Tax Loopholes That Would Be Closed by the Keep Our Pension Promises Act of 2015
The Keep Our Pension Promises Act of 2015 (S. 1631 and H.R. 2844) proposes to close two tax loopholes that primarily benefit wealthy individuals and their estates. The tax revenue saved by modifying “like-kind exchange” and “minority valuation discount” rules would offset the cost of a new Legacy Fund within the Pension Benefit Guaranty Corporation, which the PBGC will use to make specified yearly payments to certain financially-troubled multiemployer pension plans.
Modify like-kind exchange rules for real property and collectibles
Generally, individuals who sell or exchange property are taxed on increases in value since they acquired the property. However, in the case of certain investment property (including real estate, art, and collectibles), if taxpayers exchange a property for similar property instead of selling it, they can postpone paying tax on the gain until the second property is sold. This type of tax-sheltering transaction is known as a “like-kind exchange” of property. There are no limits on how many times a property can be exchanged, which can result in a “temporary” deferral that lasts indefinitely. In the case of works of art, the death of the taxpayer or donating the artwork to a museum will mean that the tax is never paid.
Like-kind exchanges of property were originally intended to make it easier for people to exchange business or investment property where it might be difficult to accurately place a value on the properties, as for example, when farmers were exchanging one field for another. Today, however, like-kind exchanges are typically coordinated through a middleman, and the value of a property is relatively easy to determine, which removes much of the problem the provision was designed to address. Narrowing the scope of the provision will close down an inappropriate tax shelter for the wealthy while retaining the provision’s proper scope.
Section 6 of the Keep Our Pension Promises Act will make two changes to current tax law. First, it will limit the amount of gain that can be shielded from taxes in an exchange of real estate to $1 million per taxpayer per year. This amount is indexed to rise with inflation. This change will allow small businesses to continue to use the like-kind exchange provision and maintain their real property investment without incurring current taxation, but it will remove the tax shelter for wealthy real-estate developers and speculators. Second, the bill will prohibit the use of like-kind exchanges for art and collectibles. Today, these items are routinely valued for insurance purposes, and this change will place them in the same investment category as stocks, bonds and other types of securities which are currently not eligible for like-kind exchange treatment.
This proposal has been a part of bi-partisan tax reform bills in previous Congresses. It is estimated that these modifications of the like-kind exchange provisions will raise $11 billion over 10 years.
Modify rules for minority valuation discounts
Generally, property that is transferred at death or by lifetime gift is subject to estate and gift taxes on the fair market value of the property if the total of such gifts exceeds $5 million. In some cases, because of a lack of clarity in the law, taxpayers have been able to undervalue substantially the value of transferred property. One technique that can result in the undervaluation of property is the application of a discount to a minority interest in a business.
There are legitimate circumstances when the value of a minority interest in a corporation, partnership, or other business entity is less than a proportionate share of the fair market value of the business as a whole, because the minority interest does not allow control of the enterprise. The ability to control the direction of a business, or the timing and distribution of company assets is itself valuable. Thus, the IRS and courts will sometimes discount the value of an interest in a business because the interest only represents a minority stake.
There are situations, however, when such discounts are not appropriate but estates nevertheless claim them. Section 7 of the Keep Our Pension Promises Act addresses two such situations. First, the legislation provides that an estate may not claim a minority discount to the extent that a business entity holds cash or securities or other non-business assets in excess of the needs of the business. The bill would value the estate’s pro-rata interest in such assets based on the actual, undiscounted, fair-market value of the assets. Second, the bill would deny a minority discount to an estate when control of a closely held business is transferred to family members.
Modifications of minority discount valuation provisions have been included in past budget submissions. It is estimated that these modifications will raise $18 billion over 10 years.
Return to the legislative summary of the Keep Our Pension Promises Act of 2015.
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A 401(k) plan is a retirement savings plan in which the benefit is based on contributions to an individual account and the investment return on those contributions. Typically, employees make contributions to the plan and, in many cases, employers match the employees' contributions. These plans are called defined contribution plans. In most 401(k) and other retirement savings plans, the employee is responsible for choosing among the investments offered by the plan. Other types of retirement savings plans are 403(b) and 457 plans.