The House Ways and Means Committee released tax proposals to raise revenue on September 13, 2021, which included notable changes to income tax and estate and gift tax. However, on October 28, and then again on November 3, the House Rules Committee released revised proposals after substantial congressional negotiations that surprised many estate planning advisors. The surprise centers around what is not included in the revisions. Although the following proposals are not included in the current version, the negotiations continue, and these provisions could resurface in the final version.
Estate, Gift and GSTT Exemption
The 2017 Tax and Jobs Act increased the base estate, gift and generation skipping transfer tax exemption amount from $5 million to $10 million, adjusted for inflation (currently $11.7 million), beginning in 2018, and such amount was scheduled to sunset, decreasing the exemption back to $5 million in 2026. The September proposal accelerated this sunset to the end of 2021, so the base exemption available to taxable gifts and estates would be $5 million ($6.2 million adjusted for inflation) beginning January 1, 2022. However, the revised proposals have eliminated this early sunset, so if enacted, the higher exemption would remain available through the previously scheduled sunset at the end of 2025.
Grantor Trust Planning
The September proposal included drastic changes to the grantor trust tax rules which would have eliminated or adversely impacted many wealth transfer planning strategies, including irrevocable life insurance trusts (ILITs), gifting trusts for spouses and descendants, and sales to grantor trusts. Grantor trusts allow the donor to continue to pay income tax on transferred assets, but those assets are deemed to be outside of the donor’s taxable estate allowing for appreciation to grow free of gift and estate tax. The effective date for the grantor trust revisions in the September proposal was the date of enactment, which could occur before year end. The new proposals do not include any changes to the grantor trust rules, therefore, if enacted, these planning strategies would still be available to transfer wealth to future generations with less tax.
Valuation Discounts
A popular planning strategy is to transfer assets, such as securities or real estate, to a family limited partnership or other entity, then gift or sell a fractional interest in the entity. The valuation on such fractional interest receives a significant valuation discount for minority interests or lack of marketability, thereby decreasing the gift amount or sale price. The September proposal included limitations on the use of these valuation discounts for gifts of nonbusiness assets held in an entity. The latest proposals, however, do not include these limitations on discounts.
Loss of Basis Step Up at Death
Currently, assets owned at death receive a step up in tax basis to fair market value, eliminating any accrued capital gains. President Biden has previously proposed elimination of this step up in basis, leaving the capital gains with the assets when inherited or triggering a taxable event upon death to realize the gains. Neither the September proposal nor the latest proposals include this loss of the step-up in basis at death, but it continues to be a topic for discussion as a possible proposal in the future.
What is included in the new proposals?
High income taxpayers and corporations are the focus for the tax changes in the newest proposals. A surcharge of 5% has been proposed for adjusted gross income (AGI) in excess of $10 million ($200,000 for trusts & estates) and an additional tax of 3% of AGI in excess of $25 million ($500,000 for trusts & estates). The new proposals include a 3.8% net investment income tax currently imposed on passive income to include active business income for taxpayers with income greater than $400,000/$500,000 (single/joint returns) and for trusts and estates. Also included is an exclusion of gains on the sale of qualified small business C-corporation stock for those with AGI of $400,000 or more.
As negotiations continue in Congress, the items to appear or reappear in future proposals are uncertain, although the discussions have circled around the provisions highlighted above, so it will not be surprising to see provisions that were eliminated in the newest proposals resurface in future versions of the new tax legislation. Now is the time to review your estate plan with your advisors to prevent missing good planning opportunities.