On September 15, 2021, the House Ways and Means Committee passed a tax bill designed to raise revenue for President Biden’s “Build Back Better” plan. It contains significant changes to the estate and gift tax laws, and the income tax laws related to them. Of course, this is only another step down a very uncertain road. Only a “fortune teller” can tell whether a very narrow and divided Democratic majority in the House and Senate will pass anything, and if so, what the final legislation would look like. That said, the bill passed by the Ways and Means Committee, if it becomes law, also has some provisions which would take effect the day it is signed into law, which some speculate may be as early as next week, though that is highly unlikely.
The key changes made by the bill include:
- Reduction in Estate and Gift Tax Exemption Four Years Early. The estate tax/gift tax/Generation-Skipping Tax exemption, which currently is $11,700,000 per person (or $23,400,000 for a married couple) will be cut roughly in half, effective as of January 1, 2022. This is four years earlier than it is scheduled to do so under the “Tax Cuts and Jobs Act” of 2017. The 2022 exemption will be approximately $6,000,000 per person or a total of about $12 million per couple (and is adjusted for inflation in the future). Therefore, gifts to take advantage of the exemption amount above $6,000,000 and below $11,700,000 per person must be made on or before December 31, 2021.
- Loss of Minority/Lack of Marketability and Similar Valuation Discounts for Certain Entities. Valuation rules would be significantly altered, to eliminate valuation discounts for transfers of entities holding “nonbusiness assets.” Gifts (or the estate tax value) of these interests would be valued without the traditional “discounts” (valuation reductions) for lack of marketability, minority interests, and the like. There is a complex definition of what constitutes nonbusiness assets, but it would seem to capture all entities which primarily hold marketable securities, and in many cases would capture entities holding real estate unless the donor/decedent was actively involved in the management of the real estate. However, it appears that gifts of undivided interests in real estate not held in an entity are not covered by the bill. It remains to be seen whether Congress will close this “loophole” in the bill.
The effective date of this change is the date the bill becomes law. Thus, if a donor wishes to take advantage of the valuation adjustments, the gift will need to be made quickly, notwithstanding the fact that one has until the end of 2021 to make gifts to take advantage of the higher overall exemption amount.
- Prospective Effective Elimination of “Defective Grantor Trusts” and Similar Trusts. Another section of the bill would immediately eliminate the ability to create new irrevocable Grantor Trusts which are designed to be excluded from the donor’s estate, but still treated as if they belong to the donor for income tax purposes (so that the donor’s payment of the “trust’s income taxes” is not also an additional gift). The bill effectively eliminates the ability to create new grantor trusts by including them in the estate of the donor at death, and treating transfers out of those trusts to beneficiaries as additional gifts.
The bill allows existing defective grantor trusts to remain in existence but effectively bans future transfers to them by subjecting the portion of those trusts attributable to future transfers to estate tax at the donor’s death or gift tax upon distribution to beneficiaries. Further, sales to such trusts would trigger the capital gain in the sold assets as if it was a sale to a third party (which is not the case under current law).
In addition, there is already concern that this bill also inadvertently effectively bans other types of trusts used for estate and gift tax savings, including GRATs, QPRTs, and possibly even irrevocable life insurance trusts and certain charitable trusts used for tax planning purposes.
These changes apply to trusts created on or after the date of enactment and transfers on or after the date of enactment to pre-existing trusts. Existing trusts will be grandfathered as long as no further transfers are made to them. There may be a very short window of opportunity to capture significant future tax benefits, as it could be only a matter of weeks until a bill is signed into law. It may at this juncture be very difficult to plan a transaction to take advantage of these rules before a bill is enacted because of the planning and analysis each of these transactions require, much less drafting and signing new trusts, and transferring all assets to them before the bill is signed. If one wants to consider the creation and funding of a Grantor Trust, it must be addressed immediately.
- Other portions of the bill increase the top ordinary income tax rate for individuals and trusts to 39.6% and the capital gains rate is increased from 20% to 25%. There also is a new surcharge of 3% on modified adjusted gross income for taxpayers making over $5 million (for trusts, this limit is only $100,000). There also is a requirement that certain “high income” taxpayers withdraw half or all of the balance of IRAs or Roth IRAs to the extent the balances exceed $10,000,000, or in some cases, $20,000,000.
These changes can significantly impact one’s estate and gift tax planning. Because in many cases these proposed changes will have an effective date that could be sometime in October, concerns must be addressed immediately. Please contact us if you have any questions with regard to this, and wish to review your own individual circumstance.
MSK’s Tax, Trusts & Estates team: