Proposed Tax Law Changes Impacting Estate Planning

I’m sure you all have heard about Biden’s current plans to increase taxes. This memo does not go into the significant proposed changes to income taxes (increased income tax for single and joint filers and an increase in capital gains tax rates). The following is a summary of most of the tax law changes impacting estate planning included in pending legislation (as released on 9/13/21 by the House Ways & Means Committee). Of course, we do not know if these proposals will become law. However, if you are concerned about them, please let us know and we can discuss how to plan around them.

Immediate Decrease in Lifetime Exclusion

Right now the lifetime estate and gift tax exclusion is $11,700,000 per person ($23,400,000 per married couple). That will keep being increased by a cost-of-living adjustment until 2025. Then, on January 1, 2026, the exclusion will drop to $5,000,000 per person subject to a cost-of-Iiving adjustment back to 2017. No one knows for sure what that number will be. A guess has been $6,400,000 per person.

Pending legislation would reduce the exclusion effective January 1, 2022, to $5,000,000 as adjusted by cost of living back to 2017 (a guess is that the figure will be about $6,000,000 per person).

What should you do if you think this will pass? Use all of your exclusion now in an intelligent, leveraged fashion. We can show you how to do this – transfer wealth to a trust for your heirs – while leaving you in effective control of the transferred assets.

In fact, if you set up the trust for your heirs under the laws of a state like Nevada, you can – in the future – become a beneficiary of that trust! IRS PLR 200944002.

Grantor Trusts

When the parents set up an irrevocable trust for their children for estate tax planning purposes, that trust is almost always a “grantor” trust. That means the trust is disregarded for income tax purposes.

Some people refer to these as “intentionally defective grantor trusts.” Another way of saying this is the parents are the “deemed owners” for income tax purposes, even though the trust’s assets are excluded from their taxable estate.

There are at least two big benefits to using these types of trusts.

  1. The parents pay tax on the income earned by the trusts. That increases the value of the assets owned by the children and reduces the parents’ taxable estate.
  2. Sales to these trusts do not create a taxable gain to the parents. So a sale for an installment note or for a private annuity is done without fear of creating a taxable gain for the parents.

There are many examples of grantor trusts in estate tax planning:

  • Irrevocable life insurance trusts (IUTs).
  • Grantor retained annuity trusts (GRATs).
  • Qualified personal residence t rusts (QPRTs).
  • Charitable lead annuity trusts (CLATs).
  • Qualified subchapter “S” trusts (QSSTs).
  • Spousal lifetime access trusts (SLATs).

The proposed legislation would attack grantor trusts in two ways.

Estate Tax Inclusion

The assets of a grantor trust will be included in the deemed owner’s estate. Also, grantor trust distributions will be treated as a gift from the parents (the deemed owners) unless the distributions are to (a) a spouse or (b) discharge a parent’s personal obligation. More bad news:

if grantor trust status ends during the parent’s lifetime, the assets are deemed gifted to the beneficiaries at that time. This change would be effective after the proposed legislation’s date of enactment.

This proposal would have massive impact on estate tax planning. It will eliminate the parent’s ability to pay income tax fortheir children. It will eliminate QPRTs (for homes) and GRATs (which we primarily use for “S” corporation stock). It may also eliminate QSSTs (to hold “S” corporation stock for beneficiaries) and Spousal Lifetime Access Trusts (“SLATs”). It will eliminate the current use of irrevocable trusts to hold life insurance policies (“IUTs”) (perhaps we will make more use of limited partnerships to own life insurance policies).

What should you do if you think this will pass? Set up and heavily fund (using your current lifetime exclusion) a grantor trust for the benefit of your children now, before this law would go into effect. You will then be able to use that trust for future estate tax planning.

Gain Recognized OnSale

Effective for sales to trusts created on or after enactment (or to any portion of a trust created before enactment due to a contribution made on or after enactment), all sales would be treated as taxable.

This would mean no more tax-free sales to grantor trusts (“IDITs”). As indicated above, if you are concerned that this will become law, you should create grantor trusts now before this becomes law with enough asset to make a 10% down payment on future purchases. If you have grantor trusts in existence, you should consider using up all or a portion of your remaining lifetime transfer tax exclusion to fund them with additional assets.

Valuation Rules for Nonbusiness (Passive) Assets

The proposed legislation would eliminate valuation discounts for interests in entities to the extent they contain passive assets. Happily, this will not apply to the extent that:

  • passive assets are needed as working capital for a closely held business; and
  • income producing real property is used in the active conduct of a real property trade or business in which the taxpayer materially participates.

This would be effective for transfers after enactment.

Discounts would continue to be available for transfers of a partial interest in real property.

Summary of the Proposed Tax Law Changes Impacting Estate Planning

In conclusion, this summary is intended to provide the key items to be on the lookout in the pending tax legislation. There are other proposals, of course. The key point is that, if you are concerned about tax law changes impacting your estate planning, we should discuss preventive planning now.

If you, or someone you know, wish to discuss what preventing planning options are available and make the most sense for you and your loved ones, please contact our office right away at (858) 461-6844 to schedule a consultation with me. Time is running out, priority given to current clients and once our schedule is full, we will close out this opportunity.

Kristina R. Hess, Esq.