Whole Lotta Congressional Tax Legislation Going On

President Biden took office advocating numerous tax law changes. Now that Democrats hold a slim margin in Congress, change is in the air, and several Democratic legislators have introduced bills focused on estate and gift taxes. These include the tax reform bill sponsored by Senators Bernie Sanders (D-VT) and Sheldon Whitehouse (D-RI), “For the 99.5% Act.” It has generated a lot of press coverage and caused ripples in the estate and tax planning world.

PRW’s Estate and Wealth Management Counsel, Janice Forgays, serves on the National Tax Committee of FINSECA, a financial services advocacy organization. In this message, Janice summarizes the various tax law changes offered in the “For the 99.5% Act” along with Senators Chris Van Hollen’s and Ron Wyden’s tax bills.

She provides her planning recommendations based upon the provisions in the bills and information shared with the Tax Committee by the FINSECA Congressional Lobbyist, Jeff Ricchetti.

It is extremely important to understand what has been proposed but perhaps more important to recognize that these proposals are not law and there are certainly no guarantees of passage even with presumptive Democratic control in Congress. Planners and clients are best served by not overreacting and making significant planning changes before we have a much better indication of where these proposals are headed. Here is a summary of the tax bills introduced so far:

For the 99.5% Act

1. The Gift, Estate and Generation Skipping Transfer Tax Exemption:The current gift, estate and generation skipping transfer tax (GST) exemption allows individuals to transfer up to $11.7 million ($23.4 million per married couple) of assets during life or at death without transfer taxes. This amount would be reduced to $3.5 million per individual ($7 million per married couple) for the estate tax (indexed for inflation) and for the GST (not indexed for inflation). Tax free gifting would be limited to $1 million (with no inflation indexing). This provision would be effective for gift, estate, and GST transfers made after December 31, 2021.This basically brings back the tax rates of 2009 and proposes a notable departure from our current unified gift and estate tax structure which provides a single gift and estate tax exemption amount. If passed, instead of the ability to remove $11.7 million from the taxable estate, individuals would be limited to $1 million of gifts during life and to $3.5 million of tax- free transfers at death. The result would be an increased exposure to the gift and estate tax and reduced inheritances due to higher transfer taxes. The FINSECA lobbyist believes that the Democrats will continue to pursue changes in the wealth transfer space this year. He believes that the lowering of the $11.7 million gift and estate tax exemption is considered by many in Congress to be “low hanging fruit.

   For planning, this approach has been dubbed, “use it or lose it.” Given the broad Democratic legislative support for a reduction in the transfer tax exemption, individuals who have not taken full advantage of the $11.7 million exemption and can afford to, may want to seriously consider gifting highly appreciating, low basis assets directly to family or to a trust for the benefit of family. Not only could this reduce future estate tax exposure, it could also avoid potential tax problems for beneficiaries who inherit assets at death. In addition to making direct gifts this year, if continued control over the assets is desired, gifting to a trust should be considered. The trust terms can be drafted to achieve specific goals plus the creator of the trust determines the trust’s Trustee. An added benefit is the creditor protection afforded certain trusts. Gifts to trust using the current lifetime exemption may be used as a source of funds to pay future premiums on a life insurance policy owned by the trust. A life insurance death benefit could significantly increase the return on the amount of the exemption used for premiums and provide an enhanced benefit for the family, a favorite charity, or both.

2. Gift, Estate and GST Tax Rate Increases:The current maximum gift, estate and GST tax rate is 40%. This Act proposes to increase the top rates to 45% for estates between $3.5 million and $10 million; 50% for estates of $10 million to $50 million; 55% for estates of $50 million to $1,000,000,000 and 65% for estates over $1,000,000,000. The effective date for this provision is January 1, 2022.These proposed tax rate increases further support the importance of exploring opportunities to reduce the taxable estate this year by making direct transfers, making transfers to trust, or making charitable gifts.
3. Grantor Trusts:Grantor trusts are irrevocable trusts used to remove assets from the taxable estate while the trust income is taxed to the Grantor at the Grantor’s income tax rate. Though the Grantor pays the income tax on trust income, Grantor trust assets are not included in the Grantor’s taxable estate. A popular planning technique using Grantor Trusts is treating transfers to the trust as sales. This eliminates exposure to both gift and income tax because sales by an individual to the same individual for income tax purposes (the Grantor) are not subject to transfer tax.This provision is intended to prevent wealthy families from avoiding gift taxes by using Grantor Trusts. It would require inclusion of all Grantor Trust assets in the Grantor’s taxable estate upon the Grantor’s death. It would eliminate the current step up in basis to fair market value on assets transferred at death unless the assets are taxed in the Grantor’s estate. Trust distributions made during the Grantor’s life would be considered taxable gifts made by the Grantor. Further, if an existing Grantor Trust is amended to eliminate its Grantor trust status, the assets in the trust will be taxed to the Grantor as gifts. This provision would be effective immediately upon the Act’s enactment.

   There has been a lot of commentary about this proposal by planners and others in the popular media. Many have expressed concern about the impact of the inclusion of all Grantor Trust assets in the Grantor’s taxable estate on trust-owned life insurance policies. What many commentators appear to have missed is that the planning impact might not be as great as they are touting. This is because gifts to the trust sheltered from tax using the annual gift tax exclusion or the lifetime exemption are exempted from the estate tax inclusion rule of this provision. In addition, there are alternatives to making annual gifts to trust for premiums or other uses. Transfers can be structured as loans from the Grantor or a split dollar life insurance plan could be adopted. Another alternative is to use LLCs or Partnerships instead of Grantor Trusts.

   This proposed provision further highlights the need to consider using the $11.7 individual or $23.4 million exemption for spouses to make transfers to a trust owning life insurance as a future funding source for premiums. This provides a double benefit because it may also reduce the taxable estate.

4. Asset Valuation Discounts:The Act would impose new rules aimed at minimizing the use of asset discount planning to reduce a business’s value in the owner’s estate. The use of valuation discounts, like lack of control and lack of marketability, would no longer be available for business-related transfers if any party to the transfer, including family members, control the business entity or are majority owners. Non-business asset transfers would be valued as a direct asset transfer to the recipient, regardless of how the asset is owned.
5. Grantor Retained Annuity Trusts (GRATs):GRATs are irrevocable trusts to which the Grantor transfers highly appreciating assets. The Grantor pays gift taxes based on the value of the assets transferred at the beginning of the trust term. The Grantor retains the right to receive a fixed income (an annuity) from the trust for a fixed period of years. At the end of the trust term, the remaining assets, including all appreciation, are transferred to the Grantor’s beneficiaries without additional transfer tax.This provision of the Act would prevent donors from avoiding gift taxes by taking assets back shortly after they are transferred to the GRAT while leaving GRAT assets plus appreciation to heirs tax-free. It does this by imposing a minimum 10-year trust term and a maximum of life expectancy of the annuitant plus 10 years. The remainder interest at the termination of the trust term must be equal to the greater of 25% of the fair market value of trust assets or $500,000.

   This provision would basically eliminate the use of GRATs in wealth transfer planning. It would apply to transfers made to existing and newly created GRATs after the enactment date of the Act.

6. Dynasty Trusts:Dynasty trusts have long been a staple of planning for high-net-worth clients. They allow for the avoidance of wealth transfer taxes over multiple generations. In fact, dynasty trust planning prompted the enactment of the GST tax rules. On his website, Senator Sanders specifically points to billionaires like Sheldon Adelson and the Walton Family who have “manipulated” trust rules to pass fortunes over multiple generations without paying estate or gift taxes. The Act would impose a 50-year limit on the life of a Dynasty trust and tax distributions to a “skip” person (grandchild or a member of a lower generation) at the highest GST rate. This proposed rule would apply to all existing and newly created trusts. Alternative planning includes the use of LLCs or Partnerships in lieu of trusts. Before pursuing this alternative, however, individual state laws should be reviewed as a limited number of states do not allow for perpetual LLCs or Partnerships.
7. Gifts using the Annual Gift Tax ExclusionCurrently, an individual can gift up to $15,000 each year to each recipient with no limit on the number of recipients. The Act would limit the total amount of annual tax-free exclusion gifts to $30,000 per individual regardless of the number of recipients and eliminate use of the exclusion altogether where the recipient cannot immediately liquidate the gift. Crummey provisions are often used in trust planning to increase the number of annual exclusion gifts that can be made in each year. They give the trust beneficiaries a temporary right to withdraw the gift. Once the limited period lapses, the beneficiaries’ rights to withdraw are terminated and the trustee is free to use the amounts transferred to the trust. Crummey provisions are often used to transfer sufficient amounts to life insurance trusts to fund annual premiums. This provision would effectively eliminate the use of Crummey trust provisions which would limit the number of annual tax-free gifts to trust. This rule would apply to gifts made in the calendar year after enactment.As with Grantor trusts, alternatives to annual tax-free exclusion gifts include lifetime exemption gifts, donor loans and split dollar life insurance planning.

It is noticeable that the “For the 99.5% Act” does not propose a general elimination of the step up in basis to fair market value for assets transferred upon death, which is current law. Fear not, other legislators have introduced additional proposals. Senator Chris Van Hollen (D-MD) introduced the “STEP” Act (Sensible Taxation and Equity Promotion) that would impose a capital gains tax on assets transferred at death. Senator Ron Wyden (D-OR) introduced a bill that would impose a tax on all increases in asset values from year to year (essentially mark to market).

These additional tax proposals may appear somewhat arbitrary, but they are the result of a much broader plan to raise the capital gains tax rate to the level of ordinary income tax rates. Should these income tax rates be equalized without a tax event at death, the concern is that individuals would retain appreciated assets until death, where the basis step up would allow them to avoid tax on gain altogether. Without an elimination of the basis step up or an imposition of a capital gains tax at death, or the imposition of an annual mark to market gains tax, clients would continue to avoid tax on appreciated assets. With an equalization of the ordinary income and capital gains tax rates plus the enactment of even one of these appreciation recapture proposals, the planning advantage of holding appreciated assets until death is eliminated.

The message being sent by the introduction of these tax bills is clear. Certain members of Congress want to combat perceived rising economic inequality by substantially increasing the transfer tax burden on high-net- worth individuals and families by eliminating many common planning techniques. The strategies that are the subject of these bills are considered by some as “loopholes” which need to be plugged.

On Friday, May 28^th, President Biden released his 2022 proposed budget and the US Department of Treasury released the “Green Book” providing explanations for the budget proposals. The President’s budget is simply a “wish list” sent to Congress. Congress ultimately approves all federal funding. The $6 trillion budget reflects the President’s economic priorities. The proposals include funding to address climate change; promotion of clean energy technologies; billions for migrant children and teenagers at the southern boarder; support for the State Department and international programs to boost the reputation of the US in the world; funding to combat domestic terrorism and for the Justice Department’s Violence Against Women Act programs; support for high poverty schools; support for health policy initiatives; increased funding for the military; and billions to increase IRS enforcement activities.

This $6 trillion budget would be funded with tax increases on corporations and the wealthy. The $2 trillion corporate tax hike includes raising the current corporate tax rate of 21% to 28%. The top individual income tax rate would increase to 39.6% for married couples with more than $509,300 of income. The individual capital gains rate would also increase to 39.6% for taxpayers with income exceeding $1 million. The step up in basis on appreciated assets transferred at death would be eliminated, imposing a capital gains tax realization event.

What is likely to happen? It is, of course, impossible to predict. According to the FINSECA Congressional lobbyist, there is general bipartisan support for infrastructure bills, and this is where the immediate Congressional efforts are being spent. After that, he believes action will be taken to roll back the “giveaways” to the wealthy and businesses enacted in 2017 by the Tax Cuts and Jobs Act. This means increases in individual and corporate tax rates and a reduction in the estate tax exemption.

Before becoming law, all proposed bills must pass both houses of Congress and be signed by the President. In the best of times, this is a lengthy process. Challenges to passage include the lack of bipartisan support and the very narrow Democratic majority. Planning challenges include the possibility that one or more of these tax proposals may be applied retroactively, possibly even back to January 1^st of this year. Retroactive application is not popular and has not occurred often, but it has happened in the past. As noted in this article, should some of these proposals become law, there are various planning strategies available to minimize the impact on current and future planning.

Now is a great time to have conversations with your advisors about the possible impact of these proposed changes on your personal and business planning and to discuss your options moving forward. Working in concert with your other advisors, your PRW Team is waiting to help you assess your planning challenges and explore your opportunities. Proper planning now may have a lasting impact on you and your family far into the future.