Potential Tax Law Changes Impacting Estate Planning
On September 27, the U.S. House of Representatives introduced a reconciliation bill that includes significant changes to estate, gift and generation-skipping tax laws. While this is just the start of the process, there are three specific changes to current law in the proposed bill that will have a direct impact on estate planning if they do become law: Estate, Gift and GST Tax Exemptions, Grantor Trust Rules and Discount Planning for Nonbusiness Assets.
Estate, Gift and GST Tax Exemptions
The proposal reduces current estate, gift and generation-skipping transfer (GST) exemptions in half. Under current law, the 2022 exemption is estimated to be around $12,000,000. Under the proposal, this would be reduced to approximately $6,000,000. This amount will be indexed for inflation. As a result, it may make sense for clients to consider the use of their full gift and GST tax exemptions ($11,700,000) in 2021—particularly given that the current enhanced exemption is scheduled to sunset on December 31, 2025, to the lower level even if the proposed legislation does not become law.
There are many options that a client can consider for use of the exemptions; our estate planning attorneys are available and ready to have these discussions. Options include:
- Make gifts, either outright or in trust that use the full gift and GST exemptions.
- If you have established an existing trust that is not GST exempt, make a late allocation of GST-exemption.
Grantor Trust Rules
Under current law, the use of a grantor trust is a popular estate planning tool. A grantor trust is a trust that is ignored for income tax purposes, even if its assets are excluded from the grantor’s estate for estate tax purposes. Grantor trusts can be extremely effective in leveraging gift tax and GST exemptions to shift value to future generations. For example, as a married couple, one spouse can set up a grantor trust to ultimately benefit future generations but still have the assets available for the other spouse (commonly referred to as a spousal access trust or SLAT). Grantor retained annuity trusts and insurance trusts are also commonly utilized grantor trusts. The proposal has two changes to the grantor trust rules that severely limit the efficacy of creating a new grantor trust or contributing to an existing grantor trust. It also limits transactions that can be done with existing grantor trusts.
The effective date of these grantor trust changes is the date of enactment of the bill. As a result, there is still time for clients to talk to their estate planning attorney about grantor trusts and their use as an estate planning tool, but there may be a shorter window of time for establishing or funding a grantor trust than for making other types of gifts. Clients making annual gifts to trusts (including to fund premiums in an insurance trust) should discuss with an estate planning attorney whether there are mechanisms to fund such trust prior to the effective date and clients with existing grantor trusts should contact their estate planning attorneys to determine whether there are steps to take in advance of potential enactment.
Discount Planning for Nonbusiness Assets
A common and effective estate planning strategy is for a client to place assets into a partnership or LLC (a pass-through entity) and then make gifts or sales of entity interests to family members or trusts for their benefit. Typically, the value of these entity interests may be discounted in an amount substantially less than the value of the underlying assets. The proposal essentially limits the ability to take discounts on the value of any entity interests to the extent those interests hold any nonbusiness assets (such as a cabin or marketable securities).
As with the grantor trust changes, this change is effective on the date of enactment. Clients may want to discuss with their estate planning attorney whether the use of a pass-through entity is an appropriate strategy to implement while current law is in place.
Other Tax Changes
The bill is over 800 pages long and contains a myriad of other tax law changes. Some of the changes most likely to impact clients include:
- Increases to the income tax rates.
- Increases to the dividends and capital gains tax rates.
- A surcharge on high income individuals, estates and trusts.
- Increased minimum distribution requirements for certain qualified plans and IRAs.
- Limitations on the ability of high-income taxpayers to take advantage of Roth conversions.
The attorneys in Fredrikson & Byron’s Trusts & Estates Group are available to discuss these proposed tax changes and help clients decide whether taking action on estate planning strategies is appropriate at this time.