The House of Representatives Committee on Ways and Means recently proposed a new tax plan. The House budget reconciliation bill H.R. 5376 contains proposed changes that could be implemented at the start of 2022 or possibly earlier. There is heightened interest and concern about what might change and what can be done to plan for these changes. What follows is a description of some proposed tax changes. Nothing has been enacted as of yet.

Estate Tax Exclusion
Under present law there is a basic exclusion amount from estate, gift and generation skipping tax that is $11,700,000 per person. This very high threshold, although scheduled to expire in 2026, had led many to conclude that federal estate tax was no longer a significant factor in estate planning. The new proposal would reduce the exclusion amount effective January 1, 2022 (rather than 2026) from $11,700,000 to an estimated inflation adjusted amount of $6,020,000. By reducing the exclusion effectively by half, more taxpayers and estates will be subject to tax. For estates or cumulative gifts above the exclusion amount, estate tax is imposed at a rate of 40% on the amount in excess of the exclusion. Many are asking whether it would be wise planning – considering the tax implications – to use up the full higher exclusion of $11,700,000 by making large gifts in the current calendar year. Whether this makes personal sense from a non-tax point of view should be part of the considered equation. Obviously by making large gifts, there is a loss of control and ownership over significant funds and if all of the gift tax exclusion is used in the present year, no meaningful amount would be available for future gift and estate tax planning (the exclusion will most likely continue to be increased annually by an inflation adjustment).

Grantor Trusts
The use of certain types of “grantor trusts” – those grantor trusts that are outside of the grantor’s estate for gift and estate tax purposes, but which are treated as owned by the grantor for federal income tax purposes – has been an effective technique for augmenting an estate plan in a tax efficient manner. The new tax proposals make several important changes to the current grantor trust rules. Most notably, all assets in a grantor trust would be includable in a grantor’s gross estate for estate tax purposes, distributions from a grantor trust would be considered taxable gifts unless the distribution is made to the grantor’s spouse, and the sale or exchange of assets between the grantor and the trust would be treated as a taxable event.

The changes to the grantor trust rules would apply to grantor trusts created after the date of enactment, or with respect to any portion of the trust “which is attributable to a contribution made on or after such date.” Trusts created before enactment should maintain full grantor trust benefits so long as the trust is not modified after enactment and there are no contributions to the trust after enactment. Accordingly, in order to engage in grantor trust planning based on the current grantor trust rules, a grantor trust must be created and funded before the date of enactment of the proposed changes (and no contributions can be made to the trust after the date of enactment).

Special attention may be warranted for clients with existing grantor trusts to which additional gifts are planned in the future. This is a common situation for clients with existing irrevocable life insurance trusts, which often require ongoing contributions to the trust to facilitate payment of the insurance premiums. One option which clients in this situation might consider is to make additional contributions to a life insurance trust before the possible changes go into effect to “pre-fund” future insurance premiums. Another option may be to use the insurance policy’s cash value to pay premiums going forward.

Elimination of Value Discounts
Presently, a tax saving estate planning strategy is the transfer of interests in family limited partnerships or LLCs to family members at a value that is discounted for lack of marketability and lack of control. The new proposals would eliminate these discounts for lifetime transfers, or the valuation of an asset for federal estate tax purposes, after the date of enactment to the extent the entity owns nonbusiness assets. Nonbusiness assets are passive assets that are not used in the active conduct of a trade or business. If this is a concern, some might seek to accelerate transfers to take advantage of the value discounts.

Change in Tax Rates
There could be an additional 3% tax on individuals, trusts and estates with high earnings. For married taxpayers filing jointly the additional tax would be triggered above $5 million of modified adjusted gross income. The top marginal income tax rate would rise from 37% to 39.6%. The top rate for long term capital gains and qualified dividends would rise from 20% to 25%.

Retirement Plans
The new law would compel distributions from retirement accounts in excess of $10 million and prohibit some Roth IRA rollovers and conversions.

It is important to note that the Senate is expected to make significant adjustments to this proposal, so the actual proposed plan may look substantially different. In addition, as is the case with all legislation, there is no guarantee that the proposed legislation as a whole will be passed by the closely divided Congress. However, while none of the above is the law as of today, if these proposals were to become the law, there will most likely be only a brief window of opportunity to make adjustments before year end or the date of enactment.

Our Trusts and Estates Practice Group is very knowledgeable about the proposed tax amendments. Please contact any of our attorneys or our Practice Management Coordinator, Julie Martin at jmartin@sogtlaw.com or 215-887-0200, Ext. 1402.