If You are Wealthy or You Counsel High Net Worth Clients Be Aware of Pending Legislation

There is presently much talk in Congress regarding taxation affecting the wealthy. While nothing is certain at this time, if enacted, the U.S. House Committee on Ways and Means’ tax proposals would significantly impact estate planning for high net worth individuals. Gift, estate and GST exemption amounts would be decreased; grantor trusts would be subject to tax in the grantor’s estate and certain grantor trust benefits would be eliminated. In addition, valuation discounts for certain nonbusiness assets would be eliminated. This will not affect most individuals, but for the wealthy, it signals significant changes and planning opportunities.

Likely to be affected are: (i) a reduction in the federal estate and gift tax exemption and the generation-skipping transfer (“GST”) tax exemption amounts, effective as of January 1, 2022; (ii) the inclusion of any grantor trust created after the date of enactment in the estate of the donor, the taxation of distributions from such trusts which are traceable to contributions made after the date of enactment and the inclusion in the estate of the donor of a portion of such trusts attributable to contributions madeafter the date of enactment; and (iii) and the elimination of valuation discounts for certain nonbusiness assets, effective as of the date of enactment. This means that, for those affected, now is the time to discuss this with your estate planning team: attorney, financial advisor and CPA.

The effect on estate taxes, gift- and generation skipping tax exemptions

The House Committee Proposal proposed to reduce the federal estate and gift tax exemption amount and the GST tax exemption amount from $10 million, indexed for inflation (currently $11.7 million), to $5 million, indexed for inflation (estimated at $6.02 million in 2022). These reduced exemption amounts would affect gifts made on or after January 1, 2022, and the estates of individuals who die on or after January 1, 2022.

If you have substantial net worth you should consider making gifts now to take advantage of the current exemption amounts before they are repealed. You must gift the greatest amount allowed by current law or lose that exemption forever. The IRS has stated that gifts made during the time period when the higher exemption is in effect will be protected from federal estate and gift tax upon the death of the donor.

The House Committee Proposal includes proposals that would eliminate tax benefits of so-called “grantor trusts.”

Many types of trusts often used in estate planning are “grantor trusts,” including spousal lifetime access trusts (“SLATs”), irrevocable life insurance trusts (“ILITs”), grantor retained annuity trusts (“GRATs”), qualified personal residence trusts (“QPRTs”), and qualified terminable interest trusts (“QTIPs”) among others.

Under irrevocable grantor trusts the donor is deemed to be the owner of the trust for income tax purposes and therefore, pays the taxes on trust income. Currently, contributions to a grantor trust are considered to be completed gifts for gift tax purposes, requiring either use of a portion of the deemed owner’s remaining gift tax exemption, if any, or the payment of gift tax by the donor at the time of contribution. Most significantly, trust assets are not included in the donor’s taxable estate. Under current law, sales and other transactions between a grantor trust and its owner are not events under which gain is realized for income tax purposes.

Many of these benefits may erode under the proposed legislation, so although it is beyond the scope of this article to analyze the effects of these changes, they should be discussed with your estate planning team promptly before the proposed legislation is enacted. If you are considering making gifts in excess of $6.02 million, less the portion of your exemption amounts you have already used, you should consult your tax advisor and consider making those gifts as soon as possible.

The new legislation would eliminate valuation discounts on transfers of certain entities that hold “nonbusiness assets,” including cash, stocks, bonds and real property not used in an active trade or business. Family limited partnerships and other such non-business entities would be valued as though the transferor had transferred the asset directly to the transferee for full fair market value. The new legislation would include a see-through rule stating that assets held by a subsidiary entity would, after the date of enactment, be treated as owned directly by the parent entity if the parent entity owns 10% or more of the subsidiary entity Furthermore, these entities would no longer qualify for valuation discounts based on lack of marketability or control.

So if you are either wealthy yourself, or counsel clients with substantial net worth, now is definitely the time to be proactive in planning for the future.