FLASH ALERT – Proposed Federal Estate Tax Law Changes (the sky may really be falling…)

Written by: Wills, Trusts, & Estate Administration

Politics aside, we all knew we would see legislation proposed to increase the estate tax and block certain planning strategies, both because Democrats control the Presidency along with the House and Senate, and to cover the spending and stimulus packages.

The legislation that has been introduced is, frankly, as bad if not worse than most expected, at least from the standpoint of transfer tax planning. It was introduced in the Senate by Bernie Sanders with several co-sponsors on March 25th. Granted, it is just a proposed bill, and there will certainly be changes and a reconciliation process as it moves forward, but this gives us a starting point of what to expect.

Briefly, the proposed legislation includes the following key provisions:

      1. Death exemption reduction to $3,500,000 per person (the current exemption is $11,700,000!);
      2. A separate lifetime gift exemption of $1,000,000 (i.e., elimination of our current unified gift and estate tax structure);
      3. An increase in the estate tax rate up to 65% at the highest bracket. The rate would increase from the current 40% to 45%, for estates valued between $3,500,000 and $10,000,000. Estates valued between $10,000,000 and $50,000,000 would be taxed at 50%. Estates valued between $50,000,000 and $1,000,000,000 would be taxed at 55%.  And for the billionaires out there, the rate would be a whopping 65%.  (These same rate brackets would apply to lifetime gifts over $1,000,000);
      4. Elimination of discounts on non-business family assets (e.g., many traditional family partnerships holding land, timber, securities, etc., if they do not engage in an “active trade or business”);
      5. The disallowance of a basis step-up on death for assets held in a Grantor Trust, if the assets are not included in the Grantor’s gross estate at death;
      6. A requirement that a Grantor Retained Annuity Trust (GRAT) have a minimum term of 10 years and a minimum 25% value of the remainder interest (which will effectively kill the use of most GRATs);
      7. Effective elimination of the tax benefits of GST/perpetual/dynasty trusts by imposing tax every 50 years.
      8. Significant restrictions on Crummey gifts, which would limit the annual gift tax exclusion amount to as little as $20,000 per donor for transfers to trusts (compared to now, where we have an annual exclusion of $15,000 per donee).

Is there any good news?  Some, if you want to call it that, but it is limited:

      1. The proposed effective date for the exemption levels and rates would be January 1, 2022. However, the effective dates for the disallowance of basis step up on assets in a Grantor Trusts, the elimination of discounts for family partnerships, the new GRAT restrictions, and the annual gift tax exclusion reduction, would all be effective for transfers made after the date of enactment of the legislation (i.e., likely to be well before January 1, 2022);
      2. The proposed bill would keep the step up in basis (except for assets currently in certain Grantor Trusts that are outside of an estate);
      3. The DSUE (Decedent Spouse’s Unused Exemption) would be retained and grandfathered in.

Additionally, as possible ‘good news’ it is anticipated from many that Senators Manchin at minimum, and perhaps one or two others,  may not likely agree with all of these provisions.  However, there appears to be serious concern that President Biden will want to eliminate the step-up in basis.

So what does all this mean?  It means we all need to keep a close eye on this legislation, and begin discussions with your clients NOW for imminent transfer tax planning that might need to occur this year, and on short notice.  Moreover, if this bill becomes law, whether  in substantially-as-proposed form, or even with likely changes,  we need to redefine what we consider to be a “high net worth client”, back to levels we might have considered prior to 2010.  If the exemption amount as proposed drops to this level, we are going to see many clients who now have a substantial estate tax problem, whereas before they were MILLIONS of dollars away from having that concern.

Our “worst case” fear of many planners these past several months was that we would see a reduction in the exemption down to $5,000,000 per person, and hoping it would still be indexed for inflation.  If this legislation passes at this level as proposed, we will now see married couples with only a combined $7,000,000 death exemption and only a combined $2,000,000 lifetime giving exemption (for a total of $9,000,000 that can be sheltered from tax), as compared to the current $23,400,000 combined exemption for lifetime and death transfers.  This will bring many, many clients who don’t even consider themselves high net worth into a taxable estate situation.

Finally, the challenge from a  planning perspective is exacerbated by the proposed effective dates.  For the pieces of the legislation that might become effective immediately upon enactment, there simply may not be enough time to ‘wait and see’ on some planning items, such as GRATs, creation and gifting of traditional family partnerships, waiting to make annual gift tax exclusion gifts to trusts until the end of the year, and the like.

I don’t want to be the ‘boy who cried wolf’, but while the sky may not be falling, yet, the forecast is not looking good.

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