On September 15, 2021, the House Ways and Means Committee approved draft legislation that, among other things, would increase taxes for high-income individuals and make drastic changes to federal estate, gift, and generation skipping transfer tax laws.
Before the proposed legislation becomes law, the Senate Finance Committee will weigh in, and a bill must pass the House and Senate, and be signed by the President. While this seems like an uphill battle, many practitioners believe that something very similar to the proposed legislation will become law potentially as early as October.
Democrats plan to pass some form of the proposed legislation through the Budget Reconciliation Process. This means that the Republicans in the Senate cannot filibuster, effectively permitting the legislation to pass with the support of all but three Democrats in the House and all fifty Democrats in the senate (i.e., with no Republican support).
The proposed legislation makes changes to the corporate income tax rates, increases the highest individual income tax rate to 39.6%, increases the maximum capital gains rate to 25%, creates a new surcharge tax for high income individuals, creates new rules for “super” IRAs, and does much more. This blog post will concentrate of the changes most relevant to estate planning. Below is a summary of such changes:
Early “Sunset” of the Temporary Increase in the Basic Exclusion Amount
The Basic Exclusion Amount is currently $11.7 million per person and is set to reduce to half that amount (adjusted for inflation) in 2026. The proposed legislation accelerates the reduction to 2022, meaning the Basic Exclusion Amount will be approximately $6 million per person as of January 1, 2022. This creates a “use it before January 1, 2022, or lose it” landscape for the increased Basic Exclusion Amount. Due to the Anti-Claw back regulations promulgated by the IRS, gifting more than $6 million dollars (including prior taxable gifts) before the end of 2021 may significantly reduce estate tax exposure for wealthy individuals. To be clear, benefit is only obtained for the amount of cumulative gift in excess of $6 million, so this opportunity is only available for very wealthy individuals.
The Death of Intentionally Defective Grantor Trusts – INCLUDING Irrevocable Life Insurance Trusts
A current estate tax mitigation strategy is to transfer assets to an Intentionally Defective Grantor Trust (“IDGT”). This is a trust which is not includable in the Grantor’s estate for federal estate tax purposes yet is deemed to be owned by the Grantor for income tax purposes. The Grantor pays the tax on any income realized by the trust even though the income was retained in trust or distributed to other beneficiaries. The benefits of a IDGT include the following: (1) the individual income tax brackets are more favorable then the highly compressed trust income tax brackets, (2) the payment of tax by the Grantor is an additional “tax free” gift from the Grantor to the trust beneficiaries effectively reducing the Grantor’s taxable estate, and (3) certain sales and transfers which would normally trigger an income tax event do not because the Grantor and IDGT are considered to be the same taxpayer under the law.
The proposed legislation would add a new section to the Internal Revenue Code which:
• Pulls any assets held by an IDGT created after the date of enactment into the estate of the Grantor for federal estate tax purposes;
• Includes in the Grantor’s estate for federal estate tax purposes any portion of a Grandfathered IDGT*** attributed to contributions made after the effective date of enactment;
• Treats the Grantor as having gifted the assets of a IDGT to the beneficiaries if, during the Grantor’s lifetime, the trust’s grantor trust status is “toggled off”; and
• Treats any distribution from IDGT as a gift from the Grantor to the recipient, so long as:
(a) the Grantor is living at the time of distribution;
(b) the beneficiary is a person other than the Grantor or Grantor’s spouse, and
(c) the IDGT was created after the date of enactment.
In short, these changes render IDGTs created after the date of enactment useless and make post enactment contributions to Grandfathered IDGTs dangerous. The impact of this is huge. Both Grantor Retained Annuity Trusts (GRATs) and most Irrevocable Life Insurance Trusts (ILITs) are types of IDGTs. For clients with large estates who have already depleted their exemption through lifetime gifting, the opportunity to create a GRAT may soon be gone. In the case of ILITs:
• Some practitioners feel these changes make ILITs impossible, but we believe that ILITs will simply need to be structured differently going forward.
• If you have an existing ILIT, it needs to either be immediately funded fully (if possible) OR if that’s not possible, it needs to be reviewed immediately to see if changes are necessary to avoid estate tax inclusion via the new code section discussed above.
Sales Between Grantor Trust and Deemed Owner
The proposed legislation would add a new section to the Internal Revenue Code which disregards the treatment of a Grantor as deemed owner of an Irrevocable Grantor Trust for purposes of determining whether a transfer is a sale or exchange for income tax purposes.
The new provision would apply (1) to any Irrevocable Grantor Trust created after the date of enactment, and (2) to the portion of any Grandfathered Irrevocable Grantor Trust attributed to contributions made after the date of enactment. It does not apply to any revocable trusts.
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In closing, the proposed legislation that is the subject of this post has not yet become law. The final law, if any, may be different. However, many of the changes in the proposed legislation are effective as of the date of enactment and so immediate action is prudent for many high-net-worth individuals. If you would like to discuss your current estate plan or possible mitigation strategies, please do not hesitate to reach out to our Estate Planning Team at Steimle Birschbach, LLC.
***For purposes of this blog, a Grandfathered IDGT refers to an IDGIT that is created before the effective date of enactment of the legislation.
This blog post is provided for informational purposes only and by its very nature is general. It is not a treatise on the issue, nor does it discuss all considerations and aspects of the matter discussed. This information is not intended as legal advice and readers should discuss with their accountant, attorney, or tax professional before acting on any information contained herein.