Potential changes might have big impact on estate taxes
On September 13, 2021, the House Ways & Means Committee released the draft of the tax portion of the Building Back Better Act. If enacted, the legislation would significantly change the tax treatment of trusts and estates.
Although the draft is extremely long and complex, precluding a completely comprehensive analysis here, three of the major provisions are as follows:
Accelerated Reduction of Lifetime Exemption Amount
The current estate and gift tax exemption is $11.7 million per taxpayer ($10 million adjusted annually for inflation since 2011). This high exemption amount is already scheduled to return to half that amount ($5 million adjusted annually for inflation since 2011, or roughly $6 million per taxpayer) on January 1, 2026. The proposed legislation would accelerate that reduction so as to occur on January 1, 2022. Thus, taxpayers wishing to take advantage of the enhanced exemption amounts will have until year-end to do so.
Significant Changes to the Grantor Trust Rules
Currently, there is a discrepancy in the rules for determining whether transfers to certain trusts are completed gifts for gift tax purposes and whether such a trust is a separate entity or, instead, the grantor is considered the owner of the trust for income tax purposes. As a result, taxpayers under current law can create a trust (often called an intentionally defective grantor trust) which is a grantor trust for income tax purposes but transfers to which are considered completed gifts for estate and gift tax purposes. This allows grantors to remove assets from their taxable estates while remaining personally liable for income tax associated with the trust assets (so the grantor’s estate is further depleted and the trust assets are not depleted as a result of income tax payments). Further, transactions between the grantor and the trust are not taxable events (because the grantor is treated as having engaged in a transaction with herself), which facilitates other planning techniques, such as sales transactions between the grantor and the trust.
The proposal would eliminate the benefit of grantor trusts by treating the grantor as the owner for estate tax purposes (resulting in inclusion in the grantor’s estate). It would also treat sales between the grantor and grantor trusts (other than revocable trusts) as taxable events. As currently written, the legislation will apply to grantor trusts established on or after the enactment date and to any portion of an existing trust attributable to post-enactment contributions (including contributions to existing life insurance trusts for the payment of premiums).
Elimination of Valuation Discounts
Currently, tax liability on transfers is based on the fair market value of the property transferred. When a gift of a minority or non-controlling interest in a private entity is made, the value of the gift can be discounted to account for lack of marketability and/or lack of control. The proposed legislation would eliminate valuation discounts for transfers of certain passive, non-business assets as of the date of enactment.
What Should You Do Now?
Although the proposals are subject to negotiations and thus may potentially change substantially, in light of the possibility that some provisions may go into effect very quickly, you should contact your estate planning team as soon as possible if: you have not used all of your lifetime exemption; you have or are considering creating a grantor trust (including a spousal lifetime access trust or SLAT, a life insurance trust, or a grantor retained annuity trust or GRAT); or you own a family LLC or limited partnership or other interest which holds non-business assets that could currently be gifted at a discount. Please contact your estate planning team with any questions.