- The tax plan proposed by the House Ways and Means committee to pay the $ 3.5 trillion infrastructure bill includes a number of significant changes to current estate planning opportunities. Taxpayers should consider taking advantage of current tax rules before the end of 2021
- Under the proposed plan, grantor trusts will be included in the grantor estate on death, distributions from grantor trusts will be subject to gift tax and sales between grantor and trust will be fully taxable.
- In addition, the lack of marketing and minority discounts will no longer be available for certain entities.
- The inheritance and gift tax exemption will also be halved, from $ 11.7 million to $ 5.85 million ($ 5 million indexed to inflation).
The House Ways and Means Committee has proposed a tax plan to fund President Joe Biden’s $ 3.5 trillion “Build Back Better” infrastructure program. Of the many changes in this proposed tax plan, three will have a significant impact on estate planning opportunities: 1) changes to the settlor’s trust rules, 2) the elimination of valuation discounts for interests in passive entities , and 3) reduction of the gift and inheritance tax. exemption. These potential changes could make year-end planning especially important this year.
Transferor trusts, where income is taxed to the transferor rather than the trust, have been an important estate planning tool as the tax brackets for trusts have become more compressed than those for individuals. Additionally, the grantor’s trust rules allow the grantor to retain some control over an irrevocable trust, such as the carefully limited ability to alter the assets and beneficiaries of the trust. Under the current rules, there are several commonly used estate planning structures that rely on the transferor trust rules, including Transferor Retained Annuity Trusts (FREEs), Spousal Life Access Trusts (SLATs). ), Intentionally Defective Transferor Trusts (IDGTs) and Irrevocable Life Insurance Trusts. (ILIT).
FREEs are used to transfer valued assets without incurring gift and inheritance taxes. Under a typical FREE, the settlor will receive an annuity for a period of several years and the remainder will be distributed to an ongoing trust, usually for the benefit of the settlor’s descendants. Annuity payments are structured so that the value of the remainder is zero or close to zero, so the initial transfer to the trust is not taxable. While the annuity payments will be included in the settlor’s estate, the appreciation of assets over the life of the FREE will shift to the ongoing trust tax-free. With assets that appreciate quickly, this can result in the transfer of significant wealth without incurring gift tax.
A SLAT is used to provide support to the settlor’s spouse while moving donation assets out of the settlor’s estate. This is a good tool to remove the appreciation of assets from the settlor’s estate while still allowing the settlor’s spouse to benefit from those assets. Distributions from the SLAT to the spouse will be included in the estate of the spouse, but the remaining assets will not be included in the estate of either spouse.
IDGTs are a similar concept to SLATs, except that they completely remove all assets from settlor and spouse estates. This is because IDGTs are for the benefit of someone other than the principal or the principal’s spouse, so that the distributions of the IDGT are not included in any estate. IDGTs are attractive for two reasons. First, the settlor can continue to pay income tax to the IDGT, allowing the assets of the trust to grow tax-free without additional taxable donations from the settlor. Second, the settlor can sell assets to the IDGT without any tax consequences, thereby freezing the value of the assets transferred to the settlor’s estate and transferring the appreciation of those assets to the IDGT.
ILITs are used to provide life insurance to a tax-free beneficiary. The grantor may make annual contributions to ILIT to pay insurance premiums. The ILITs can take advantage of the annual exclusion so that these contributions do not entail any gift tax. By definition, ILITs are grantor trusts.
Although the assets of a grantor’s trust are deemed to belong to the grantor for federal income tax purposes, to date they have not necessarily been included in the grantor’s taxable domain for purposes of the grantor. federal inheritance tax, and this lag allowed taxpayers to engage in the planning techniques outlined above.
The Ways and Means Committee’s proposal would end this mismatch by treating all assets of any grantor trust as eligible for inclusion in the gross grantor estate for estate tax purposes. In addition, as proposed by the Ways and Means Committee, distributions from a grantor trust will be taxable gifts. Under current law, there is no taxable gift until the transferor trust is created and distributions are tax free. These changes would apply to trusts created after the promulgation date and to contributions to any trust if the contribution occurs after the promulgation date, even if the trust was created before the promulgation date.
Finally, sales between the trust and the settlor will be fully taxable and in-kind distributions will be treated as fulfillment events that trigger a capital gain. Currently, these sales are tax-exempt because the settlor and the trust are considered the same taxpayer, so the sale is a non-taxable event. Additionally, in-kind distributions are not a recognition event under current law. These two changes apply to all trusts, regardless of when they were created. The current wording of the bill provides that these changes apply only to trusts created after the effective date, but the Ways and Means Committee has clarified its intention to also cover trusts created before the effective date. in force, and it is likely that the change will be in a new version of the bill.
The Ways and Means Committee grantor’s estate inclusion rule would effectively end planning with SLATs and IDGTs. Since the rules apply to transfers made after the effective date, ILITs will also be problematic, as ILITs sometimes require ongoing contributions to the trust to facilitate the payment of insurance premiums. FREEs could be affected if the new rules treated distributions of in-kind assets to satisfy the annuity as a sale or trade for income tax purposes. In addition, the language of the proposal is so broad that it could create other unintended consequences for the CHARs.
Refusal of valuation haircuts for interests in passive entities
The Ways and Means Committee’s proposal also modifies the use of valuation haircuts for transfers of participation in passive entities. Under current law, lack of market value and minority interest discounts are appropriate when valuing private entities for gift and inheritance tax purposes. Under the new tax proposal, these common discounts are removed for entities that hold non-business assets. The definition of non-commercial assets appears to include securities and real estate, unless the donor or deceased has actively managed the real estate. These changes will apply to transfers made after the promulgation date.
Exemption from inheritance and gift tax
The current gift and inheritance tax exemption is $ 11.7 million per person, which makes the vast majority of estates exempt from inheritance tax. This amount is adjusted annually for inflation. Under current law, if Congress does nothing, the exemption will drop to $ 5 million per person, indexed to inflation ($ 5.85 million) in 2026. The Ways and Means Committee proposal of the House would accelerate this reversion, making it effective for the estates of deceased and deceased persons. donations made after December 31, 2021.
Any unused exemption greater than $ 5.85 million will be “lost” on January 1, 2022, so taxpayers should consider transferring as much of their exemption as possible before the end of the year.
The House Ways and Means Committee’s proposal could make many commonly used estate planning tools much less effective than they used to be. Of course, the Senate would have to amend this proposal, and the end result could be quite different. In addition, there is no guarantee that the legislation as a whole will be passed by the much divided Congress.
Given the uncertainty surrounding these proposals and the potentially short time frame to act, interested parties should consult with estate planning and tax advisors as soon as possible to determine whether action should be taken now. =