On September 12th, the House Ways and Means Committee released draft legislation as part of Congress’ ongoing budget reconciliation process. The proposed legislation includes significant tax proposals that, if enacted, would dramatically change the tax and estate planning landscape for high-income and high-net worth individuals. Below is a general overview of the Federal tax proposals that are particularly relevant for estate planning purposes. While there is great uncertainty as to which, if any, of these proposals will be enacted, the window for taking action may be very limited.
Reduction in Gift, Estate, and Generation-Skipping Transfer (“GST”) Tax Exemptions:
The current exemption amounts for gift, estate, and GST taxes would decrease from $11.7 million to about $6 million.
Effective for gifts made and decedents dying after December 31, 2021 (under current law, the decrease in the exemption amounts is not scheduled to occur until January 1, 2026).
Estate Inclusion for New Grantor Trusts:
Under current law, the grantor of certain trusts (called “grantor trusts”) is required to pay the tax on the income and capital gains of the trust and the payment of such taxes is not a taxable gift. In addition, transactions between the grantor and the trust are ignored for income tax purposes, allowing for sales and loans on beneficial terms. Grantor trusts are typically not subject to tax in the grantor’s estate under current law. The proposed legislation would make the following changes:
- Assets owned by a grantor trust would be subject to estate tax upon grantor’s death;
- Distributions from grantor trusts to beneficiaries would be treated as taxable gifts as would the termination of grantor trust status; and
- Sales and other transactions between a grantor trust and its grantor would be subject to income tax.
If the proposed legislation is enacted, estate planning techniques that require the use of grantor trusts (e.g., GRATs, SLATs, ILITs, IDGTs, BDOTs, and BDITs) would no longer be beneficial.
Effective after the date of enactment for trusts created on or after such date and to existing trusts to the extent contributions are made to such trusts or certain trust transactions occur on or after such date, and possibly with respect to transactions between the grantor and existing trusts after the enactment date.
Elimination of Valuation Discounts for Nonbusiness Assets:
The valuation discounts currently commonly applied in valuing gifts of minority interests in closely held companies would be disallowed for entities holding “nonbusiness assets” (e.g., cash, stocks, bonds, and real property).
Effective for transfers made on or after the date of enactment.
Tax Increases for High-Income Taxpayers:
- The top marginal income tax rate would increase from 37% to 39.6% for individuals, trusts, and estates; and
- A 3% surtax would apply to modified adjusted gross income in excess of $5 million for single individuals and married individuals filing joint returns ($2.5 million for married individuals filing separate returns) and on estates and trusts with income more than $100,000.
Effective for taxable years beginning after December 31, 2021, with a transition period.
- The top capital gains rate would increase from 20% to 25%.
- The current 75% and 100% capital gains exclusion for qualified small business stock would be reduced to 50% for those earning more than $400,000.
Effective September 12, 2021 (with exceptions for pre-existing contracts).
Net Investment Income Tax (“NIIT”) Expansion:
The NIIT would now cover net investment income derived in the ordinary course of a trade or business for taxpayers with taxable income greater than $500,000 (joint filers) and would also apply to trusts and estates. Effective for taxable years beginning after December 31, 2021.
Restrictions on Retirement Accounts:
Various changes to the current law would reduce the value of high-balance IRAs ($10 million or more) belonging to a taxpayer with adjusted gross income that exceeds $400,000 (single) or $450,000 (married filing jointly) and would accelerate tax revenues from taxable accounts.
Although the consequences of the above changes would be significant, it is noteworthy that the following proposals did not make it into the House Ways and Means Committee’s legislation:
- No imposition of a “capital gains tax on death,” or any rule that would change the current tax laws that provide for a basis “step up” of assets owned at death; and
- No increase in the 40% estate tax rate.
The uncertainty caused by the potential changes to the law render estate planning more difficult and complicated. As a result, it is important to consider some of the following planning options:
- “Use it or lose it”—make gifts in 2021 that take advantage of the current lifetime gift and GST exemption amounts before they are reduced at the end of the year;
- Make contributions to existing grantor trusts prior to the date of enactment, including insurance trusts that require contributions to cover premium payments;
- Create and fund new grantor trusts, such as SLATs, prior to the date of enactment;
- Consider refinancing existing notes to grantor trusts before the date of enactment to take advantage of a lower interest rate; and
- Consider exchanging low basis assets in a grantor trust for cash or higher basis assets and examine existing GRATs before the date of enactment.
If you would like to schedule a review of your documents or discuss proactive planning in light of the aforementioned potential changes, please contact one of the lawyers in our Private Wealth & Family Offices Group.
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