TAX UPDATE: 2016 DEMOCRATIC NATIONAL CONVENTION TAX REFORM POLICY UPDATE

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1 Insights on... WEALTH PLANNING TAX UPDATE: 2016 DEMOCRATIC NATIONAL CONVENTION TAX REFORM POLICY UPDATE Details of the post-convention tax reform for A Fair Tax Code Suzanne L. Shier, Wealth Planning Practice Executive and Chief Tax Strategist/Tax Counsel July 2016 The 2016 Democratic National Committee concluded its 48 th Convention on July 28, 2016, in Philadelphia, the City of Brotherly Love, after officially nominating Hillary Clinton and Tim Kaine as the Party s Presidential and Vice Presidential candidates and adopting Mrs. Clinton s tax policy proposals the New Democratic Tax Plan as the official Democratic Party policy platform. As we have witnessed throughout the Presidential campaign season, tax policy and tax reform are major issues that will challenge the incoming President and new Congress no matter which candidate eventually moves into the Oval Office. Without knowing which party will control the next Congress or occupy the White House after 2016, there is no way to predict an outcome for actual tax reform. Only time will tell how this process will evolve. In this Wealth Planning Tax Update, we will summarize the key issues of the Democratic Party s platform on tax policy and tax reform as we emerge from the Convention and await the November general election. As always, we will continue to advise you as substantive developments occur. THE NEW DEMOCRATIC TAX PLAN The New Democratic Tax Plan proposes several new tax reform policies to help address some of the challenges faced by working class American families. Building off of various tax reforms proposed by the Obama Administration s Fiscal Year 2017 Budget, under the New Democratic Tax Plan most taxpayers would see little change in their after-tax income. However, those at the highest end of the income spectrum would see decreases in after-tax income as a consequence of increased income tax rates and limitations in deductions. The following summarizes select proposed changes by the New Democratic Tax Plan to the Internal Revenue Code of 1986 (the Code ): Individual Income Tax Proposals: Keeps current ordinary income tax rates in effect and enacts a 4% surcharge on taxpayers with adjusted gross income ( AGI ) over $5 million (see Table 1). Table 1: TAX BRACKETS UNDER THE NEW DEMOCRATIC TAX PLAN (2016) Ordinary Income Long-term Capital Gains and Dividends Single Filers Taxable Income Married, Filing Jointly 10% 0% $0 < $9,275 $0 < $18,550 15% 0% $9,275 < $37,650 $18,550 < $75,300 25% 15% $37,650 < $91,150 $75,300 < $151,900 28% 15% $91,150 < $190,150 $151,900 < $231,450 33% 15% $190,150 < $413,350 $231,450 < $413,350 35% 15% $413,350 < $415,050 $413,350 < $466, % 20% $415,050 < Over $466,950 < Over Adjusted Gross Income 43.6% 24% $5,000,000 and over $5,000,000 and over northerntrust.com Insights on...wealth Planning 1 of 5

2 Imposes a 30% minimum Fair Share Tax ( FST ), also called the Buffett Rule, on taxpayers with AGI above $1 million. Taxes counted toward the new FST include: regular income taxes (after certain credits and including the 3.8% Affordable Care Act surtax on net investment income), the alternative minimum tax, the 4% surcharge on AGI and the employee portion of the payroll tax. Taxpayers with AGI over $2 million would owe an additional tax on the difference between 30% of AGI and the sum of those taxes. The tax payment phases in ratably between $1 and $2 million of AGI. For example, if a single taxpayer had AGI of $1.25 million, tentative FST of $375,000 and regular tax of ($1.25 mmmmmmmmmmmmmm $1 mmmmmmmmmmmmmm) $250,000, her payable FST would be: (375,000 ($2 mmmmmmmmmmmmmm $1 mmmmmmmmmmmmmm) $250,000) = $31,250. The $31,250 FST amount is in addition to the amount of regular tax payable, resulting in federal income tax payable of $281,250, or a 22.5% effective tax rate. Limits the tax value of all itemized deductions (except for charitable contributions) and exclusions to 28% for taxpayers in the 33% and higher tax brackets (see Table 2). Table 2: EFFECT OF LIMITING THE TAX BENEFIT OF ITEMIZED DEDUCTIONS AND EXCLUSIONS TO 28% Federal Income Tax Rate Bracket 28% 33% 35% 39.6% Maximum tax benefit of deduction or exclusion 28% 28% 28% 28% Percentage reduction in tax benefit 0% 15% 20% 29% Creates a new tax schedule for capital gains with rates declining with holding period (see Table 3*). Table 3: TOP CAPITAL GAINS TAX RATE SCHEDULE UNDER THE NEW DEMOCRATIC TAX PLAN Holding Period New Democratic Tax Plan Current Top Rate* (years) Top Rate* <1 39.6% 39.6% % % 20% % % 6+ 20% *Tax rates do not include the 3.8% surtax on net investment income. Limits the total value of tax-deferred and tax-free retirement accounts by preventing taxpayers with very high balances from making additional contributions. The account balance limit for an individual age 62 in 2016 would be approximately $3.4 million under this proposal and would be increased annually by cost-of-living adjustments. Enacts a new $1,200 tax credit for caregiving expenses for elderly family members and high out-of-pocket healthcare expenses. northerntrust.com Insights on...wealth Planning 2 of 5

3 Taxes carried (profits) interests as ordinary income. Under current law, general partners of an investment partnership, such as a private equity firm, who receive a portion of their compensation as a share of the firm s profits a carried or profits interest are taxed on that portion at long-term capital gain income tax rates. Accordingly, partners receiving carried (profits) interests benefit from the reduced long-term capital gain tax rate (currently, a top rate of 20% plus the 3.8% surtax on net investment income) and are not subject to payroll taxes on that compensation. This proposal would tax carried (profits) interest income as ordinary income (currently, a top federal income tax rate of 39.6%), and would subject that income to self-employment taxes. Transfer Tax Proposals Permanently reduces the estate tax exclusion from $5 million ($10 million for married couples), adjusted for inflation from 2010 ($5.45 million in 2016), to $3.5 million ($7 million for married couples) with no adjustment for future inflation. Under current law in 2016, a married couple can transfer up to $10.9 million dollars free from federal estate tax. If enacted, this proposal would subject that same couple to a 45% federal estate tax rate on $3.9 million (the excess of $10.9 million less $7 million exclusion), resulting in an estate tax payable of approximately $1.755 million. Table 4: ESTIMATED BURDEN OF PROPOSED FEDERAL ESTATE TAX ON ESTATES OF MARRIED COUPLES Current Law (2016) New Democratic Tax Plan Gross Estate $10,900,000 $10,900,000 Applicable Exclusion ($10,900,000) ($7,000,000) Maximum Estate Tax Rate 40% 45% Estate Tax Payable $0 $1,755,000 Permanently increases the top tax rate for the estate tax from 40% to 45%. Permanently sets the lifetime gift tax exemption at $1 million, not indexed for inflation. Modifies the transfer tax rules for grantor retained annuity trusts ( GRATs ) and other grantor trusts. GRATs and sales to grantor trusts are often used for transferring significant amounts of wealth while minimizing the gift and income tax cost of transfers. In both cases, the greater the post-transaction appreciation, the greater the transfer tax benefit achieved. The gift tax cost of a GRAT often is essentially eliminated by minimizing the term of the GRAT. In addition, with both GRATs and sales to grantor trusts, future capital gains taxes can be avoided by the grantor s purchase at fair market value of the appreciated asset from the trust and the subsequent inclusion of that asset in the grantor s gross estate at death. The proposal would require that a GRAT have a minimum term of 10 years and a maximum term of the grantor s life expectancy plus 10 years. Among other stipulations, the proposal would prohibit any decrease in the annuity during the GRAT term, and would prohibit the grantor from engaging in a tax-free exchange of any asset held in the trust. Business and International Tax Proposals Increases the threshold for foreign ownership in an inversion transaction before a U.S. company can give up its U.S. tax residence from 20% to 50% of the combined company shares. A corporate inversion is a transaction in which a U.S. corporation changes its tax residence to reduce or avoid paying U.S. taxes by being acquired by a northerntrust.com Insights on...wealth Planning 3 of 5

4 foreign corporation. Under current law, if the continuing ownership of historical U.S. shareholders (the pre-inversion shareholders) of the U.S. corporation in the new foreign corporation is 80% or more (by vote or value), the new foreign corporation is treated as a U.S. corporation for all U.S. tax purposes. In order to limit the ability of U.S. corporations to engage in such transactions, this proposal would broaden the definition of an inversion transaction by reducing the 80% threshold of continued ownership to a 50% threshold, which would have the result of treating inverted corporations as U.S. corporations for U.S. tax purposes unless more than 50% (by vote or value) of the new foreign corporation is foreign-owned. Levies an exit tax on unrepatriated earnings. Multinational companies are able to defer recognition and avoid current U.S. income taxation of earnings accumulated in their foreign subsidiaries. The proposal would tax the accumulated untaxed earnings of the foreign subsidiaries of any U.S. corporation that voluntarily leaves the U.S. or is acquired by a foreign corporation. Limits interest deductions for U.S. affiliates of multinational companies to prevent earnings stripping transactions. Earnings stripping transactions occur when the U.S. affiliate of a multinational corporation makes interest payments, rather than dividend payments, to a parent company located in a low-tax foreign jurisdiction. The interest payment is deductible against the U.S. firm s earnings and becomes taxable income for the foreign corporation. Thus, the U.S. firm strips earnings from its U.S. taxable income and sends it to the parent, which is located in a country with a much lower or zero tax rate. This proposal would limit a corporation s U.S. interest deductions if the corporation s share of net interest expenses for U.S. tax purposes exceeds its share on consolidated financial statements. Enacts an unspecified rate of tax on high-frequency trading. Eliminates tax incentives for fossil fuels. Provides tax credits for businesses that invest in community development and infrastructure. Provides tax credits for businesses that hire apprentices or share profits with employees. Reauthorizes and expands the Build America Bonds program, which expired at the end of 2010, to increase state and local funding for capital projects. Table 5: ESTIMATED REVENUE IMPACT OF THE NEW DEMOCRATIC TAX PLAN Fiscal Year ($ billions) Total for Individual Income Tax $21.76 $ $ Total for Corporate Income Tax $6.82 $16.85 $ Total for Transfer Tax $1.79 $25.56 $ Total Federal Tax Revenue Impact $30.37 $ $1, Tax reform and simplification have been topics of ongoing discussion in Washington for years and have garnered significant attention during the 2016 Presidential election campaign. Depending on the outcome of the election in November, we may finally experience reformation, simplification and modernization of the U.S. tax code come As always, we will continue to keep you informed of any substantive developments. northerntrust.com Insights on...wealth Planning 4 of 5

5 FOR MORE INFORMATION As a premier financial firm, Northern Trust specializes in life-driven wealth management backed by innovative technology and a strong fiduciary heritage. For more than 125 years we have remained true to the same key principles service, expertise and integrity that continue to guide us today. Our Wealth Planning Advisory Services team leverages our collective experience to provide financial planning, family education and governance, philanthropic advisory services, business owner services, tax strategy and wealth transfer services to our clients. It is our privilege to put our expertise and resources to work for you. If you d like to learn more, contact a Northern Trust professional at a location near you or visit us at northerntrust.com. Special thanks to Benjamin Lavin, Wealth Planner and Associate Tax Strategist at The Northern Trust Company, for his contributions to this piece. 2016, Northern Trust Corporation. All rights reserved. LEGAL, INVESTMENT AND TAX NOTICE: This information is not intended to be and should not be treated as legal advice, investment advice or tax advice. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. northerntrust.com Insights on...wealth Planning 5 of 5

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