• Opportunity zone (OZ) gain deferrals
• Reversal of the highest marginal individual income tax rate to 39.6% from 37%
• Lowered AMT exemption
• Elimination of the Section 199A deduction
• Decrease in the estate and gift tax exemption

Most of the taxable gains from a liquidity event generally are taxed as capital gains. Note that capital gains marginal tax rates generally are not directly affected by the sunsetting provisions of the TCJA. Nonetheless, there are sale transactions that can generate ordinary income, such as the sale of business assets subject to the recapture rules or a sale of a partnership interest where the partnership has “unrealized receivables” including depreciation recapture. Other provisions of the Internal Revenue Code can also result in the recognition of ordinary income, like Sections 707, 1239, and 988.

OZ gain deferrals

Under current law, the OZ rules allow a taxpayer to defer the taxation of a capital gain or a Section 1231 gain from a liquidity event until the end of 2026. If the OZ provisions are extended, however, then taxpayers would be able to benefit from the gain deferral provisions in the new legislation, which likely would be more favorable.

Transactions with ordinary income

Where a liquidity transaction would result in ordinary income, tax advisors should consider the impact of the potential increase in personal income tax rates if the sunsetting were to occur. Significant tax savings can arise if a transaction occurs prior to the sunsetting. Alternatively, additional tax savings can result by deferring the incurrence or payment of various deductible expenses until after the tax rates sunset.

AMT exemption

In addition to regular income taxes, the Alternative Minimum Tax (AMT) is a factor to consider. As a taxpayer’s taxable income increases, the amount of AMT liability may be increased if the AMT exemptions and limitations are not extended. Further, if the AMT exemptions and limitations are not extended, it may present an opportunity to exercise incentive stock options prior to their sunsetting.

Section 199A

In the case of a partnership or an S corporation, ordinary income that is allocated to their owners is taxed at a lower rate by virtue of the Section 199A 20% deduction. If the Section 199A deduction is not extended, then the effective tax rate for taxpayers owning partnership interests and S corporation interests will effectively increase. This is a factor to consider in determining whether a liquidity transaction should be accelerated prior to Dec. 31, 2025.

Although not directly impacted by a liquidity transaction, it is important to note that if the Section 199A deduction is not extended, REIT dividends would no longer benefit from the Section 199A deduction and, in addition, would be taxable at the highest marginal rates, which could increase from 37% to 39.6%.

Estate and gift tax exemption

Potential gifting must be considered in conjunction with any contemplated liquidity event (and should be considered irrespective of any pending transactions). Upon sunsetting, the current TCJA estate and gift tax exemption ($13.61 million) would be reduced to roughly half the current exemption. Thus, the current unified estate and gift tax exemption creates an opportunity to make larger gifts. If structured and timed properly, valuation discounts (lack of marketability, lack of control, etc.) may apply to any gifted business interests, allowing more appreciation to grow outside the taxpayer’s estate. Along with other estate freeze techniques, such as grantor retained annuity trusts or sales to intentionally defective grantor trusts, there is an opportunity to move significant appreciation outside the taxpayer’s estate prior to any liquidity event.

Next steps

Engaging valuation professionals early in the process is essential, as they can advise on any applicable discounts and help determine the optimal amount to transfer. This information will also allow the advisor team to develop a plan that is both income and estate tax efficient. As the completion of the liquidity event draws closer, there is heightened risk of IRS scrutiny on any transfers, so it is ideal to complete any wealth transfer planning as early in the process as possible.

In light of the many moving pieces concerning the possible sunsetting of various provisions of the TCJA, it may be useful to prepare pro forma calculations of potential tax costs or savings in connection with contemplated liquidity transactions, and to consider the amount and timing of gifts and other estate planning techniques. Valuations of assets may also be helpful in evaluating the optimal time to engage in a liquidating transaction.

While not covered in this article, the outcome of the U.S. presidential election could also have significant impacts on tax planning and structuring and should be considered when discussing tax planning with clients.