On September 13, 2021, the U.S. House of Representatives Ways and Means Committee introduced a bill (the “Proposed Tax Act”) proposing changes which could significantly impact estate planning. Although the Proposed Tax Act is still awaiting a vote in the House, some of the changes summarized below may be effective as of the date of introduction (September 13, 2021), if the bill is signed into law. Other key provisions will either become effective the date on which the bill is signed into law by President Biden or on January 1, 2022. The key tax proposals that may affect estate plans are summarized below.
Reduction of Estate and Gift Tax Exemption
The estate and gift tax exemption may be reduced from $11,700,000 to $6,000,000 (figures to be adjusted for inflation), effective on January 1, 2022. In order to take advantage of part or all of the “disappearing exemption,” an individual would have to make a gift in excess of $6,000,0000, up to $11,700,000, and must do so prior to December 31, 2021, or to obtain the current benefits of gifting strategies utilizing Grantor Trusts (described below), by the date of enactment, which may be as soon as late October or early November.
Grantor Trust Reformation
The Proposed Tax Act will change “Grantor Trust” tax law, which has long been a useful estate planning technique for those with potentially taxable estates. The current Grantor Trust rules allow the taxpayer (i) to remove assets from his taxable estate by gifting assets to an irrevocable trust that may benefit a spouse during the taxpayer’s lifetime (Spousal Lifetime Access Trust or “SLAT”), (ii) to leverage the gift tax exemption and remove assets from his taxable estate while providing an income stream to the taxpayer (Grantor Retained Annuity Trust or “GRAT”), and (iii) to sell an asset to a Grantor Trust without triggering capital gains tax while removing the future appreciation of the asset from the taxpayer’s estate (sale to an Intentionally Defective Grantor Trust or “IDGT”). The Proposed Tax Act will significantly and negatively impact the benefit of these estate planning techniques by including Grantor Trusts in the taxpayer’s estate; by causing distributions from the trust, or turning off the trust’s “grantor trust status,” to be treated as taxable gifts (if done during the taxpayer’s lifetime); and by treating transactions between the taxpayer and his Grantor Trust to be recognized for income tax purposes, thus triggering immediate income tax consequences. Although not required to be structured as a Grantor Trust, many irrevocable trusts that own life insurance policies (“ILIT”) are structured as such. As stated above, because the Proposed Tax Act will cause Grantor Trusts to be included in the taxpayer’s estate, it is important to seek legal advice prior to making any new gifts to an ILIT. As proposed, the Grantor Trust law changes may take effect as soon as the bill is signed into law (which may be as early as late October or early November) and may not only be applicable to Grantor Trusts established after the effective date, but also to transfers made after the effective date to or from pre-existing Grantor Trusts. If your estate plan includes a Grantor Trust, such as a SLAT, ILIT, IDGT or GRAT, or you are interested in implementing these techniques before the effective date of the Grantor Trust law changes, you should seek legal counsel as soon as possible.
Elimination of the Valuation Discounts
The current tax law permits ownership interests in certain entities such as limited liability companies and limited partnerships that hold non-business assets to be valued at a “discount” for gift and estate tax purposes. Some of the discounts include a reduction for ownership of a minority interest and for lack of marketability of an ownership interest in the entity. The Proposed Tax Act will eliminate the valuation adjustments of ownership interest in entities that own “non-business” assets. Transfers of such interests will be valued as if the asset itself were transferred directly the to the individual.
Income Taxation for Individuals, Estates and Trusts
The Proposed Tax Act brings back the 39.6% tax rate that was eliminated by the 2017 Tax Act. Married couples filing jointly with taxable income over $450,000 ($400,000 for single taxpayers) will now be in the 39.6% income tax bracket. Non-grantor trusts will once again be taxed at 39.6% on income exceeding the $12,500 threshold. This change is anticipated to take effect on January 1, 2022. In addition to the 39.6% income tax rate, married couples filing jointly with a modified adjusted gross income over $5,000,000 and for trusts and estate income over $100,000, a 3% surcharge will be assessed on the income over such thresholds. This will be in addition to the 3.8% Affordable Care Act surcharge that is currently in effect. Another significant income tax proposal is an increase in the 20% capital gain tax rate to 25% for single taxpayers with taxable income over $400,000 and married taxpayers with taxable income over $450,000. The 25% capital gain tax rate will apply to non-grantor trusts with income over $12,500. As the Proposed Tax Act is currently drafted, this change will be effective September 13, 2021.
Changes in IRAs and Qualified Retirement Plans
The Proposed Tax Act will also change contribution and distribution rules for retirement plans for taxpayers with more than $10,000,000 in IRAs and qualified retirement plans, if the taxpayer’s AGI exceeds certain thresholds. For those taxpayers, in addition to the current required minimum distribution rules, an additional distribution must be taken of 50% on balances that exceed $10,000,000. Additional rules are proposed for those taxpayers with IRA and qualified retirement plans balances that exceed $20,000,000. Taxpayers with IRA’s valued in excess of $10,000,000 will no longer be able to contribute to a qualified retirement plan. Married taxpayers with taxable income in excess of $450,000 (or $400,000 if single) will no longer be able to convert their traditional IRAs to Roth IRAs effective January 1, 2022.
Please note that the above summary is in reference to the Proposed Tax Act introduced by the U.S. House of Representatives Ways and Means Committee, which has not yet been enacted into law. If you would like more information regarding your estate plan and how that may be impacted by the Proposed Tax Act or any other matters being considered by Congress, please do not hesitate to reach out to us. We also recommend that people seek legal counsel prior to taking any action given the fluid nature of these potential changes.
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