President Biden and Democrats in Congress have been working on a $3.5 trillion spending and tax package, and the details are starting to be revealed. On September 15th, the House Ways and Means Committee voted to approve tax provisions to be included in the Build Back Better Act (BBBA). It is important to note that this is not a final piece of legislation and there are many steps remaining in the legislative process. We know that some change is certain and the time to consider the potential impact is now.
While the proposals are far-reaching and impact personal, corporate and estate tax provisions, below we’ve highlighted the proposed gift and estate tax changes that may impact your estate planning considerations.
Surcharge on High Income Individuals, Trusts, and Estates
Under current law, no surcharge taxation rules exist.
This provision would introduce a new 3% surcharge tax on taxpayers modified adjusted gross income (MAGI) above certain thresholds: $5,000,000 for taxpayers who file as single, head of household, or married filing jointly; $2,500,000 for a married individual filing separately; and $100,000 for trusts and estates.
Given the lower threshold for trusts and estate, trustees may need to consider making distributions to beneficiaries who would not be subject to the surcharge in order to lower the effective tax rate on the trust’s income if such distributions align with the terms of the trust and the intent of the settlor.
The amendments made by this section would apply to taxable years beginning after December 31, 2021.
Termination of Temporary Increase in Unified Credit
The 2017 Tax Cuts and Jobs Act (TCJA) temporarily doubled the gift, estate, and generation-skipping transfer (GST) tax exemption amounts from $5,000,000 to $10,000,000 per person, indexed for inflation ($11,700,000 in 2021). This temporary increase is scheduled to sunset or “expire” on December 31, 2025.
This provision would accelerate the original expiration date to December 31, 2021. This would give individuals until the end of the year to take advantage of the enhanced gift, estate and GST tax exemption of $11,700,000 per person. As proposed, if taxpayers don’t use the increased exemption prior to December 31, 2021, they will lose it. *It is important to note the proposed changes to the treatment of grantor trusts when choosing the recipient of your gift in this limited window.
In addition to making new gifts before the year end to utilize any available gift tax exclusion and GST tax exemption, individuals should also consider allocating some or all remaining GST tax exemption to any pre-existing trusts that are not currently exempt from GST tax.
Increase in Limitation of Estate Tax Valuation Reduction for Certain Real Property Used in Farming or Other Trades or Businesses
In general, the value of property included in a decedent’s estate for estate tax purposes is equal to its fair market value. The proposal increases the special valuation reduction available for qualified real property used in a family farm or family business. This reduction allows decedents who own real property used in a farm or business to value the property for estate tax purposes based on its actual use rather than fair market value.
This provision also increases the allowable valuation reduction from $750,000 to $11,700,000, indexed for inflation.
The provision would be effective for estates of decedents date of death after December 31, 2021.
Certain Tax Rules Applicable to Grantor Trusts
Under current law, if a grantor makes an irrevocable completed gift to a trust and retains certain benefits or powers over the trust, the trust is treated as a “grantor trust” for federal income tax purposes and all trust income is taxable to the grantor.1 Taxpayers do this to remove trust assets from their taxable estate, allowing them to appreciate for future generations, without being subjected to the trusts higher income tax rate.
If this provision is enacted, it may limit the benefit of using grantor trusts for estate planning purposes.
Grantor trusts that are currently funded or additional contributions made before the Date of Enactment, which could be prior to year-end, will be grandfathered in under the old rules and continue to be treated as completed irrevocable gifts outside of the grantor’s taxable estate.
The following proposals would ONLY apply to any newly created grantor trusts, or any additional contributions made to pre-existing grantor trusts on or after the Date of Enactment (note that the term “contribution” was not defined within the bill):
- Similar to a revocable trust, assets held in a grantor trust would be included in the grantor’s taxable estate.
- Distributions from grantor trusts (other than to the grantor or the grantor’s spouse) would be treated as gifts made by the grantor.
- If a grantor trust status ceases during the grantor’s life, the grantor is deemed to be making a taxable gift of the trust assets.
- Sales between a grantor and their grantor trust would no longer be disregarded for income tax purposes.
- A Grantor Retained Annuity Trust (GRAT) is a technique where the grantor transfers assets to a trust in exchange for a series of payments that are roughly equal to the value of the originally contributed property over two or more years. At the end of the term, if the assets have appreciated and the grantor survives the term, the appreciated value can pass to the estate tax free to the next generation. As the proposal is currently written, the use of a GRAT would offer almost no benefit. Any remaining value in a Grantor Retained Annuity Trust (GRAT) (or Qualified Personal Residence Trust (QPRT)) after the Date of Enactment will be considered a taxable gift at the end of the annuity term, basically negating the benefits of using the strategy. GRATs and QPRTs already in existence at the Date of Enactment will be grandfathered in.
- A Spousal Lifetime Access Trust (SLAT) is a common trust that names a spouse as a beneficiary (typically alongside descendants). SLATs may also be affected by these grantor trust changes. SLATs are typically grantor trusts because the grantor’s spouse is one of the beneficiaries (as the name implies). After the Date of Enactment, SLATs may potentially need to utilize an independent trustee to maintain non-grantor trust status or limit the percentage of trust income or principal which the spouse may receive annually.
- In addition, Irrevocable Life Insurance Trusts (ILITs) are typically grantor trusts because trust income may be used to pay insurance premiums. ILITs may need to prohibit use of income for the payment or premiums and ensure the terms will not deem the grantor the owner of the ILIT. For existing ILITs, consideration should be given to pre-funding the ILIT with enough principal to support the premium payments prior to the Date of Enactment and avoid estate inclusion or gift tax consequences associated with the ILIT in the future. If the grantor makes additional contributions to an ILIT to fund insurance premiums, these contributions may result in some portion of the trust, and possibly the insurance proceeds, being taxable alongside the rest of the grantor’s estate.
Individuals should consider establishing such new trusts or making contributions to pre-existing trusts prior to the Date of Enactment.
Valuation Rules for Certain Transfers of Nonbusiness Assets
This proposal would eliminate valuation discounts for transfer tax purposes for certain nonbusiness assets. Nonbusiness assets are passive assets that are held for the production of income and not used in the active conduct of a trade or business. Exceptions are provided for assets used in hedging transactions or as working capital of a business.
If the entity holds as a passive asset a 10% or greater interest in any other entity, the proposal includes a look-through rule treating the assets in that lower entity as being held directly by the top entity. This rule is applied successively to any 10% interest in another entity held by any lower tier entities.
The proposal would apply to transfers made on or after the Date of Enactment.
Final Estate Planning Considerations
With potential changes quickly approaching, it is important to consider accelerating discussions around your estate plan. If you intend to make use of your current $11,700,000 million estate, gift and generation-skipping transfer tax exemptions, gifts must be completed prior to January 1, 2022. If your intention is also to make gifts to trusts that qualify for grantor trust status, the gifts should be made before the Date of Enactment.
While there are many uncertainties, the NewEdge Wealth team can help you plan to minimize the effect of the proposed income tax surcharge, accelerated estate gift and GST exemption decrease, grantor trust, and valuation rules based on your unique circumstances.
1For purposes of this discussion, a grantor trust is one in which the taxpayer is the “deemed owner” for income tax purposes.
For this purpose, MAGI is defined as adjusted gross income (AGI) reduced by any deduction allowed for investment interest (as defined in section 163(d)).
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