Congress Proposed Tax Changes

As you may be aware, Congress recently drafted proposed legislation that, if enacted, would have a significant impact on estate planning. On Monday, September 13, 2021, the House Ways & Means Committee released a proposed tax plan to fund President Biden’s “Build Back Better” social and economic spending package. It is important to note that these are only proposals and Congress is still in the early stages of the legislative process. We expect the final version of the package to include changes, possibly significant, from the current proposal.

While the full picture remains uncertain, some of these proposals would take effect on the date of enactment, others would take effect January 1, 2022 and some could be retroactive to January 1, 2021. It is also possible that a portion of the legislation would be retroactive to September 13, 2021, the date the draft legislation was introduced. Below is a summary of the proposed changes that we believe are most relevant to our estate planning clients.

Reductions of the Estate, Gift and GST Tax Exemptions

In 2017, the exemption applicable to the estate, gift and generation skipping transfer (GST) tax increased from $5 million, indexed for inflation, to $10 million, indexed for inflation ($11.7 million per person for 2021). While the increased exemption amount is slated to sunset after December 31, 2025, the current proposal would revert the lifetime exemption amount back to $5 million, indexed for inflation, beginning on January 1, 2022 (approximately $6,000,000 per person).

These proposed changes provide a limited window for individuals to make full use of their $11,700,000 exemption.

Effective Elimination of Grantor Trusts

Under the current law, a settlor can establish a so-called “grantor trust,” which is structured such that the assets transferred to the trust are removed from the settlor’s taxable estate, while the settlor remains personally liable for income taxes on income earned within the trust and capital gains. This structure removes future appreciation of assets transferred to the trust from the grantor’s estate while also allowing the trust assets to grow unencumbered by income taxes.

The proposed legislation provides that grantor trusts created on or after the date of enactment would be included in the settlor’s taxable estate. Fortunately, grantor trusts existing prior to the date of enactment would be grandfathered under the proposed rules. However, the portion of the pre-existing trust attributable to any gifts made after the legislation’s enactment date would be included in the settlor’s estate. In addition, under the proposed legislation, sales between grantor trusts and the trust’s settlor would no longer be disregarded for income tax purposes.

If enacted, the new legislation would largely eliminate the benefits of common estate planning techniques and vehicles such as sales to grantor trusts, spousal lifetime access trusts (SLATs), qualified personal residence trusts (QPRTs), and grantor retained annuity trusts (GRATs).

Irrevocable life insurance trusts (ILITs) are also a commonly used estate planning vehicle and are typically structured as grantor trusts. Life insurance policies are purchased by or transferred into the ILIT and annual gifts are made by the settlor to the ILIT to pay the life insurance premiums. Under the proposed legislation, sales of life insurance policies would trigger capital gains and future gifts to the ILIT to pay the life insurance premiums would trigger inclusion of a portion of an existing ILIT in the settlor’s estate. To avoid inclusion in the settlor’s estate, the settlor may wish to pre-fund their ILIT with multiple years’ worth of life insurance premiums before the new legislation is enacted.

Since grantor trusts are the most common form of irrevocable trusts, we will need to determine the best course of action for each client moving forward.

Changes to Valuation Discounts

The proposed legislation would eliminate the valuation discounts currently allowed for the transfers of minority interests in LLCs and partnerships which own non-business assets, including, but not limited to, publicly traded securities, bonds, cash or debt instruments.

Changes to Income Tax Rules

• The proposed legislation would increase the top marginal income tax rate for trusts and estates to 39.6% for taxable income in excess of $12,500.
• The top capital gains rate would be increased to 25%.
• A new surcharge of 3% for trusts and estates with a modified adjusted gross income over $100,000 would be imposed.
• The 3.8% net investments income tax (NIIT) would be expanded to apply to net investment income in excess of $13,450 derived in the ordinary course of business or the disposition of property earned outside of a passive activity.

Conclusion

The proposed legislation would significantly limit certain estate planning opportunities currently available to high-net worth individuals. We encourage clients who have estate plans incorporating grantor trusts, GRATs and life insurance trusts in particular, or who wish to take advantage of the gifting opportunities under the current law, to get in touch with the attorney they are regularly in contact with, or one of the attorneys in our Trust and Estate Planning Practice Group.