Authored by Mark Lobb
We hope you had a great end to 2023. There are a host of new laws and to be mindful of as we move into 2024 with some dangerous landmines to avoid.
In this edition, we provide you with an overview of new laws and reporting requirements and the potential impact of these new laws on your business operations, along with expert insights into emerging trends, and practical advice for business owners.
We hope you find this newsletter to be a valuable resource and an insightful guide as you continue to build and expand your business.
Alert: New Laws and Active Landmines
FinCen Reporting: In this edition is an article by my law partner Sara regarding new reporting requirements for closely held entities. You must read this article. The Corporate Transparency Act (CTA) came into effect January 1, 2024. The CTA requires you report the beneficial owners of your entities. If you do not complete the new reporting on time, you can be subject to a $500 per day penalty and potential criminal prosecution. We can help you with your reporting, but you must contact us if you want assistance. You will be receiving Spam mail and e-mail from lawyers and other opportunists telling you to pay them to do your reporting. We highly recommend you do not use unknown third parties to do your reporting.
Non-compete Agreements: It is now unlawful to include a non-compete in an employment contract or a standalone non-compete agreement. A violation of the prohibition on non-compete agreements also constitutes unfair competition under California’s Unfair Competition Law, Business & Professions Code Section 17200.
The new law also requires employers to individually notify by mail or email all current employees and any former employees employed after Jan. 1, 2022, that any agreements they signed in violation of Section 16600 are unenforceable. The notice must be provided by February 14, 2024, and failure to provide the notice can constitute unfair competition under California’s Unfair Competition Law.
PAGA/Arbitration Agreements: According to data maintained by the California Department of Industrial Relations, the number of PAGA notices filed has increased exponentially over the past two decades. The number grew from 11 notices in 2006, to 4,530 in 2014, and to 7,780 in 2023. In California, it is not a question of whether a company will be sued under PAGA, but when the company will be sued. Arbitration agreements continue to be upheld, however, the law on arbitration agreement continually shifts as the result of court rulings. It is imperative to continually have your company employee arbitration agreements updated to keep in step with the changes emanating from case law. A well drafted and properly entered into arbitration agreement can substantially limit PAGA liability exposure.
Estate Planning in 2024: The federal lifetime estate, gift and GST applicable exemption amounts are $13,601,000 for an individual and $27,220,000 for a married couple. These dollar figures represent the amount of wealth each individual can transfer during their lifetime or the amount excluded from tax at death which currently are assessed at a rate of 40 percent.
Furthermore, each year, individuals are entitled to make gifts using the “Annual Exclusion Amount” without incurring gift tax or using any of their applicable lifetime exemption amount against estate and gift taxes. The Annual Exclusion Amount for 2024 is $18,000 per donee.
On January 1, 2026, the lifetime exemption will be cut in half. The only to preserve the elevated exemption level is to use it before the end of 2025. Waiting until 2025 to complete planning to use up the exemption is not recommended. At the very least, your structure should be in place by the end of 2024 so that in 2025, the only action item will be funding of the estate planning structure.
Income Tax Basis Planning: DO NO WAIT UNTIL 2025 to COMPLETE ESTATE PLANNING. There are a lot of issues to address. For instance, when determining whether it is prudent to gift a certain asset to apply against the lifetime exemption, it is important to consider the basis of the asset. There is a tradeoff in using the increased exemption amount during lifetime to gift assets to others, as opposed to retaining appreciated assets until death to receive a stepped-up income tax basis.
Gifted assets do not get a step-up in basis upon death. IRS Revenue Rule 2023-02 confirms this previously well-established result. Prioritizing high-income tax basis assets for lifetime gifting to use up the exemption is important. Gift the high-income tax basis assets and retain low-basis assets in the taxable estate if a gifting strategy is to be employed.
This is but one example of issues which will have to be resolved before the end of 2025.
Swap or Buy-Back of Appreciated Low Basis Assets from Grantor Trusts: Most business owners and wealthy individuals we meet already have irrevocable grantor trusts. If such a trust has already been funded with a low-basis asset, the grantor can swap or buy back the assets in exchange for high-basis assets or cash. With the swap or purchase of the asset back from the grantor trust for fair market value, no gain or loss is recognized. As discussed above, on the grantor’s death, the purchased or reacquired asset with the low basis will be included in the taxable estate and receive a step-up in basis equal to fair market value. This eliminates the income tax cost to the beneficiaries. swapped assets.
2024 Federal Tax Brackets and Rates
2024 Federal Income Tax Rates:
There are presently seven individual income tax brackets, with a maximum rate of 37%. The 37% tax rate affects single taxpayers whose income exceeds $609,350 in 2024, and married taxpayers filing jointly whose income exceeds $731,200. Estates and trusts reach the maximum 37% rate with taxable income of more than $15,200.
The threshold for the imposition of the 3.80 percent surtax on net investment income and the 0.90 percent Medicare surtax on earned income is $200,000 for single taxpayers, $250,000 for married taxpayers filing jointly, and $15,200 for trusts and estates in 2024.
Tax Relief for American Families and Workers Act of 2024
On January 19, 2024, the Ways and Means Committee made a significant bipartisan move by approving the Tax Relief for American Families and Workers Act of 2024 (“TRA”).
Three provisions in the TRA involve extensions of policies that were in effect as of 2021, but which have expired or are beginning to phase out. These include the following:
- The deduction for research and experimental (R&E) expenditures.
- Bonus depreciation for short-lived capital assets.
- The increased interest-deduction limitation.
Deduction for Research and Experimental Expenditures. Until 2021, businesses could fully deduct R&E expenditures in the year the business incurred the expenditures. Beginning in 2022, businesses were required to amortize R&E performed domestically over five years and non-domestic R&E over 15 years. In the case of a $10 million expenditure on domestic R&E in 2022, $1MM of the cost would be allocated as a deduction in 2022, $2MM each year would be deducted from 2023 to 2026, and the final $1MM would be deducted in 2027.
The TRA will bring back full deductibility of domestic R&E expenditures. Instead of having to allocate 2024 R&E expenditures between 2024 and 2029, businesses will be able to deduct the full 2024 R&E expenditure immediately in the 2024 tax year.
The change will only be in effect for the 2024 and 2025 tax years before expiring. The changes will apply retroactively to 2022 and 2023.
Bonus Depreciation for Short-Lived Capital Assets. The Tax Cuts and Jobs Act of 2017 allowed “bonus depreciation” for equipment, machinery, and certain other qualified assets with a depreciation recovery period of 20 years or less. Bonus depreciation was enacted in tax year 2018, but under current policy gradually sunsets between 2023 and 2026 before fully phasing out in 2027.
The TRA temporarily pauses the gradual phase-out of bonus depreciation in 2024 and 2025 and retroactively eliminates the partial phase out in 2023. Again, the changes are temporary and retroactive.
Under current law, in 2023, businesses were allowed 80 percent of bonus depreciation, and that percentage is currently set to decline by 20 percentage points each year. Under the TRA, businesses have access to 100 percent bonus depreciation through 2025 and then the phaseout restarts. The allowable bonus depreciation will drop to 20 percent in 2026 before fully expiring in 2027.
Increased Interest-Deduction Limitation. Currently, there is a limitation on the amount of interest expenses businesses may deduct. Interest expenses cannot exceed 30 percent of earnings before interest and taxes (“EBIT”). Currently, the deduction limitation decreases as the volume of a businesses depreciation and amortization increases. The TRA removes depreciation and amortization from the interest limit calculation, thus restoring the limitation of 30 percent of earnings before interest, taxes, depreciation, and amortization (“EBITDA”). This was the rule in place at the end of 2021. Again, the interest expense deduction provision expires at the end of 2025 and is retroactive to 2022.
Increase in Limitation on Expensing of Depreciable Assets. Under current law, businesses can deduct up to $1MM of qualifying short-lived capital expenses placed in service during a year. The $1MM of allowable Section 179 deductions is reduced dollar for dollar once companies’ qualifying expenses surpass $2.5MM.
The TRA increases the maximum allowable Section 179 deduction from $1MM to $1.29MM and increases the $2.5MM threshold to $3.22MM. Inflation adjustments apply to these amounts beginning after 2024. This is intended to be a permanent change.
Pending Proposals from the Biden Administration
In March of last year the Biden Administration released its tax proposals for fiscal year 2024 in the General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals (the “Green Book”). The Green Book is not proposed legislation and will not pass through Congress. However, the Green Book provides a vision with respect to the priorities the Biden Administration wishes to pursue in the event the 2024 election yields favorable results for the Democratic party.
Individuals: The Green Book proposes significant changes with respect to the taxation of capital gains and the taxation of accumulated wealth. It includes a return to the 39.6% top marginal tax rate as well as increasing the net investment income tax and Medicare tax by an additional 1.2% each. Furthermore, it proposes a 25% minimum tax, inclusive of unrealized gains, for individuals whose total net worth exceeds $100MM and imposes an annual reporting requirement on these individuals.
Corporations and Partnerships: The proposals at the entity level are similar to past Biden Administration proposals. The Green Book proposes to raise the corporate tax rate from 21 percent to 28 percent and targets corporate stock transactions, as well as address the so-called “carried- interest loophole.”
Trusts and Estates: The Administration proposes significant changes in the areas of estate and gift tax. It proposes the following:
- Treating a grantor’s payment of an irrevocable grantor trust’s income taxes as a taxable gift,
- Treating a sale to a grantor trust as a recognition event, effectively eliminating the usefulness of GRATs by having requirements for the length of the GRAT’s terms and value of the remainder interest, and
- Imposing an annual maximum of $50,000 for all annual exclusion gifts. Additionally, the Biden proposal would roll back the applicable exemption amount to pre-TCJA levels which would be approximately $7.2MM per individual.
Concluding Comments on 2024
There will not be significant tax policy changes in 2024. The TRA is helpful for businesses, but short-lived. The Green Book is nothing more than a projection of what the Biden Administration would like to implement if it could. In this election year there will be no major changes as it concerns taxation.
Regarding estate planning, it is imperative to finalize a structure in 2024 at a very minimum. If you already have a structure in place, keep in mind the lifetime exemption will go up one more time next year before it drops down to about one half of the current exemption level. Existing structures will need to be updated to take advantage of the increased exemption levels.
As we navigate our way through 2024, our firm will do our best to keep you updated on changes in laws, new laws and strategic moves business owners can make to protect assets, be tax efficient and efficiently execute succession planning.