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Three Estate Planning Proposals to Watch 

by Schwabe, Williamson & Wyatt

Published: September, 2021

Submission: September, 2021

 



House Democrats recently released additional legislative proposals that, if passed, would affect several commonly used estate planning techniques. Among those proposals are three that would significantly impact some of the more common wealth transfer strategies. It is too early to tell whether this legislation has any chance of passing, but clients who are planning to use strategies that would be affected by these changes should watch carefully for future developments.


Proposed changes include:


  • Reduction in the federal estate tax exemption. The proposed legislation would cut the current exemption in half. The current federal exemption is based on a $5M exemption in 2010 dollars. In 2017, the exemption was temporarily doubled through the end of 2025. The proposed legislation would cause the increased exemption to expire at the end of 2021, instead of 2025. The 2021 exemption is $11.7M, and half of that would be $5.85M. This amount could increase some in 2022 due to adjustments for inflation. If this proposal were to become law, the potential drop in the exemption might be a reason to consider completing large gifts before year-end.
  • Changes to the grantor trust rules. Under current law, it is possible to create irrevocable trusts that are treated as grantor trusts for income tax purposes, but not for estate tax purposes. These trusts, sometimes called “intentionally defective grantor trusts” can be very advantageous in certain situations and are commonly used for gifting. The assets in these trusts are not included in the grantor’s taxable estate for estate tax purposes. However, because the person who sets up the trust is treated as the grantor for income tax purposes, that person can continue to pay the income taxes on the trust assets. The payment of the trust’s tax by the grantor is essentially an annual gift to the trust that is not treated as a gift for gift tax purposes, so the payment does not use any more of the grantor’s estate and gift tax exemption. The grantor’s payment of the trust’s taxes allows the trust to grow without diminishing it because of the payment of taxes. It is also possible for the grantor to sell low basis assets to these trusts without recognizing gain. The proposed legislation would cause trusts that are treated as grantor trusts for income tax purposes to be included in the grantor’s estate for estate tax purposes and would also require the grantor to recognize gain on assets sold to this type of trust. If this proposal were to become law, it would eliminate the estate planning strategies that are currently employed with these trusts. The proposal would make these rules effective for trusts created and transfers made after the enactment date of the law. Clients planning on creating intentionally defective grantor trusts or selling assets to such trusts might want to complete these transactions as soon as possible.
  • Limits on the discounts available for nonbusiness assets. Under current law, valuation discounts are available for estate and gift tax purposes when transferring closely held business interests. Those discounts are typically applied to the entire business entity—including the portion of the entity that consists of non-business assets like excess cash on hand, marketable securities, and investment real estate. The proposed legislation would eliminate discounts on passive assets that are not used in the active conduct of a trade or business. If this proposal were to become law, it would reduce the total discounts available to transfers of closely held family entities, like limited liabilities and partnerships, that hold passive assets. This proposal would apply to transfers after the effective date of the law. Clients who are planning gifts of closely held businesses that hold passive assets might want to consider completing the gifts as soon as possible.

At this stage, these are just proposals and there is no certainty about whether these proposals will become law, or if so, in what form. In reviewing these proposals, it is interesting to note the prior proposals that were not included. Specifically, this proposal does not include reducing the exemption to $3.5M, does not change the step up and gain recognition rules for assets held at death, does not decouple the estate and gift tax exemptions, does not reduce the gift tax exemption to $1M, and does not contain estate tax changes that would be retroactive. It is too soon to know for sure, but it is possible that the lack of these changes in current proposals might give some indication that those changes might not be moving forward.


There is no telling whether these proposals will ultimately become law, but clients with pending plans to use these strategies should watch future developments carefully and might want to consider completing pending transactions to take advantage of the current law and minimize the risk that changes in the law will affect their plans.


This article summarizes aspects of the law and does not constitute legal advice. For legal advice for your situation, you should contact an attorney.


 



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