Drastic proposed changes to our current estate and gift tax system may have a dramatic impact on wealth transfer planning. On March 25, 2021, Senator Bernie Sanders released his proposed estate and gift tax reform legislation, which includes lowering the federal estate tax exemption to $3.5 million and the federal gift tax exemption to $1 million. On March 29, 2021, several senators introduced a discussion draft of the Sensible Taxation and Equity Promotion (STEP) Act, which among other things would tax unrealized capital gains of assets transferred by gift or at death.
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- For the 99.5% Act
Sanders’ legislation, known as the “For the 99.5% Act,” reduces the $11.7 million estate tax exemption to $3.5 million ($7 million for a married couple) and the reduction of the gifting exemption to $1 million in 2022. Thankfully, the “portability allowance” will not be reduced under the proposal and so the unused estate tax exemption from a deceased spouse would still be available to the surviving spouse.
Reduction of the gift tax exemption from the current ($11.7 million) estate tax exemption amount to $1 million per person (with no inflation adjustment) will mean that an individual will only be able to gift the $15,000 annual exclusion amount per person, plus $1 million per person without paying gift tax.
Currently, the maximum federal estate and gift tax rate is 40%. However, the new legislation proposes to increase the rate to 45% once a deceased person’s estate exceeds the $3.5 million exemption, 50% for estates exceeding $10 million, 55% for estates exceeding $50 million, and 65% for estates exceeding $1 billion.
While these increased rates might benefit charities whose donors will be incentivized to give to them rather than to Uncle Sam, there certainly will be an unwanted impact on a person’s empire that took a lifetime to build and the current estate planning for the same.
- STEP Act
The Sensible Taxation and Equity Promotion (“STEP”) Act proposes eliminating the tax-free step-up in basis at death and taxing unrealized capital gains on death. The STEP Act does, however, include a $1 million exemption to protect smaller estates and up to 15 years to pay the tax for illiquid assets such as farms and businesses. This would be a major shift in federal tax policy and would have a wide-ranging impact on estate planning.
IMPACT ON PLANNING
If these proposed changes are made law, many mainstays of estate planning will be curtailed. The following are some of the planning strategies that will be impacted under the new rules:
- Valuation Discounts. Valuation discounts for lack of control and marketability used, for example, in family limited partnerships, will be eliminated or reduced for transfers of interests in such entities that are not conducting an active trade or business.
- Grantor Trusts. Grantor trusts considered to be owned by the grantor for income tax purposes will be treated as if the grantor owns the assets of the trust. Further, the proposed changes also provide that when the grantor of such a trust dies, there will not be a new fair market value income tax basis for the assets of the trust.
- GRATs and IDGTs. Grantor retained annuity trusts (GRATs) will be required to have a minimum 10 year term and a 25% minimum value for the remainder interest. Intentionally Defective Grantor Trusts (IDGTs) will, under the proposed legislation, be included in the grantor’s taxable estate and reduced only by the value of any gifts made to the trust. These changes remove the appeal of GRATs and IDGTs as the benefit of moving assets out of an estate would be gone.
- Generation Skipping Tax: The new legislation provides that allocation of the Generation Skipping Tax (GST) exemption would be effective for no more than 50 years, and that a qualifying trust would need to terminate within 50 years. This would constrain the use of dynasty trusts that are exempt from generation skipping taxes.
- Annual Gifting. Under the proposed legislation, the annual gifting exclusion amount of $15,000 per donee will be limited to $30,000 per donor in the case of a transfer in a trust and a transfer of an interest in a pass-through entity, among others.
Whether and in what form such proposed legislation will be passed is difficult to predict. However, the attorneys at Goosmann Law Firm will continue to monitor the proposed legislation as the situation progresses. In any event, reviewing current planning is a must, especially those families having assets expected to exceed $3.5 million per person and/or families whose existing plan implements advance wealth transfer strategies.
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