30 September 2021

Tax Reform on the Horizon May Impact Estate Planning

Congress has been active this year in its efforts with tax reform.  This past spring, several key bills were proposed that impact the estate planning arena.  Two bills in particular—the Sensible Taxation and Equity Promotion (STEP) Act and the For the 99.5% Act—seek to, among other things, significantly reduce federal transfer tax exemptions, increase transfer tax rates, trigger gross estate inclusion with certain types of irrevocable trusts, and remove basis step up in assets at death.  As of the date of this alert, both of these bills are still progressing through the legislative process.

Continuing its efforts with tax reform, the House Ways and Means Committee recently released its draft of proposed legislative text to fund the $3.5 trillion Build Back Better Act (“the Act”).  The Act was published in bill number HR 5376 this week and includes many possible revisions to the Internal Revenue Code. The following summary focuses on the most important changes to the income and transfer tax rules which could impact your tax and estate planning objectives and possibly existing vehicles in place.

 Provisions Directly Impacting Estate Planning

  • Reduction of current $11.7 million per person estate tax exemption to an estate tax exemption of $6,020,000 per person on January 1, 2022.
  • Valuation discounts for lack of marketability and control, which are often used with transfer tax planning techniques, would no longer be available when determining the valuation of interests in non-business entities.
  • Loss of many of the benefits for irrevocable trusts which are treated as “grantor” trusts for tax purposes (e.g. the grantor is the deemed income tax owner of the trust), including:
    • Elimination of ability to exclude value of the trust from the grantor’s gross estate if the trust is created and funded after the date of enactment of the law.
    • Removal of existing estate tax protection of trusts, on a pro rata basis, if it receives a contribution after the date of enactment of the law (it is unclear what types of transfers are included in the term “contribution”).
    • Distributions from a grantor trust, other than distributions to the grantor or the grantor’s spouse, or to discharge a debt of the grantor will be treated as a taxable gift by the grantor, with certain adjustments for gift tax paid.
    • If the trust ceases to be a grantor trust during the grantor’s life, it will be treated as a gift by the grantor of all trust assets.
    • Sales between a grantor and the trust (normally non-recognition events if applicable rules are carried out properly) that are initiated after the date of enactment of the law could be treated as a taxable event if deemed to be a “transfer.”
    • Along those same lines, sales between a grantor and the trust, which are already in progress prior to the date of enactment of the law may also be impacted based on varying interpretation of the proposed legislative text.

Expected Changes Which Were Not Included in the Act

  • The maximum transfer tax rate remains at 40% percent.
  • The gift tax exemption remains unified with estate tax exemption.
  • Effective date rules for gift and estate exemptions are for transfers after December 31, 2021 (giving the balance of this year to utilize remaining exemption).
  • Annual gift tax exclusion remains same.
  • GST tax rules and the treatment of dynasty trusts remain same.
  • Basis step up rules remain same.
  • No capital gains tax at death of taxpayer or when a lifetime transfer is made.

Key action items to consider in anticipation of the Act becoming law include the following:

Action Items

  • Utilize remaining lifetime transfer tax exemption to complete gifts before year-end.
  • Reconsider planned contributions to existing grantor trusts to prevent an adverse consequence under the date of enactment deadline.
  • Reconsider planned “substitution” of assets between a grantor and an existing grantor trust, which may constitute a “contribution,” to prevent an adverse consequence under the date of enactment deadline.
  • Reconsider use of grantor trusts such as Spousal Lifetime Access Trust (SLATs), Irrevocable Life Insurance Trusts (ILITs), and Grantor Retained Annuity Trusts (GRATs).
  • Analyze existing SLATs and GRATs to determine whether certain provisions in the trusts, planned distributions, contributions, or transfer (e.g. a substitution of assets) associated with the trusts, or transactions contemplated with the trusts, should proceed, be halted, or modified in a certain way.
  • Halting, accelerating, or modifying sale to grantor trust transactions.
  • Analyze existing ILITS, which are utilized to own sizeable insurance policies and remove the death benefit from the grantor’s gross estate, to determine how best to fund future premium payments that will be due, without triggering a “contribution” after date of enactment. While the life insurance lobbying industry is expected to aggressively advocate for carve-outs to any new tax legislation, ILITs and the policies they own should still be reviewed now.

The Act is moving through the legislative process and will most likely change before the final bill becomes law.  Nonetheless, since the Act is the starting point for any final legislation, estate planning professionals and their clients alike have some sense of what may be expected as we approach the year-end.  There is still time to meet with your estate planning attorney and tax advisors to review your specific circumstances and consider available options before final legislation is enacted.