House Ways and Means Committee Releases Tax Plan

Pillsbury Winthrop Shaw Pittman LLP

Plan focuses on eliminating certain available estate planning opportunities and increasing rates for corporations and high net worth individuals.

TAKEAWAYS

  • The proposed tax plan from House Ways and Means Committee seeks to eliminate many of the available estate planning opportunities used to reduce estate taxes.
  • Clients concerned about the proposed changes to the law should consider action now ahead of the enactment of any legislation.

On September 13, 2021, the House Ways and Means Committee released its tax plan, which includes tax increases on high earners and corporations. In addition, the plan seeks to eliminate many of the available estate planning opportunities used to reduce estate taxes. Specifically, the plan terminates the increased exemption amount enacted under the 2017 Tax Cuts and Jobs Act, substantially reduces the efficacy of grantor trusts, limits valuation discounts, and reduces the exemption for capital gains taxes for qualified small business stock (QSBS). Below is a summary of some of the new laws contained in the House proposal:

1. Reduction in the Unified Credit. The unified credit against estate and gift taxes will revert to its 2010 level of $5,000,000 per individual, indexed for inflation. The current unified credit of $10,000,000 ($11,700,000 when indexed for inflation) was set to expire on December 31, 2025. The new credit amount would be effective January 1, 2022.

2. New Grantor Trust Rules.

  1. Grantor trusts created on or after the date of enactment of the new law are includable in the Grantor’s taxable estate. In addition, any amounts transferred to a pre-existing Grantor Trust (i.e., a Grantor Trust established prior to the new law) are also includable in the Grantor’s taxable estate.
  2. Sales between a grantor trust and the Grantor (or the deemed owner) are treated the same as sales between the Grantor and a third party. This means realization of gain by the Grantor upon a sale to the Grantor Trust. Interest earned on a promissory note and payable by the grantor trust will also be treated as taxable income to the Grantor. The rule applies to future sales to grantor trusts (i.e., payments on existing notes may not result in gain recognition, but details of the new law remain to be clarified.)

3. Limiting Valuation Discounts. “Nonbusiness assets” cannot receive valuation discounts for transfer tax purposes. Nonbusiness assets are classified as passive assets that are held for the production of income and not used in the active conduct of a trade or business. This rule is effective upon enactment.

4. QSBS Limitation for Certain High-Income Individuals. The 75 percent and 100 percent exclusion rates for gains realized from QSBS if taxpayer’s income exceeds $400,000 will be eliminated. The 50 percent exclusion will still apply. This rule applies to sales after September 13, 2021.

5. Graduated Corporate Rate Structure; Rate Increases. A graduated corporate rate structure will be introduced:

    1. 18 percent on the first $400,000 of income;
    2. 21 percent on income $400,001 to $5 million;
    3. 26.5 percent on income thereafter.

Phaseout will apply to corporations making more than $10,000,000 (i.e., they will not receive the full benefit of the lower graduated rates for income under $5,000,000). Personal services corporations are not eligible for the graduate rates and pay the flat 26.5 percent rate.

6. Individual Income Tax Rate Increase. The top marginal individual income tax rate increases to 39.6 percent. New rate applies to single individuals earning over $400,000, and to married couples filing jointly earning over $450,000 (under current law, the top rate is 37 percent for single individuals earning over $523,600; $628,300 for married couples filing jointly). The new rate becomes effective January 1, 2022.

7. Increase in Capital Gains Rate for Certain High-Income Individuals. The top capital gains rate increases to 25 percent (current rate is 20 percent). The new rate will apply to tax years ending after enactment of the new rule.

8. 3 percent Surcharge on High Income Taxpayers. A 3 percent tax will be imposed on income over $5,000,000. This surcharge also applies to trusts and estates. The new tax applies to tax years beginning after December 31, 2021. Note that this surcharge is in addition to the 3.8 percent Net Investment Income Tax, which applies to married filers earning over $250,000 and single filers earning over $200,000.

Planning Opportunities – For clients concerned about the changes that the proposed legislation might bring to popular estate planning strategies, such as making gifts to grantor trusts, it may make sense to consider action now ahead of the enactment of any legislation. For instance, for individuals and married spouses who have not used all of their applicable federal gift, estate, and generation skipping transfer tax exemption, making gifts now and using their applicable exemption before those amounts get reduced may be advantageous.

Further, if the proposals regarding grantor trusts are enacted, the effectiveness of establishing a grantor trust will be significantly curtailed. As proposed, the grantor trust rules, i.e., inclusion in the grantor’s estate and recognized sales between the grantor and the grantor trust, will be effective as of the date of enactment. There may be a small window of opportunity for clients to establish grantor trusts, make contributions into existing grantor trusts, or sell assets to a grantor trust prior to the date of enactment. Please note that we cannot predict the date of enactment for the legislative proposals at this time, and there is a risk that such planning will not get completed prior to such date.

Another issue that could arise is for existing irrevocable life insurance trusts (ILITs). Typically, ILITs are structured to be grantor trusts and the grantor makes contributions annually into the trust to provide liquidity for the ILIT to pay the premiums for the life insurance policy. Under the current proposals, there is a risk that a portion of the ILIT will be included in the grantor’s estate since contributions will be made to the ILIT after the date of enactment. Clients with existing ILITs may want to consider making larger contributions to their ILIT(s) now to provide enough liquidity for the trust to pay premiums going forward. It may be possible to modify an ILIT (through decanting, for example) to avoid grantor trust status, if the new law does not include another exemption for an ILIT, which is to be determined. However, clients should consult their estate planning attorneys at Pillsbury prior to making such contributions, in order to carefully navigate the nuances of their specific ILIT.

Staying Up to Date - We anticipate there will be technical changes to the proposed rules that may clarify the impact the proposed rules will have on existing grantor retained annuity trusts (GRATs), ILITs, and other grantor trusts. We are closely monitoring the situation and will provide updates when they are released.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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