuals who have qualified income from S corporations and partnerships are limited in the deduction to 50% of their share of the wages paid by the entity (There was a similar rule in the production deduction, which is slated for repeal). Why this part of the rule applies to S corporations and partnerships but apparently not to proprietorships seems a little odd. It would seem to encourage the type of eat what you kill partnerships that some lawyers have to move to expense sharing arrangements.
From a tax policy viewpoint, the Senate bill is a little more subject to gaming in this area. There will be a huge incentive, beyond what already exists, to keep the salaries of S corporation principals low. Paul Dougherty of EisnerAmper made this point when commenting about the House provision with its “guardrails”.
The House is concerned about possible abuse in this area and is considering anti-abuse provisions.
The wage requirement would seem to be a real detriment for something like triple net real estate held in a partnership.
Tax Shelters
The Senate bill seems to be headed to finally to kill tax shelters for the very wealthy. An “excess business loss” provision, kicking in at taxable income of $500,000 on joint returns would cause net negative losses from trades or businesses to become part of the taxpayers NOL and be carried forward. A rule like this would prevent partnership losses from sheltering salary and investment income. Another provision limiting charitable contributions to a partner’s basis in the partnership would wipe out the sketchy syndicated conservation shelters, but it could also harm some legitimate transactions.
Summary
The Senate bill seems more oriented toward the moderately wealthy, while the House bill is mainly for the mega-wealthy. The Senate bill also provides legitimate relief for actual small businesses with some incentive for them to actually have people on the payroll.