The House Ways and Means Committee released, and advanced out of committee, draft tax legislation addressing corporate, international and individual income tax changes. Changes are also proposed for gift and estate tax laws, and the taxation of trusts. These changes remain subject to revision as the legislation moves through the legislative process before a full vote.
There are several gift and estate tax provisions in the proposed legislation that would significantly impact both current structures and future planning. The proposed legislation contains some provisions that would take effect based upon the date of introduction (September 13, 2021), some that would take effect based upon the date of enactment, and some that would take effect on January 1, 2022.
Several key proposals that would affect the current gift and estate tax laws and the taxation of new and existing trusts are set out below:
- Early Elimination of Increased Exemption from Gift and Estate Tax and Generation-Skipping Transfer Tax Exemption – Effective Date January 1, 2022
The temporarily increased estate and gift tax exemption and generation-skipping transfer (“GST”) tax exemption (each currently $11.7 million) would be reduced by 50% for gifts made or deaths occurring on or after January 1, 2022, rather than the currently scheduled reduction date of January 1, 2026 under the Tax Cuts and Jobs Act of 2017. Under the proposed legislation, both the estate and gift tax exemption and the GST tax exemption would be reduced to $6.03 million beginning January 1, 2022. The proposed legislation would retain the current 40% estate, gift, or GST tax rate.
- Changes Affecting Grantor Trusts
An irrevocable grantor trust occurs when the grantor is treated as continuing to own the trust assets for income tax purposes even though the grantor is not treated as owning the trust assets for estate tax purposes. The taxation of any portion of an irrevocable grantor trust established after the date the legislation is enacted and of the portion of an irrevocable grantor trust established prior to enactment (which is attributable to a contribution made after the date of enactment), is subject to change, as follows, pending the passage of the legislation:
- Affected irrevocable grantor trusts will be included in the grantor’s estate at death based on the value of those assets on the date of death.
- A distribution from an affected irrevocable grantor trust during the grantor’s lifetime to anyone other than the grantor or the grantor’s spouse will be treated as a taxable gift from the grantor on the date of the distribution.
- If an affected irrevocable grantor trust ceases to be a grantor trust during the grantor’s lifetime, the assets of affected irrevocable grantor trust will be treated as if the grantor made a taxable gift of those assets on that date.
- Sale or exchange transactions between a grantor and an affected irrevocable grantor trust would no longer be disregarded for income tax purposes.
Irrevocable grantor trusts established prior to the enactment date and to which no further contributions are made after the date of enactment and non-grantor trusts would not be affected by these proposals.
These changes would impact not only the ability to create new irrevocable grantor trusts as effective estate tax planning structures, but may impact existing irrevocable grantor trusts that rely on additional contributions.
- Elimination of Valuation Discounts on Passive Assets – Effective on Enactment of Legislation
Valuation discounts for lack of control and lack of marketability typically associated with partial interests will be disallowed for the portion of closely-held entities made up of “non-business” assets. Non-business assets are defined generally as passive assets held for the production of income and not used in an active trade or business.
- Increased Income Tax Rates for Non-Grantor Trusts – Effective Date January 1, 2022
Non-grantor irrevocable trusts, which are separate income taxpayers whose income is not reported by the grantor, would be subject to the same increase in tax rates as individuals in the highest income tax bracket (from the current 37% to 39.6%). Trusts would reach the 39.6% bracket at approximately $12,500 and would be subject to a 3% “surcharge” on income in excess of $100,000. In contrast, this surcharge would only apply to individuals with income over $5 million. These rate increases would take effect beginning January 1, 2022.
- Limitations for Non-Grantor Trusts on Sale or Exchange of Qualified Small Business Stock – Effective Date September 13, 2021
Trusts would also be subject to limitations regarding the exclusion from gain on the sale or exchange of qualified small business stock for sales or exchanges occurring after the date on which the legislation was proposed, September 13, 2021.
If you currently have an irrevocable grantor trust in place (such as a life insurance trust or defective grantor trust, etc.), please contact us to discuss some strategies that may preserve – at least in part – the efficiency of those trusts.