There’s been a lot of coverage of President Joe Biden’s proposed changes to the tax laws, including reducing the federal estate tax exemption and eliminating the step-up income tax basis rules. But recently, some senators have come out with bills that seek to make drastic changes to the tax laws, including the estate tax. Reviewing some of these potential tax law changes can help practitioners better equip their clients with planning strategies to consider now and before the end of 2021 Here’s a brief review.
For the 99.5 Percent Act
U.S. Sen. Bernie Sanders introduced an 18-page bill called the “For the 99.5 Percent Act.” It includes federal estate tax rate increases to 45% for estates over $3.5 million with further increased rates up to 65% for estates over $1 billion. The basic exclusion amount will be a $3.5 million estate tax exemption and a $1 million lifetime exemption for gifts. These proposals, if enacted, would become effective for individuals dying after Dec. 31, 2021. This includes any transfers that apply to descendants who are two or more generations below the transferor, known as generation-skipping transfers (GSTs).
Part of this bill includes several pages of valuation discount limitations for minority interest holdings on nonbusiness entities. The language is complex and detailed, and exceptions are included. These amendments would apply for any transfer activity after the date of enactment of this proposed bill. Thus, different measures of this bill have different timing effectiveness if passed.
Grantor retained annuity trusts (GRATs) will have required 10-year minimum terms. Also, the term of a GRAT can’t exceed more than 10 years beyond the life expectancy of the grantor. Certain minimum remainder amount thresholds must apply. Therefore, the so-called zeroed-out GRAT (this is a trust in which the grantor’s payments are calculated to compute a zero or near zero remainder value based on the current monthly applied interest rate known as the Internal Revenue Code Section 7520 rate) appears to be specifically addressed to be eliminated. This measure will apply to transfers made after any date of enactment if this provision is passed.
The federal grantor income tax rules have several tax code sections in which the transferor of property who retains certain rights, powers, control, or beneficial enjoyment of those assets will be treated as the “owner” of that trust for income tax purposes. That means all income, gains/losses, deductions, and tax credits will be reportable to the grantor, and all income tax liability is the responsibility of that grantor. Estate and tax planners may intentionally create this situation to save estate and possibly income taxes for the family.
This doesn’t mean, in many situations, that the grantor is the owner for estate tax purposes, however. For example, the grantor may have made a completed gift of certain property and didn’t retain certain benefits or estate tax inclusion powers. This bill attempts to cause estate tax inclusion by virtue of holding certain grantor powers or causing gift tax implications if certain powers are “toggled” off prior to the grantor’s life. If these elements are enacted, the so-called intentionally defective grantor trust may not be a planning option in the future.
Trusts may use the GST tax exemption to provide benefits for many generations for long periods of time depending on state law allowances. This bill limits the GST tax exemption of a qualifying trust to a period not exceeding 50 years. The bill also states, “In the case of any trust created before the date of the enactment of this subsection, such trust shall be deemed to be a qualifying trust for a period of 50 years after the date of the enactment of this subsection.”
Currently, annual exclusion gifts of a present interest are permitted up to $15,000 per donee. A donor may make such gifts to an unlimited number of donees. This bill changes the amount to $10,000 and imposes a new annual limit on the donor not allowing annual exclusion gifts to exceed twice this amount in any one year. This provision would go into effect beginning Jan. 1, 2022, if this bill is enacted in 2021.
Ultra-Millionaire Tax Act
Sen. Elizabeth Warren’s Ultra-Millionaire Tax Act, generally, includes an annual 2% tax on wealth over $50 million with a 3% tax on wealth that exceeds $1 billion. Trusts that have “substantially the same beneficiaries” will be treated as a single applicable taxpayer. Interestingly, this bill states, “If a trust transfers property by gift or decantation to another trust in any calendar year after December 31, 2020, the transferor trust and the transferee trust shall be treated as a single applicable taxpayer for such calendar year.”
Sensible Taxation and Equity Promotion Act
Several senators, including Sen. Chris Van Hollen, have proposed the Sensible Taxation and Equity Promotion (STEP) Act. It would tax certain amounts of unrealized gains received by heirs when they receive assets at death. It provides for modification or the substantial elimination of the stepped-up basis rules. One million dollars of assets would continue to receive a stepped-up basis plus up to $500,000 for personal residences. The legislation allows taxpayers to pay the tax in installments over a 15-year period for capital gains that apply to any illiquid asset like a farm or business. Estates that incur estate tax will be allowed an offset deduction for income taxes paid.
Death Tax Repeal of 2021
Quite different from the several bills discussed above is the Death Tax Repeal of 2021 introduced by Sen. John Thune and others. As the name indicates, it’s tax legislation that proposes to eliminate federal estate taxes.
Tax Planning Actions to Take Now
Here are some planning strategies to discuss with your clients.
- Don’t wait until year’s end to complete annual exclusion gifting. Consider maximizing gift amounts before the law changes or the year comes to an end.
- Consider fully using most if not all of the client’s current lifetime gift exemption, including planning for future generations. Any reduction in transfer tax exemption won’t result in a recapture, clawback or takeback of completed gifts occurring before any possible tax law changes.
- Owners of closely held businesses who perform compensation-based services for their business may wish to consider an S corporation entity (if eligible to be an S corp) as the preferred choice of business entity. There may be the opportunity to reduce additional payroll Social Security tax if the Biden proposal on this matter is enacted.
- It appears revisions to GRAT structures will apply only to GRATs executed after the date of any enacted legislation.
- Some clients may be concerned with tax changes applying retroactively. Much of the proposed language for potential tax law changes appears to apply currently and prospectively and not retroactively—taking action may be better than waiting for actual tax law changes to occur.
- If your client plans to sell certain assets or business interests, the transaction may be optimal to close before year’s end or any tax law changes. If future long-term capital gains rates materially increase and/or a loss of some level of stepped-up basis on death, financial realization of appreciation now may lessen overall income tax impact.
- Owners of business activities and pass-throughs whose income is in excess of $400,000 may want to work with tax advisors to determine if ownership among different owners/trusts may provide proactive opportunity to reduce exposure to possible reduction of any qualified business income deduction.
- For those clients with larger wealth potentially subject to any annual wealth tax, both gifting to family and charitable interests are two possible mechanisms to reduce tax exposure if such measure would be passed.
As part of the Wilmington Trust and M&T Emerald Advisory Services team, Director of Income Tax Planning Tom Kelley is responsible for developing customized and comprehensive wealth transfer and financial management plans for high-net-worth families and business owners throughout the United States.
Note that tax, estate planning, investing, and financial strategies require consideration for suitability of the individual, business, or investor, and there is no assurance that any strategy will be successful. Wilmington Trust is not authorized to and does not provide legal, accounting, or tax advice. Our advice and recommendations provided to you are illustrative only and subject to the opinions and advice of your own attorney, tax advisor, or other professional advisor.