The following article appeared in the August 2021 issue of Legacy.
Changes to the federal tax laws could take place as early as January 1… ..2021. You read that right. There are currently three major proposals to amend the Federal Income and Transfer Tax Act, one of which would tax transfers retroactively as of January 1 of this year:
The For The 99.5 Percent Act, introduced by Senator Bernie Sanders, focuses on transfer taxes and would reduce the current tax exemptions for inheritance, endowments and cross-generational transfers (GST). Instead of the current combined gift and inheritance tax exemption of $ 11.7 million ($ 10 million, adjusted for inflation) along with an equal GST exemption, the inheritance and GST tax exemptions would increase to $ 3.5 million (not adjust) reduces inflation) and the gift tax exemption is further reduced to $ 1 million. Transfer tax rates would also be increased by replacing the current flat rate of 40% with a progressive tax system that would include rates between 45% and 65%. Other major changes would limit a donor’s ability to include haircuts when valuing certain assets; Restrict the use of GRATs (Grantor Retained Annuity Trusts); radical change in the treatment of grantor trusts (whose income is currently taxed directly to the donor and not to the trust during the donor’s lifetime); limit the ability to use generation skip planning; and significantly limit the options for giving annual gifts. The effective date of tariff and exemption changes would be January 1, 2022, but many of the other changes would take effect on the effective date.
The most notable change proposed by the Sensible Taxation and Equity Promotion (STEP) Act would remove the current step-up basis that would allow the recipient of an asset to use the fair market value of an asset from the date of the donor Death as the basis of wealth for income tax purposes. Instead, the STEP Act legislation would treat transfers of valued assets in the event of death as capital gains tax purposes and treat lifelong transfers to and from trusts in a similar manner as if they were sales subject to withholding tax (with certain exceptions, such as transfers to Spouse trusts or charities). The proposed effective date of this law is January 1, 2021. Thus, any transfer during that year prior to the effective date could be subject to these rules. A similar law introduced into the House of Representatives has a proposed effective date of January 1, 2022.
The Biden Administration’s American Families Plan (“Administrative Proposal”) tax proposals focus on the treatment of capital gains. In addition to increasing capital gains tax rates for individuals with adjusted gross income greater than $ 1 million, the “Greenbook” description of the administrative proposal includes changes similar to those proposed in the STEP Act. In some respects, however, these changes would be larger as they would treat transfers to not only trusts but also to partnerships and other non-corporate entities as sales. Apart from its proposals on tax rates, the administrative proposal would generally come into force on January 1, 2022.
The STEP Act and Administrative Proposal represent dramatic changes that would effectively create a new capital gains tax on the transfer of valued assets. However, neither the Administrative Proposal nor the STEP Act include changes to the current gift, inheritance, or GST tax exemptions or rates, or many of the other proposed changes to transfer tax contained in For The 99.5 Percent Act. Statements made in connection with the publication of the Administrative Proposal indicate that the von Biden government believes that the changes made by its proposal would be significant enough to result in changes to the property transfer tax regime such as those proposed in For The 99.5 Percent Act, not necessary or appropriate.
Any increase in the expected tax burden will affect future planning, but in particular the uniqueness of some of the current proposals could also significantly affect the treatment of previous asset transfers. This could include not only retrospective taxation of gift transactions completed prior to the Effective Date in 2021, as proposed in the STEP Act, but also the possible imposition of capital gains tax on trusts (and in the case of the management proposal, partnerships and other partnerships), those for at least 21 years (in the case of the STEP Act) or in the case of the administrative proposal). Such an application could have far-reaching implications for trusts and other institutions established many decades ago (as the trial period in the case of the management proposal is part of a long-term gift program.
Unlike many previous legislative changes in this area, the bill will not only affect planning for very wealthy clients. These changes could result in taxes being imposed on clients across the wealth spectrum and affect lifelong gifts and estate planning.
Many customers are currently interested in donations and / or setting up family foundations for various reasons. Specifically, many customers are considering such a plan in order to transfer their assets to their family members at a lower tax rate – for example through gifts that are intended to “hold” the currently high allowances before they are reduced (which will take place on January 1, 2026 without the passing of new laws). However, Congress is only now beginning to consider the budget proposals that would include these tax changes, and that process is likely to extend into the fall. Given the uncertainty surrounding final legislation, as well as the unique nature of each individual’s estate plan, there is no one-size-fits-all solution to avoiding the potential impact of the proposed tax legislation.