Regular readers of this blog know that we have been on the lookout for tax changes on the horizon since the beginning of the current presidential administration. Reading the tea leaves of campaign promises and statements to the press, we have counseled our clients as to tax planning strategies to respond to possible changes. The House Ways and Means Committee has recently released a proposal that arises from President Biden’s tax proposals.
This move toward tax reform would, if enacted into law, affect various aspects of estate tax and financial planning for millions of Americans. As predicted, the plan would significantly limit certain estate planning opportunities and raise tax on high-net worth individuals and corporations. In our efforts to keep you up to date, we have summarized this initial proposal. We are dedicated to keeping you educated as this bill makes its way through the legislative process.
There are a variety of advanced strategies estate planners use to minimize the tax burden on beneficiaries and maximize the assets they receive from an estate. These tools include Spousal Lifetime Access Trusts (SLATs), Intentionally Defective Grantor Trusts (IDGTs), and Qualified Personal Residence Trusts (QPRTs). Each of these excludes assets from the grantor’s estate by retaining grantor trust status for income tax purposes, but enabling a transfer for gift tax purposes.
If signed into law, the House Ways and Means Committee’s bill would eliminate SLATs and IDGTs as of the date the bill is enacted. In addition, there are issues regarding the ownership of Qualified Subchapter S Trusts (QSSTs) under the language of the bill. The future of GRATs and QPRTs is uncertain, despite the fact that these trusts are sanctioned by the Internal Revenue Code (IRC).
Irrevocable Life Insurance Trusts (ILIT) would no longer be able to use trust income to pay premiums without including the insurance proceeds in the grantor’s estate for estate tax purposes.
Another tool used to minimize gift and estate taxes is to create a sale between the grantor and an IDGT. Under the current law, no capital gain is recognized. This legislation would force recognition of capital gains, treating the sale between the grantor of the trust and an IDGT the same as a sale between the grantor and a third party.
Effective immediately, the long-term capital gain tax rate would increase from 20% to 25% for married couples with taxable income of more than $450,000 filing jointly, individuals with taxable income of more than $400,000, and trusts and estates with taxable income of more than $12,500. Including the new 25% rate, the new 3% surcharge, and the current 3.8% surtax on net investment income, the highest marginal long-term capital gain tax rate would rise to 31.8% under the House Ways and Means Committee proposal.
Current law provides for a discount on the taxable value of transferred interests in businesses, real estate and even investments, when those interests are held in a company, partnership, or LLC. The discounts relate to the fact that the closely held business interests aren’t marketable, are usually a minority interest and lack voting control.
Passive business interests and other non-business assets would no longer receive these valuation discounts for tax purposes. The only exception would be active business interests in which the taxpayer is an active participant.
For qualifying small companies, shareholders who have held their stock for at least five years were previously able to exclude 75% or even 100% of gains on the sale of that stock from federal taxation. Under the proposed legislation the amount of gains that would not be subject to tax is capped at 50% for taxpayers with adjusted gross income (AGI) of $400,00 or more.
If you own a farm you have a special exemption to reduce its value, rather than being taxed at its highest and best use. The farm provisions are the only pro-taxpayer provisions in this legislation.
Despite the number of changes to tax law contained in the bill, some expected changes to tax law did not materialize. These include:
The absence of a proposed change regarding the step up in basis was a welcome surprise. When the owner of an asset dies, their heir or beneficiary receives the asset at a “stepped-up” basis: the value of the asset at the time of death. There were concerns that under new law, the beneficiary would take the previous owner’s basis, resulting in greater capital gains when the asset was sold.
Similarly, there had been murmurings that a transfer at death would have become a taxable event, triggering capital gains for an heir or beneficiary. Fortunately, this “deemed sale at death” provision did not make it into the bill.
Despite early concerns, the House Ways and Means Committee legislation also does not include any added limitations on GRATs, so short-term GRATs appear to remain feasible. In addition, the bill does not eliminate dynasty planning, to the extent that taxpayers have enough remaining exemption to plan to eliminate estate tax at each generational level. Furthermore, despite the threat to many estate planning strategies, the actual gift and estate tax will remain the same under the bill.
Last but not least, the bill contains no estate tax surcharge for billionaires. That’s good news for Bill Gates and Jeff Bezos, though most of the rest of us will remain unaffected.
While there is no guarantee that the bill in its current form will become law, it should serve as a wake-up call for taxpayers who have put off estate and tax planning. You may want to focus on creating SLATs, undertake sales to grantor trusts using valuation discounts, and use your unified gift and estate tax exemption before you lose it. For individuals who have already exhausted their gift tax exemption but not their generation-skipping tax (GST) tax exemption, it may make sense to make gifts equal to the balance of the GST tax exemption and pay tax on the gift. If the donor lives for three years from the date of the gift, the gift tax paid will be removed from the estate.
We’ll keep you posted with further developments on changes to federal tax law. In the meantime, if you have questions about what you have read here, or want to update your estate plan in light of this information, please contact Gudorf Law Group to schedule a consultation.