The changes to tax laws proposed by President Joe Biden have been extensively covered, including reducing federal tax exemptions and repealing rules for increasing income tax. Recently, some senators have put out bills aimed at making drastic changes to tax laws, including the estate tax. Review some of these potential tax changes can Help practitioners better equip their clients with planning strategies to consider now and before the end of 2021. Here’s a quick look back.
For the 99.5 percent law
US Senator Bernie Sanders introduced an 18-page bill entitled “For the 99.5 Percent Act”. It includes an increase in the federal estate tax rate to 45% for land over $ 3.5 million and further increases in the estate tax rate to 65% for land over $ 1 billion. The base exclusion amount is an inheritance tax exemption of $ 3.5 million and a lifetime tax exemption of $ 1 million for gifts. If these proposals go into effect, they would take effect for those who die after December 31, 2021. This includes all transmissions that apply to offspring two or more generations below the transmitter, so-called generation skipping transmissions (GSTs).
Part of this invoice contains several pages of valuation discount restrictions for minority holdings in non-commercial companies. The language is complex and detailed, with exceptions. These changes would apply to any transfer activity after the entry into force of this bill. Therefore, different measures of this bill have different temporal effectiveness when they are adopted.
Annuity trusts (GRATs) retained by the grantor must have a minimum term of 10 years. In addition, the duration of a GRAT must not exceed the life expectancy of the grantor by more than 10 years. Certain minimum thresholds must apply to the remaining amount. Hence the so-called zeroed GRAT (this is a trust where the grantor’s payments are calculated to calculate a residual value of zero or near zero based on the current monthly applied interest rate, known as the Internal Revenue Code Section 7520 rate is known) specifically addressed in order to be eliminated. This action will apply to transfers made after an Effective Date when this provision is adopted.
The federal donor’s income tax rules contain several sections of tax numbers that treat the transferor who retains certain rights, powers, control or benefit from those assets as the “owner” of that trust for income tax purposes. This means that all income, gains / losses, deductions and tax credits must be reported to the grantor and all income tax liability is the responsibility of that grantor. Estate and tax planners can create this situation on purpose to save estate and possibly income taxes for the family.
However, in many situations this does not mean that the grantor is the owner for estate tax purposes. For example, the founder may have given away certain property entirely and not retained certain benefits or powers to include inheritance tax. This bill seeks to effect inheritance tax inclusion by retaining certain powers of the grantor or by having an impact on gift tax if certain powers are “turned off” before the life of the grantor. When these elements come into effect, the so-called intentionally flawed grantor trust may not be a planning option for the future.
Trusts can use the GST tax exemption to provide long-term benefits for many generations, subject to government allowances. This bill limits the GST tax exemption of a qualified trust to a maximum period of 50 years. The Bill also states: “In the case of a trust created prior to the effective date of this Subsection, that trust will be deemed to be a qualifying trust for a period of 50 years from the effective date of this Subsection.”
Currently, no annual present interest gifts are allowed up to $ 15,000 per recipient. One donor can give such gifts to an unlimited number of offenders. This bill changes the amount to $ 10,000 and sets a new annual limit on the donor that will not allow annual lockout gifts to exceed double that amount in any one year. This provision would come into force on January 1, 2022 when this bill comes into effect in 2021.
Ultra Millionaire Tax Act
Senator Elizabeth Warren’s Ultra Millionaire Tax Act generally provides a 2% annual tax on assets over $ 50 million and a 3% tax on assets over $ 1 billion. Trusts that have “essentially the same beneficiaries” are treated as a single applicable taxpayer. Interestingly, this bill states: “If a trust transfers property to another trust by donation or decantation in a calendar year after December 31, 2020, the Transferor Trust and the Transfer Trust will be treated as a single applicable taxpayer for that calendar year.”
Reasonable Taxes and Equity Promotion Act
Several Senators, including Senator Chris Van Hollen, have proposed the Reasonable Tax and Equity Promotion Act (STEP). It would tax certain amounts of unrealized gains that heirs would receive if they received assets at the time of death. It provides for a change or the substantial elimination of the stricter basic rules. A million dollar fortune would continue to grow, plus up to $ 500,000 for private homes. The legislation allows taxpayers to pay the tax in installments over a period of 15 years on capital gains applicable to illiquid assets such as a farm or business. Estates that are subject to estate tax are compensated for income taxes paid.
Abolition of the death tax by 2021
Quite different from the bills discussed above is the 2021 repeal of the death tax introduced by Senator John Thune and others. As the name suggests, it is tax legislation that is proposing to eliminate federal estate taxes.
Tax planning actions that need to be taken now
Here are some planning strategies you can discuss with your clients.
- Don’t wait until the end of the year to complete the annual exclusion gift. Consider maximizing Gift amounts before the law changes or the year ends.
- Consider taking full advantage of most, if not all, of the current customer lifetime gift waivers, including planning for future generations. A reduction in the transfer tax exemption will not result in any completed gifts being reclaimed, reclaimed, or withdrawn before possible changes to tax law are made.
- Related party owners providing compensation-based services to their business may wish to consider an S corporation entity (if eligible as an S corporation) as their preferred choice of business entity. There may be an opportunity to reduce the additional income tax on Social Security when the related Biden proposal goes into effect.
- It appears that changes to GRAT structures only apply to GRATs implemented after the effective date of laws.
- Some customers may be concerned about tax changes being applied retrospectively. Much of the suggested language for potential tax law changes appears to be current and prospective rather than retrospective. Taking action may be better than waiting for actual tax law changes.
- If your client plans to sell certain assets or business interests, the transaction may be optimal to close before year-end or tax changes. If future long-term capital gain rates increase significantly and / or some increased base is lost due to death, the financial realization of the increase in value can reduce the overall income tax impact.
- Business owners / passageways with incomes in excess of $ 400,000 may wish to work with tax advisors to determine whether inter-owner / trust ownership provides a proactive way to mitigate the risk of a potential reduction in a qualified business income deduction.
- For clients with greater wealth who may be subject to annual wealth tax, both family gifts and charitable causes are two possible mechanisms to reduce tax exposure if such a measure were passed.
As part of the Wilmington Trust and M&T Emerald Advisory Services team, Tom Kelley, Director of Income Tax Planning, is responsible for developing bespoke and comprehensive wealth transfer and financial management plans for wealthy families and business owners in the United States.
Note that tax, estate planning, investment, and finance strategies must take into account the suitability of the individual, company, or investor and there is no guarantee that any strategy will be successful. Wilmington Trust is not authorized to provide legal, accounting or tax advice. Our advice and recommendations are for illustrative purposes only and are based on the opinions and advice of your own lawyer, tax advisor, or other professional advisor.