Last year, we published a newsletter commenting on possible estate planning changes that might result from the 2020 elections. See our August 2020 newsletter, “Pandemic and 2020 Election Estate Planning: Frequently Asked Questions.” On March 25, 2021, Senator Bernie Sanders (VT) and Representative Jimmy Gomez (CA) introduced the “For the 99.5% Act.” If enacted, the law will dramatically change estate planning by reducing the federal estate and gift tax credits, increasing estate, gift, and generation-skipping transfer (“GST”) tax rates, and including certain assets that are not now includable in an individual’s taxable estate, among other changes. Additionally, on March 29, 2021, senators Chris Van Hollen (MD), Cory Booker (NJ), and others introduced the “Sensible Taxation and Equity Promotion (STEP) Act.” Among other things, the STEP Act proposes the taxation of unrealized gains of certain assets on transfers by gift, in trust, or at death, and changes to the taxation of assets held in trust. Lastly, the Biden administration has proposed significant changes to income tax laws, including higher taxes on investment income and new capital gains taxes at death.
This newsletter provides a summary of current law and proposed changes, with some comments and considerations. In the conclusion, we also list some actions to consider taking before any new federal law affecting estate and tax planning is enacted or goes into effect.
The For the 99.5% Act (the “Act”)
- Tax Rates and Exemptions
- Current law: The maximum federal rate for estate and gift taxes is 40%, and the exemption per individual is $11.7M. As a result, married couples are able to shield up to $23.4M in assets from the federal estate tax through the lifetime exemption.
- Proposed changes: The Act proposes a gift tax exemption of $1M, and an estate tax exemption of $3.5M, thereby drastically reducing the amount an individual and a married couple can give away. Moreover, tax rates would be increased to progressively higher levels from between 45% for estates under $10M to 65% for estates over $1B.
- Comment: These changes would have a huge impact on not only wealthy couples but also couples and individuals whose net worth is currently under the exemption amount. A hypothetical couple with a net worth of $20M who would have no tax liability under current federal estate tax laws, could owe $6.35M in taxes upon the death of the second of them to die.
- Annual Exclusion Gifts
- Current law: Individuals may make unlimited $15,000 annual gifts (per recipient), and these gifts do not count against the lifetime exemption. There is no limit on the number of gifts a donor can make, and no limit on the number of gifts a recipient can receive.
- Proposed changes: The Act would impose a limit on annual gifts to double the annual exclusion with respect to any transfer to a trust, transfer of an interest in a pass-through entity, transfer of an interest subject to a prohibition on sale, or any other transfer of property that cannot be immediately liquidated.
- Comment: Making annual exclusion gifts is a popular approach to reducing an individual’s estate. The Act’s reduction to available annual exclusion gifts would have far-reaching implications for estate planning techniques. It would be particularly problematic for transfers to trusts and certain family entities, and for life insurance trusts funded with annual gifts. Individuals with life insurance policies that are currently funded by making annual exclusion gifts may consider paying the policies in full in 2021.
- Valuation discounts
- Current law: The value of one’s assets may be discounted for estate and gift purposes due to factors like lack of marketability and lack of control.
- Proposed changes:
- Discounts would be limited to assets used in an active trade or business. “Non-business assets” would receive no discount; and
- Transfers of minority interests would be limited where majority family members retain ownership.
- Comment: The proposed changes represent a significant departure from the current ability to transfer business interests, particularly for family businesses that are to be transferred to a new generation.
- Grantor Trusts
- Current law: Individuals have been able to take advantage of high gift and estate tax exemption rates by making transfers to grantor trusts. An important additional benefit of having a grantor pay taxes on the trust assets can allow even more money to be transferred out of the estate.
- Proposed changes: Grantor trusts would be included in the estate of the deceased grantor and be subject to the estate tax. Distributions would be treated as gifts to the beneficiaries and subject to the gift tax.
- Comment: Currently, the proposed changes would only be applied to trusts created after the date of the enactment of the bill. Individuals and couples considering grantor trusts would be wise to consider creating and funding their trusts before any new laws are enacted.
- Generation-Skipping Transfer (“GST”) Trusts
- Current law: Individuals can transfer up to $11.7M to a long term “generation-skipping” trust (a “GST-Exempt Trust”). Distributions to any grandchild or more remote descendant (“skip-persons”) are not subject to any estate or gift tax.
- Proposed changes: GST-Exempt Trusts would be limited to 50 years. The rule would apply to both new and pre-existing trusts. After the 50-year period, distributions to skip-persons would be subject to GST tax at the same rates as the estate tax.
- Comment: Currently, very few families are subject to any GST tax. The proposed change would capture tax on distributions to successive generations.
- Grantor Retained Annuity Trusts (“GRATs”)
- Current law: As an estate planning technique, a GRAT allows an individual to transfer future appreciation of an asset out of his or her estate by creating an annuity trust. GRATs are typically used in situations where assets are expected to increase in value.
- Proposed changes: GRATs would have a required minimum term of 10 years. Additionally, the gift made at the inception of the trust would have to be the greater of $500,000 or at least 25% of the value of the trust.
- Comment: The proposed minimum term and the gifting requirements would significantly limit the benefit of GRATs as an estate-planning tool.
The Sensible Taxation and Equity Promotion (STEP) Act
- Step-Up in Basis
- Current law: Assets receive a “step-up” in basis if they are transferred through a bequest. The step-up in basis allows assets like stocks to pass to heirs without capital gains tax on their appreciation value.
- Proposed changes: Property transferred by gift or bequest, or transferred to a non-grantor trust, would be treated as sold for fair market value, triggering immediate capital gains taxes.
- Comment: The STEP Act would effectively eliminate the step-up in basis at death and preclude assets from being passed to heirs without a capital gains tax on their appreciation value. Because the STEP Act’s effective date is December 31, 2020, gifts made in 2021 to take advantage of the current gift tax exemption may trigger capital gain recognition, should the STEP Act become effective. Clients will need to carefully consider the tax implications of gifts made this year.
- Trust taxation
- Current law: Gains are reported upon transfer by sale or gifts during the grantor’s lifetime.
- Proposed changes: Non-grantor trusts would have to report gain on all of their appreciated assets every 21 years. Trusts with over $1,000,000 in assets or more than $20,000 gross income would have additional reporting requirements.
- Comment: The STEP Act’s proposed changes to the transfer taxes would apply retroactively to gifts or inheritances after December 31, 2020.
Biden Tax Plan Proposals
- Taxes on Capital Gains
- Current Law: The top capital gains tax rate is 20%.
- Proposed Changes: The top capital gains tax rate would be increased to 39.6%, and long-term capital gains over $1,000,000 would be taxed as ordinary income.
- Comment: The proposed changes may propel high-income investors to sell off assets before the tax increase takes effect. Individuals may want to consider other alternatives to lower capital gains taxes.
Given the broad scope and significant measures being proposed, there seems to be momentum in favor of changes to the present income, gift, and estate tax system in the current legislative session. Notwithstanding the current proposals, several parts of the current system are already set to expire at the end of 2025. Therefore, now is the time for well-to-do individuals to be proactive and consider options for their estate planning. These options include, for example, using lifetime exemptions this year, making annual exclusion gifts, obtaining or paying up life insurance policies, and setting up tax advantageous trusts, including spousal lifetime access trusts (also known as SLATs). While none of the proposed changes described in this newsletter are law at this time, it is important to understand how they may affect the wealth of you and your family. Individuals should consult with their financial advisors and legal counsel to plan a strategy and take action now, while there is still time.
FVLD publishes updates on legal issues and summaries of legal topics for its clients and friends. They are merely information and do not constitute legal advice. We welcome comments or questions.