President Joseph Biden and the Democratic majority in Congress are working on a $3.5 trillion tax and spending package that could dramatically increase taxes on the wealthy. In addition, new proposals are being floated almost monthly that could significantly change how families transfer wealth.

It is unclear when or if the $3.5 trillion package will be enacted, but as of this writing a bill is scheduled to be brought before Congress in the next week.The effective dates on the various proposals also vary, with some going into effective December 31, 2021, and some sooner, based on the date of enactment of new laws.

From the For the 99.5% Act, to the STEP Act, to the latest offering from the House Ways and Means Committee, it is important to know what changes could happen in order to take advantage of tax planning opportunities before it is too late. Here is a look at the current law, some of the proposals being discussed and how those changes could impact planning opportunities if they become law.

Current Law

Under current law, every individual may exempt $11.7 million ($23.4 million for two spouses) before either a gift tax or an estate tax is imposed. Thus, many individuals can pass all or a significant majority of assets to heirs without gift or estate tax consequences, should the value of their estate assets not exceed the stated exemptions.

Heirs also benefit from two income tax rules currently on the books. First, inheritances pass from the estates of deceased individuals to their heirs’ income tax free. Second, the value of the inherited asset gets a step-up in cost basis to the asset’s value on the decedent’s date-of-death. That is, when the heir later sells the inherited asset, no matter what the original cost basis was in the hands of the deceased owner, the heir recognizes capital gain only on any increase in value between date of death and date of sale—the tax on any gain prior to death is effectively wiped out. For example, stocks that an individual purchased for $1 million that are worth $5 million when the owner dies will pass income tax free to the owner’s heirs, and when the heirs later sell those assets, the first $5 million of sale proceeds result in no income tax.

Proposed Changes

There are at least three separate proposals being considered that could significantly impact how high net worth individuals transfer wealth. In one proposal, the gift tax exemption will be limited to $1 million and the estate tax exemption will be reduced to $3.5 million. Other proposals, including the House Ways and Means Committee proposal, would effectively limit both gift and estate tax exemptions to approximately $6 million—in effect accelerating a reduction previously scheduled for January 1, 2026.

On the income tax side, some earlier proposals would curtail or reduce the ability to increase basis of assets to date of death values. And in some cases, they also would require taxable gain recognition upon death. While these proposals were omitted on the latest House Ways and Means Committee report, both this report along with prior bills would increase capital gains rates and ordinary income to a segment of the wealthy population.

Planning Opportunities

The proposed exemptions can affect individuals with assets of $3.5 million in some cases, and $6 million in others. Listed below are a few of the planning opportunities that are currently available, but which could be eliminated prior to year-end:

1. Discount Planning. Minority and non-voting interests in corporate, LLC or partnership business entities, including entities funded with non-business assets, are often entitled to valuation discounts, usually between 20 and 40 percent, depending upon the type of asset and structure of the entity. This means that the value of an interest in these entities for gift and estate tax purposes may be less than full market value. Under the recent House Ways and Means Committee proposal, valuation discounts for interests in entities funded with non-business assets will no longer be available.

1. Grantor Trust Changes. Grantor Trusts enable individuals to pass wealth to younger generations often without gift estate, generation-transfer tax or income tax consequences. Under Grantor Trust rules, the trust incurs no income tax on its assets, including capital gains, interest and dividends and income from business assets. Instead, the individual grantor incurs income tax on the assets owned by the trust, making it effectively a tax-free gift to the trust beneficiaries. Furthermore, sales of assets by the grantor to the trust are ignored for income tax purposes.

All of the foregoing has presented significant opportunities for tax savings and the passage of wealth to younger generations.

Proposed changes to the Grantor Trust rules would eliminate many, if not all, of the above benefits. The result: the trust assets being taxable in the estate of deceased grantor and taxable gifts being made on lifetime distributions to trust beneficiaries. These proposed changes could be effective upon enactment of the new laws or by year end.

1. Life Insurance Trust. Planning life insurance is often a significant portion of individual wealth. Estate tax consequences are traditionally avoided by having an Irrevocable Life Insurance Trust (“ILIT”) designated as the owner and beneficiary of the insurance policy. But since an ILIT is often construed as a Grantor Trust, the current benefit of an ILIT could be eliminated, with the result that life insurance proceeds could be taxable in a grantor’s estate. Under the current House Ways and Means Committee proposal, the new rules may only apply to new Grantor Trusts and contributions to existing Grantor Trusts after the effective date of the law, but this is not clear at this time.

1. Spousal Lifetime Access Trusts (SLAT), Grantor Retained Annuity Trusts (GRAT) and Qualified Personal Residence Trusts (QPRT). All of these trusts currently enable the senior family member to retain direct or indirect control and enjoyment of assets for a designated period and avoid or reduce gift and estate taxes associated with transfer of the trust assets to the next generation. But all of these are Grantor Trusts and the current tax benefits associated with them could therefore be curtailed or eliminated.

The final form of any tax bill cannot be predicted with any degree of certainty, but the Fox Rothschild team of tax advisors are keeping abreast of proposed changes, modifications and effective dates. Individuals concerned about the impact these proposals could have on their estate planning should consult with an attorney immediately.

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