Though there are likely changes to come before any final bill is passed, taxpayers should be proactive in reaching out to their tax advisors and estate attorneys to discuss their options and consider taking advantage of the current favorable planning opportunities available to them. Though the eventual outcome is hard to determine at this stage, having an open conversation now and keeping your planning fluid will help eliminate a last-minute push to cram in some changes at year end. Please note the implementation date varies amongst the various proposals and have been noted below.
The 2017 Tax Cuts and Jobs Act (TCJA) temporarily increased the lifetime exclusion amount from $5 million to $10 million, adjusted for inflation, and it is scheduled to sunset on December 31, 2025. The current gift and estate exemption amount for tax year 2021 is $11,700,000. The proposed legislation aims to move up the current sunset date to December 31, 2021, and to revert to the pre-2018 level of $5 million adjusted for inflation (which would be approximately $7 million).
For those taxpayers who have maximized their exemption or have made gifts in excess of $7,000,000, the Treasury Department and the IRS issued final regulations in November 2019 and released IR-2019-189 addressing the issue of a claw back. Taxpayers that take advantage of the current gift and estate tax exclusion amount will not be adversely impacted if such the amount is subsequently reduced; thus, they would utilize the greater of the exclusion amount applicable to gifts made during life or the exclusion amount applicable on their date of death.
Valuation discounts are a common planning technique to minimize the gift or estate tax associated with the transfer of an interest such as closely-held businesses or family limited partnerships. These discounts may be reduced or eliminated due to the proposed amendment to Section 2031 to prohibit a valuation discount for transfers of nonbusiness assets. In the case of a transfer of any interest in an entity other than an interest which is actively traded, the value of any nonbusiness assets held by the entity shall be determined as if the transferor had transferred such assets directly to the transferee and the nonbusiness assets shall not be taken into account in determining the value of the interest in the entity. This proposal would apply to transfers after the date of the enactment of the proposal.
Grantor trusts have been a useful tool to allow taxpayers to transfer assets out of their estate while retaining certain powers that subsequently treat the grantor as the owner for federal income tax purposes. The trust’s income is taxed to the grantor as if he or she received it directly and this allows the trust assets to continue to grow (outside of their estate) without being reduced by the annual tax liability. Another popular planning technique with grantor trusts is for the grantor to sell assets to the trust in return for a promissory note which does not trigger the recognition of a taxable gain or loss. However, under the proposed legislation, where a grantor is deemed to be the trust owner, these would now become taxable events. The grantor trust would be pulled into a decedent’s taxable estate and be subject to estate tax. Sales between a grantor trust and their deemed owner would be treated as a sale between the owner and a third party, resulting in a taxable transfer. These proposals would apply only to future trusts and to future transfers.
Section 2032A provides a special valuation tool to help certain farms and closely-held businesses value real property at its farm or business use value rather than its fair market value (FMV), which is generally higher. The value cannot be decreased from the FMV by more than $750,000, adjusted for inflation. The current decrease permitted for tax year 2021 is $1,190,000. From the numerous House proposals, this is one with a positive impact to estates. The proposed legislation would amend Section 2032A to increase the limit to $11,700,000 for the estate of decedents dying after December 31, 2021.
Trusts will want to keep a close eye on several other proposals that may impact the total tax liabilities they will incur. The increases reflected under Part 2 of the summary related to increase for High-Income Individuals also encompass trusts and estates.
Trusts are taxed at the highest ordinary rates once its taxable income is over $12,950. Significantly lower than individuals who are taxed at the highest ordinary rates when their taxable income is in excess of $622,051 (married filing joint or $518,401 for single filers). Proposals to increase the marginal income tax rate from 37% to 39.6%, and an increase in the rate of tax on long-term capital gain and qualified dividend income from 20% to 25%, retroactive to gain recognized after September 13, 2021, will have many trusts paying in larger tax bills at the end of the day. In addition to these higher rates, there is a proposal to have an additional surcharge of 3% of a trust’s modified adjusted gross income in excess of $100,000. Again, significantly lower than the 3% surcharge on an individual’s modified adjusted gross income in excess of $5 million.
The proposals also address an expansion of the net investment income tax to apply to net investment income derived in the ordinary course of a trade or business and imposing limitations on qualified business income deductions and business losses. These may result in more income being taxed and putting a larger tax burden on a trust.
The proposed capital gain increase would apply to long-term capital gains and qualified dividend income recognized after September 13, 2021. The other items would apply for tax years after 2021.