The two bills currently under review are commonly referred to as the “For the 99.5% Act,” introduced by Senators Sanders and Whitehouse, and the Sensible Taxation and Equity Promotion Act of 2021, or the STEP Act, introduced by Senator Van Hollen and others. Each bill proposes several technical changes to the Internal Revenue Code. The details of these suggestions are too extensive to be covered in this newsletter, but the following is a summary of what we believe to be more notable changes. Please note that these proposals are independent of and in addition to the “Made in America Tax Plan” recently outlined by the Biden government. This plan is primarily concerned with corporate tax and will not be discussed further in this newsletter.
Proposed changes affecting estate plans
Both the Sanders and Van Hollen bills propose changes to the federal tax law that not only disrupt existing estate plans, but could also significantly affect future estate planning. These changes, when they came into effect, would affect not only the amount of inheritance tax each US citizen can deduct (commonly referred to as “inheritance tax exemption”) and the applicable inheritance tax rates, but also the effectiveness of many common estate planning techniques.
Exemption from inheritance tax and tariffs
The Sanders Act calls for the inheritance tax exemption to be reduced to $ 3.5 million. This would reduce the tax exemption by more than $ 8 million (current tax exemption is $ 11.7 million). Additionally, Sanders’ bill would increase inheritance tax rates, creating a tiered range of rates with a top tax rate of 65%. The following example illustrates the effects of these changes:
The estate of a person who dies today and leaves behind a fortune valued at $ 11 million would not pay federal estate tax under applicable law (provided the person had not previously given taxable gifts). Under the changes proposed in Sanders’ Act, that person’s estate would pay approximately $ 4.7 million in federal estate tax unless the same person “inherited” an exemption from a previously deceased spouse or the estate was transferred in some way who qualifies for an estate tax deduction (e.g., to a surviving spouse or charity).
If a reduction in the allowance is decided, most families will need to reassess the impact of federal estate tax when making decisions about their estate plans.
In addition to changing the inheritance tax exemption, Sanders Act also proposes reducing the lifelong gift exemption to $ 1 million. Currently, the gift tax allowance is the same as the inheritance tax allowance, essentially allowing an individual to use all or part of the $ 11.7 million allowance on gifts made during lifetime rather than waiting to to use it in the event of death. Lifelong gift strategies can be an effective and efficient way to use the allowance if properly implemented with the right assets. This reduction in gift tax exemption would limit the effectiveness of many lifelong gift giving strategies.
Sanders’ Act would also restrict certain types of gifts eligible for annual gift tax exclusion (currently $ 15,000 per beneficiary) and limit any annual gift donor to a cumulative amount equal to twice the annual exclusion. This applies to gifts to irrevocable trusts or other asset transfers that cannot be liquidated immediately by the recipient. These changes could disrupt estate plans, which include a pattern of annual donation to trusts, particularly irrevocable life insurance trusts.
Get asset recognition in the event of death for specific trusts
According to the existing tax laws, assets that are included in the estate of a natural person for the purposes of federal inheritance tax receive a so-called “top-up” as a basis for income tax purposes. This means that the beneficiaries who inherit the property do not have to pay income tax on capital gains built into the property and a beneficiary’s base in the inherited property is adjusted for income tax purposes based on the market value at the time of death. This essentially means that there is no such capital gain at the time of death, so that the beneficiary only has to pay income tax on the profits that arise after the date of death.
Van Hollen’s law would cause the estate to recognize the gain on the property that perishes after death as if the property had been sold, making the gain subject to income tax at that time. The bill would also provide for a recognition of the gain on property transferred by gift for life (either direct or fiduciary) and would require certain trusts to periodically pay capital gains taxes on trust assets.
Other changes: Grantor Trusts, GRATs, evaluation rules, generation skipping transfers
The bills include a number of other changes to certain estate planning techniques, including Grantor Retained Annuity Trusts (GRATs), trusts often referred to as “Grantor Trusts”, and the rules for valuation of family businesses, LLCs and partnerships for gift and donation Inheritance tax purposes. The Sanders Bill also proposes changes to the application of the Generation Skipping Transfer (GST) tax exemption. It is not possible here to go into the details of these suggestions, but be aware that in many cases they can significantly affect the effectiveness of certain estate planning techniques.
When will these changes occur?
It is currently not known with certainty whether and when these changes can occur. None of these bills passed the Senate. It is possible that they will never pass, or that they will be changed before they are passed and entered into the House for scrutiny. It is important to note that certain changes are intended to apply retrospectively as of January 1, 2021. However, the proposed reduction in gift and inheritance tax exemptions, as currently formulated in the Sanders bill, would not apply until January 1, 2022. Should this bill finally come into effect on that date of entry into force in relation to these exemptions, it would provide an incentive to take advantage of the currently higher allowance through gifts before the end of this year (although, due to the Van Hollen bill, it may be best to Weigh carefully the nature of the assets used for these gifts so as not to transfer ownership with significant unrealized gain).
In addition, other proposals relating to Grantor Trusts, GRATs and Valuation Rules are being drafted which will take effect immediately upon entry into force and (in the case of certain proposals relating to Grantor Trusts) will “grandfather” trusts prior to the Effective Date. Accordingly, in some cases, individuals who could benefit from these estate planning arrangements may want to consider implementing them before enacting new legislation.
What you want to do
Given the number of proposed changes in the Sanders and Van Hollen bills and the uncertainty as to whether they will be passed with or without amendment, it is not possible to make a general statement about how individuals should respond to these proposals. Estate planning always requires an analysis of the individual situation and goals of each customer, but this is particularly true with regard to this draft law. It has different effects on each individual or family, depending on their wealth, the assets involved, and the extent to which a prior estate plan has been drawn up.