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House Ways & Means Committee Tax Proposal – Estate and Gift Tax

on Wednesday, 15 September 2021 in The Closer - M&A, Securities and Corporate Counsel: Kevin P. Tracy, Editor

On September 13, 2021, the U.S. Ways and Means Committee released draft legislation advancing a number of tax increases and changes. The proposed changes would help to pay for the social and economic policies advanced in the $3.5 trillion budget reconciliation package Congress has been working on, which the Democrats and President Biden hope to pass this fall. The text of the proposals are here.

Note:  the Ways & Means Committee’s proposals are still being crafted and finalized, and these proposals still need to be crafted into legislation. Accordingly, this article should be used as a view to what tax changes may be coming on the horizon legislatively.

Included in the proposed legislation is a series of tax increases related to estate and gift tax planning, summarized below:

i. Termination of Temporary Increase in Unified Credit.

When President Trump signed the Tax Cuts and Jobs Act into law, it increased the unified credit against estate and gift tax from $5,000,000 per individual, indexed for inflation, to $10,000,000 per individual, indexed for inflation.  Pursuant to these thresholds, the unified credit jumped from $5,490,000 in 2017 to $11,700,000 in 2021. 

The increased exemption was – by its terms – temporary.  It was scheduled to “sunset” at the end of 2025. The Ways and Means Committee has proposed expediting the sunset, so that the credit will revert to its 2010 level of $5,000,000 per individual, indexed for inflation, at the end of this year—presumably meaning the 2022 would be $5.85 million per person, plus an inflation adjustment for 2020 versus 2021.  This will be an important consideration for individuals with more than $5.85 million of assets, couples with more than $11.7 million of assets combined, and persons with appreciating assets lower than those thresholds.

ii. Increase in Limitation of Estate Tax Valuation Reduction for Certain Real Property Used in Farming or Other Trades or Businesses

The Ways and Means Committee has proposed amending Section 2032A of the Internal Revenue Code to increase the special valuation reduction available for qualified real property used in a family farm or family business from $750,000 to $11,700,000 for 2021.  This reduction may allow decedents who own real property used in a farm or business to value such property for estate tax purposes based on its actual use rather than fair market value.  However, our experience has been that Section 2032A has been of limited utility for most farmers and ranchers for several reasons, among them increased farm rents.

iii. Certain Tax Rules Applicable to Grantor Trusts

The Ways and Means Committee has proposed adding Section 2901 to the Internal Revenue Code, which would pull grantor trust assets into a decedent’s taxable estate when the decedent is deemed the owner of the trust for income tax purposes.  Taxpayers have been able to use grantor trusts to exclude assets from their estates while picking up the tab for the trust for federal income tax purposes.  Most estate planning—including of wealthy individuals—involves the use of grantor trusts.

The Ways and Means proposal also adds a new Section 1062, which treats transfers between grantor trusts and their deemed owners as equivalent to sales between the owner and a third party that would cause a recognition of income taxes.  The amendments made by this section would only apply to trusts (or contributions to trusts) occurring after the effective date of enacted legislation.

These proposals, if enacted in current form, would have a detrimental effect on a number of regularly-used estate planning strategies, such as grantor-retained annuity trusts, spousal lifetime access trusts, and irrevocable life insurance trusts.  The proposed rules render some of these strategies unworkable.  If individuals are currently considering estate planning strategies involving grantor trusts, they should consider finalizing those trusts, and the transfers to the trusts, as soon as possible.

iv. Items not Currently in the Ways and Means Proposals

The Ways and Means proposals do not contain changes to Code Section 1014, which provides a “stepped-up” basis to most assets of a decedent equal to the fair market value as of date of death.  President Biden’s Green Book proposal had proposed a repeal of stepped-up basis, coupled with a recognition event triggering gain at death.  Ways and Means likely confronted concerns about how a recognition event would harm small businesses, and as a result it was not included.

In addition, the lifetime gift tax exclusion was not lowered to $1 million as President Biden had proposed.  Similarly, the generation-skipping transfer tax exemption remains equal to the unified lifetime exclusion amount, even though some proposals had sought to lower the GST exemption.

Finally, the estate, gift, and GSTT rates remained at a flat 40%, rather than being increased for larger estates.

As the proposed legislation has only been approved at the Committee level, it remains somewhat speculative.  Before passing into law, the proposed legislation will be subject to review and approval by both Houses of Congress and the President.  Nonetheless, a shakeup of the tax rules applicable to estate planning seems probable in the near future

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