With democratic control of the White House and Congress, there has been much speculation about what President Biden's tax proposal will look like, as well as the likelihood that President Biden's tax plan will be turned into law. In April 2021, the Biden administration announced the American Families Plan, which proposed significant changes to tax law to increase taxes for both businesses and high net worth individuals and to devote more resources to IRS tax enforcement efforts to enhance. On May 28, 2021, the United States Department of the Treasury released a report entitled "General Explanation of the Fiscal 2022 Revenue Proposals" (commonly referred to as the Green Paper) that provided further details on tax law changes previously proposed in the American Family Plan. The purpose of this memorandum is to provide a brief overview of some of these proposed changes and to focus on how these potential changes may affect estate planning.
Recognition of long-term capital gains
Generally, applicable tax laws provide that the basis of the recipient's assets acquired upon death is the market value of those assets at the time of the death of the deceased. The recipient's basis of ownership acquired through a gift is the same as that of the giver at the time of the gift. There is no liquidation event when property is acquired in the event of death or by gift, unless and until that property is subsequently sold (and any gain would be determined based on the recipient's adjusted basis).
Under the current Green Paper proposal, capital gains will be realized when those gains exceed a foreclosure of US $ 1 million per person, in the transfer of valued assets in the event of death or through a gift, including transfers to and distributions from irrevocable trusts and partnerships. The proposal would include various exclusions and exceptions for certain family businesses.
In addition, unrealized appreciation gains will be recognized by a trust, partnership, or other non-corporation at the end of an applicable 90-year "trial period" if that property was not the subject of a recognition event during that trial period. The 90-year inspection period for properties begins on January 1, 1940 or the date of the original acquisition of the property, with the first possible recognition event taking place on December 31, 2030. realized gains in the event of death could be paid out over 15 years (unless the gains were derived from cash such as listed securities). There would be no recognition of profit for transfers to U.S. spouses or charities in the event of death. The Green Paper states that the above changes would take effect for property transferred by gift and property in the event of death of the deceased after December 31, 2021.
Potential transfer tax regulations and repercussions
It is noticeable that the Green Paper lacks any changes to the federal tax system for inheritance, gifts and generation skips (GST) proposed by President Biden during his campaign. Currently, state inheritance, gift, and GST tax exemptions are $ 10 million per person (inflation-indexed). After factoring in inflation in 2021, the exemption is $ 11.7 million per person (or $ 23.4 million for married couples). President Biden had proposed expanding the impact of transfer taxes through a combination of lowering the inheritance tax exemption from its current level to $ 3.5 million per person and increasing the inheritance tax rate from 40% to 45%. The lack of any proposed changes to the transmission control system does not currently mean that such changes will not be proposed by the Biden Administration at a later date.
Additional transfer tax proposals
In March of this year, legislators (but not the Biden administration) proposed additional bills for high net worth individuals, including the Ultra-Millionaire Tax Act, the For the 99.5% Act, and the Sensible Taxation and Equity Promotion (STEP) Act .
The Ultra-Millionaire Tax Act was introduced by Senator Elizabeth Warren on March 1, 2021 and would impose a 2% annual tax on the net worth of households and trusts worth over $ 50 million to $ 1 billion, plus an additional annual surcharge of 1% raise over $ 1 billion on households and trusts.
On March 25, 2021, Senator Bernie Sanders introduced the For the 99.5% Act, the most comprehensive of the proposed bills. The proposal includes the following changes that would affect estate planning: (i) reduce the inheritance tax allowance to $ 3.5 million and the gift tax allowance to $ 1 million; (ii) a graduated increase in inheritance tax rates between 45% and 65%; (iii) elimination of certain family-owned company discounts; (iv) requirement that Grantor Retained Annuity Trusts (GRATs) have a minimum term of 10 years and a minimum residual rate of US $ 500,000 or 25% of the amount deposited; (v) require GST exempt trusts to be liquidated after 50 years; and (vi) change the annual gift tax exclusion, which is currently $ 15,000 per person, to limit each donor to a cumulative annual gift tax exclusion of $ 30,000 regardless of the number of individuals for certain transfers. In addition, the For the 99.5% Act would have a material impact on grantor trusts, commonly used in estate planning, by requiring that (i) assets in a grantor trust be added to the estate of the grantor trust; (ii) treat distributions from a grantor trust as gifts from the grantor; and (iii) treat the entire trust as a gift from the grantor if the status of the grantor trust is "disabled" during the term of the grantor.
The STEP Act was introduced by Senator Chris Van Hollen on March 29, 2021. The STEP Act seeks to increase the base by treating property transferred by gift, trust, or death as sold at fair market value and by triggering immediate capital gains taxes. The exemption for such a win would be $ 1 million. In addition, all non-grantor trusts would have to pay taxes on unrealized gains every 21 years.
There have been some concerns among practitioners about the possible entry into force of new transfer tax laws. In the past, tax legislation was generally prospective. For example, many Green Paper proposals, if adopted, will come into force after December 31, 2021. However, there are some precedents that suggest that a new tax law could come into effect retrospectively. A retroactive date means that the date when the law was introduced, or earlier, could be the date when new transfer tax laws came into effect. For example, the proposed STEP Act discussed above would apply retrospectively from January 1, 2021. Most commentators believe a retrospective date is unlikely because taxpayers who make planning decisions based on applicable tax law are penalized and limited in scope for making such meaningful tax law changes retrospectively.
Expiry of the current increased transfer tax exemptions
Even if the above proposed changes to land transfer tax will not become part of a new tax law, the currently increased exemptions for inheritance, gift and GST tax will automatically expire at the end of 2025 and the exemptions will then revert to a basis of USD 5,000,000 per person (inflation-indexed). The indexed time off at this time (2026) is expected to be around $ 6,400,000 per person.
Given the uncertainty of the new tax laws, high net worth individuals with inheritance tax concerns should consider taking advantage of the currently tightened exemptions by implementing wealth transfer strategies such as the following:
Intentionally Defective Grantor Trust (IDGT). An IDGT is a type of irrevocable trust fund that takes advantage of the discrepancy between income tax and inheritance tax rules and allows you to transfer assets in trust during your lifetime for the benefit of your family, removing those assets from your taxable assets. An IDGT is structured so that the trust income is taxed as a "Grantor Trust" so that the income is taxed on you and not on the beneficiaries of the trust. This tax payment becomes a gift tax-free benefit for the beneficiaries, which further increases the final value of the transfer as your beneficiaries avoid income tax. This allows the trust's capital to grow with no income tax deduction, while your income tax payment further reduces the value of your taxable assets. The IDGT can be designed in such a way that the status “Grantor Trust” for income tax purposes can be switched off at any time, whereby the trust becomes an independent taxpayer for income tax purposes. Another benefit is that you can sell assets to the IDGT to freeze the value of those assets for inheritance tax purposes. The "freeze" occurs because after the assets are sold, any subsequent increase in the value of those assets escapes inheritance tax.
Spouse Lifetime Access Trust (SLAT). A SLAT is an irrevocable trust created by you for the benefit of your spouse, but the terms of the trust can also be designed to provide benefits for your children or other descendants during your spouse's lifetime. A SLAT is designed so that assets donated or sold to the trust cannot be included in your estate or that of your spouse for federal estate tax purposes. Because wealth is not taxable in the event of your death or the death of your spouse, the wealth that is passed on to your children or other descendants will be significantly higher as the wealth increases in value. A SLAT is almost always structured as an IDGT, so that the advantages of the “Grantor Trust” status can also be realized with a SLAT.
Grantor Retained Annuity Trust (GRAT). Given the historically low level of interest rates, a GRAT is particularly beneficial. A GRAT is an irrevocable trust that you create and fund with assets that are expected to increase in value over time. You have the right to receive an annuity from the GRAT for a period of years calculated by applying the IRS rate of return to the value of the assets transferred to the GRAT. At the end of the GRAT term, the remaining assets of the trust will pass to your family members or trusts in their favor. If the assets brought in exceed or generate the returns from the IRS, that growth or appreciation will be passed on to those family members or trusts tax-free.
Charitable Lead Annuity Trust (CLAT). If you have charitable inclinations, you should also consider a CLAT, which in current terms is cheap for reasons similar to those outlined above in relation to a GRAT. A CLAT is an irrevocable trust that you fund with assets that are expected to increase in value over time. A charity receives an annual pension from the CLAT, which is determined by applying the applicable IRS rate of return to the value of the assets transferred to the CLAT. In addition, you will receive an immediate donation deduction from income tax equal to the calculated value of the pension payments. At the end of the CLAT term, the remaining assets are transferred to your family members or trusts in your favor. If the property brought in appreciates at a rate that exceeds the applicable IRS rate of return, that growth or appreciation can be passed on to those family members (or trusts on their behalf) tax-free.
Annual gifts. You can make an annual tax-free gift of $ 15,000 per person (inflation indexed) that doesn't count towards your lifetime gift tax exclusion. Any amount you give over $ 15,000 annually will count towards your lifetime gift tax exclusion. If you are able and have adequate cash flow, consider giving gifts sooner rather than later to avoid future appreciation and future income from your estate.
These are just a few potential techniques to consider, but there may be other useful strategies that are applicable depending on your particular circumstances. While there are still a number of unknowns, it's important to plan and evaluate your options, especially while the land transfer tax exemptions remain at record levels. We cannot predict the actions of Congress, but there seems to be a dynamic in the Democratic Party to at least implement these changes.
© Polsinelli PC, Polsinelli LLP in CaliforniaNational Law Review, Volume XI, Number 207