ESTATE PLANNING ADVISORY

House Ways and Means Proposal

The House Ways and Means Committee recently proposed sweeping changes to the tax code that would significantly impair fundamental wealth transfer planning techniques. We recommend that you consider taking action now.

• Decreasing transfer tax exemption amounts: Under current law, the unified federal estate, gift and generation-skipping transfer tax exemption amount is $11.7 million and scheduled to decrease to $5 million, adjusted for inflation, on January 1, 2026. Under the proposal, the effective date of that decrease would be accelerated to January 1, 2022 and the inflation-adjusted exemption amount is expected to be approximately $6,020,000. Any excess exemption not used prior to January 1, 2022 will be lost.
• Eliminating the benefits of grantor trusts: The proposal would destroy the benefits of grantor trusts created after the effective date, such as life insurance trusts (ILITs), GRATs (grantor retained annuity trusts), QPRTs (qualified personal residence trusts) and SLATs (spousal lifetime access trusts), as well as seriously erode the benefits of grantor trusts established before the effective date.
  
  Under current law, a “grantor trust” is a trust where the creator of the trust (the “grantor”) is treated as the owner of the trust’s assets for income tax purposes. It is a useful estate planning tool because (i) trust assets and any appreciation thereon are not taxable in the grantor’s estate, (ii) trust assets grow income tax free since the grantor pays the income tax attributable to trust assets, (iii) the grantor’s payment of such income tax is not subject to gift tax, making it tantamount to tax-free giving, (iv) the grantor’s taxable estate is reduced by his payment of such income tax and (v) transactions between a grantor and his grantor trust are not realization events for income tax purposes.
  
  The proposal would alter the treatment of grantor trusts as follows:
  • Trust assets would be subject to estate tax at the grantor’s death.
  • A distribution to a beneficiary (other than to the grantor or the grantor’s spouse) during the grantor’s life would be treated as a gift from the grantor for gift tax purposes.
  • If the trust ceases being a grantor trust during the grantor’s life, this would be treated as a gift for gift tax purposes.
  • Transfers between a grantor and his irrevocable grantor trust would no longer be disregarded for income tax purposes. For example, a grantor’s sale of appreciated property to his trust, or a GRAT’s use of appreciated property to satisfy an annuity payment due the grantor, would result in capital gains to the grantor, and interest payments on a note due to a grantor from his trust would be taxable income to the grantor.

This new tax treatment of grantor trusts would apply to grantor trusts created after the date of enactment of the proposal, that is, the day the new law is signed by President Biden. Importantly, it would also apply to the portion of any trust created before the date of enactment that is attributable to a contribution made on or after the date of enactment. Accordingly, a transaction between a grantor and his grantor trust occurring after the date of enactment (such as, for example, a premium payment paid by the grantor on a life insurance policy owned by his ILIT), would cause the trust to be partially includable in the grantor’s estate. Even more worrisome, there have been unofficial indications that the effective date of the proposal would be retroactive to September 13, 2021, the date of introduction of the proposal rather than the date of enactment of the proposal.

• Eliminating valuation discounts: Under the proposal, valuation discounts for lack of control or lack of marketability would no longer be available when transferring a partial interest in a family-owned LLC (limited liability company) or FLP (family limited partnership) that does not engage in an active trade or business.

It is unclear which, if any, of these provisions will be enacted into law. What is clear is that, if enacted, the proposal will substantially increase the transfer tax burden on high-net-worth families and limit the tools we have used for decades to plan around it. By engaging in proactive planning now, however, you may still be able to take advantage of current law, which is considerably more favorable.

Please contact us if you wish to consider engaging in planning for these potential changes prior to the end of the year.