Last week, the House Ways and Means Committee released, and advanced out of committee, draft tax legislation intended to form a part of the Democratic budget reconciliation bill. At almost 900 pages in length, this draft legislation addresses corporate, international and individual income tax changes, as well as changes to the gift and estate tax laws and the taxation of trusts, all of which remain subject to revision as the legislation moves through the legislative process before a full vote.
There are several gift and estate tax provisions in the proposed legislation that would significantly impact both current structures and future planning that you should be aware of and may wish to discuss with us or another of your tax advisors as soon as possible. While changes in the legislation remain likely, the proposed legislation contains some provisions that would take effect based upon the date of introduction of the legislation (September 13, 2021), some that would take effect based upon date of enactment, and some that would take effect January 1, 2022.
Several of the key proposals that would affect the current gift and estate tax laws and the taxation of new and existing trusts are set out below:
Early Elimination of Increased Exemption from Gift and Estate Tax and Generation-Skipping Transfer Tax Exemption – Effective Date January 1, 2022
The temporarily increased estate and gift tax exemption and generation-skipping transfer (“GST”) tax exemption (each currently $11.7 Million) would be reduced by 50% for gifts made or deaths occurring on or after January 1, 2022, rather than the currently scheduled reduction date of January 1, 2026. Under the proposed legislation, both the estate and gift tax exemption and the GST tax exemption would be reduced to $6.03 Million beginning January 1, 2022. The proposed legislation would not increase the current 40% estate, gift or GST tax rate.
Changes Affecting Grantor Trusts
The taxation of any portion of an irrevocable grantor trust established after the date the legislation is enacted and of the portion of an irrevocable grantor trust established prior to enactment which is attributable to a contribution made after the date of enactment will be dramatically impacted.
- Affected irrevocable grantor trusts will be included in the grantor’s estate at death based on the value of those assets on the date of death.
- A distribution from an affected irrevocable grantor trust during the grantor’s lifetime to anyone other than the grantor or the grantor’s spouse will be treated as a taxable gift from the grantor on the date of the distribution.
- If an affected irrevocable grantor trust ceases to be a grantor trust during the grantor’s lifetime, the assets of affected irrevocable grantor trust will be treated as if the grantor made a taxable gift of those assets on that date.
- Sale or exchange transactions between a grantor and an affected irrevocable grantor trust would no longer be disregarded for income tax purposes.
Irrevocable grantor trusts established prior to the enactment date and to which no further contributions are made after the date of enactment and non-grantor trusts are not affected by these proposals.
The changes, if enacted in their current form, will impact not only the ability to establish new irrevocable grantor trusts as effective estate tax planning structures, but may impact existing irrevocable grantor trusts that rely on additional contributions.
- If you wish to create and fund an irrevocable grantor trust, both the establishment of the trust and full funding must occur before the date the legislation is enacted if you do not wish for the trust to be subject to the new rules.
- If you wish to engage in a sale transaction with an existing irrevocable grantor trust or substitute assets out of an existing irrevocable grantor trust, the transaction should be completed before the date the legislation is enacted if you do not wish for the substitution transaction to be subject to the new rules.
- If you have an existing irrevocable grantor trust which owns a life insurance policy that requires ongoing contributions to pay premiums, you should consult with us or another of your tax advisors to consider funding alternatives if you wish to avoid the proposed tax consequences of post-enactment contributions.
- If you have an existing irrevocable grantor trust to which you plan to make annual exclusion gifts (currently $15,000 per year per beneficiary), you should consult with us or another of your tax advisors to consider funding alternatives.
- While not directly addressed in the proposed legislation, the impact of the proposal will likely limit the use and effectiveness of grantor retained annuity trusts (GRATs), qualified personal residence trusts (QPRTs) and trust decanting provisions.
Because these new rules would only apply to grantor trusts, if you have an existing grantor trust in place, you may wish to consult us or with another of your tax advisors to discuss whether it is advisable to terminate grantor trust status if you anticipate additional contributions will be made to the trust.
Elimination of Valuation Discounts on Passive Assets – Effective on Enactment of Legislation
Valuation discounts for lack of control and lack of marketability typically associated with partial interests will be disallowed for the portion of closely-held entities made up of “non-business” assets. Non-business assets are defined generally as passive assets held for the production of income and not used in an active trade or business.
Increased Income Tax Rates for Non-Grantor Trusts – Effective Date January 1, 2022
Non-grantor irrevocable trusts, which are separate income taxpayers whose income is not reported by the grantor, would be subject to the same increase in tax rates as individuals in the highest income tax bracket (from the current 37% to 39.6%). Trusts would reach the 39.6% bracket at approximately $12,500 of income (as compared to an individual who reaches the highest rate at approximately $525,000 of income). In addition, trusts and estates would be subject to a 3% “surcharge” on income in excess of $100,000. In contrast, this surcharge would only apply to individuals with income over $5 Million. These rate increases would take effect beginning January 1, 2022.
Limitations for Non-Grantor Trusts on Sale or Exchange of Qualified Small Business Stock – Effective Date September 13, 2021
Trusts would also be subject to limitations regarding the exclusion from gain on the sale or exchange of qualified small business stock for sales or exchanges occurring after the date on which the legislation was proposed, September 13, 2021.
 An irrevocable grantor trust is a trust in which the grantor (contributor) is treated as continuing to own the trust assets for income tax purposes even though the grantor is not treated as owning the trust assets for estate and gift tax purposes. As a result, the income generated by the trust is included in the grantor’s income but the trust assets are not subject to estate tax at the grantor’s death.
 Preliminary projections suggest that this amount will increase to $16,000 in 2022.