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Legislative Update: Estate Planning Action To Take Now

by Westray Veasey, J.D.

Last week, the House Ways and Means Committee released its first draft of the “Build Back Better” legislation.  The revenue component of the bill includes several tax law changes which, if enacted, could have significant estate planning implications.  Below is a summary of the most significant estate planning-related components in the proposed legislation.

Reduction in the Estate and Gift Tax Exemption

Under the Tax Cuts and Jobs Act of 2017 (“TCJA”), the exemption against estate, gift and generation-skipping transfer (“GST”) tax was increased from $5 million per person to $10 million per person, indexed for inflation ($11.7 million for 2021). Under TCJA, this increase in the exemption amount sunsets after December 31, 2025.  The current draft of the bill eliminates the increase beginning on January 1, 2022, meaning that for gifts or estates on or after that date, the exemption amount is back to $5 million, indexed for inflation (approximately $6 million for 2022). Clients who want to take advantage of the current $11.7 million exemption should consider making lifetime gifts using as much of the increased exemption amount as possible before the end of 2021.  Be aware that any such gifts must exceed the “base” exemption amount of $6 million in order to use any of the increased exemption amount.  Exemption is used from the bottom up, so while a gift of $6 million or less will at least get any future appreciation on that gifted amount out of the transferor’s taxable estate, it will not be taking advantage of any of the additional $5.7 million of exemption currently available through the end of the year.

Elimination of Intentionally Defective Grantor Trusts

Under current law, a person can establish and fund a trust, known as an intentionally defective grantor trust (“IDGT”), where the trust assets are excluded from his or her taxable estate but are treated as owned by grantor for income tax purposes.  As a result, with an IDGT, the grantor can enter into transactions with the trust, such as sales, loans or asset swaps, with no income tax consequences.  In addition, the grantor pays the tax on the trust’s income, effectively making additional “tax free” gifts to the trust and allowing the trust assets to grow income tax-free outside of the grantor’s estate.  Under the current draft of the bill, new rules will apply with respect to grantor trusts that are signed after enactment of the legislation as well as for post-enactment contributions to and transactions with existing grantor trusts.  These new rules provide that the grantor trust assets will be included in the grantor’s taxable estate, distributions from them will be treated as taxable gifts, and transactions between the grantor and the trust will trigger income tax.  Many common estate planning techniques are IDGTs, including grantor retained annuity trusts (“GRATs”), spousal lifetime access trusts (“SLATs”) and irrevocable life insurance trusts (“ILITs”).  Clients could have a very small window to establish IDGTs or to add additional funds to existing ones in order to lock in the existing favorable tax treatment.

Elimination of Valuation Discounts for Family Entity Interests

Under current law, the gift tax value of a minority interest in a family entity (LLC, corporation or partnership) can be discounted off of its proportionate share of the value of the entity’s underlying assets due to the interest being unmarketable and lacking in control.  As proposed under the draft bill, for interests in family entities transferred on or after the date of enactment, no such valuation discount will be allowed to the extent the entity’s assets include publicly-traded securities, non-operating cash or other passive, non-business assets.  Clients may have a limited window to establish and transfer family entities holding passive investments at a discounted value.

There will likely be changes to these estate planning related components as the bill makes its way through Congress.  However, you should consider them with your estate and tax advisory team as soon as possible in case there are tax savings strategies you should implement before they may be eliminated, possibly as soon as date of enactment.