The U.S. House Committee on Ways and Means has approved a slate of legislative proposals (the “House Committee Proposal”) intended to raise revenue. The House Committee Proposal includes a variety of proposed changes to the Internal Revenue Code (the “Tax Code”). This alert is not a comprehensive analysis of the House Committee Proposal but instead focuses on a small number of proposals that, if enacted, would affect high net worth taxpayers and their estate planning: (i) a reduction in the federal estate and gift tax exemption and the generation-skipping transfer (“GST”) tax exemption amounts, effective as of January 1, 2022; (ii) the inclusion of any grantor trust created after the date of enactment in the estate of the donor, the taxation of distributions from such trusts which are traceable to contributions made after the date of enactment and the inclusion in the estate of the donor of a portion of such trusts attributable to contributions made after the date of enactment; and (iii) and the elimination of valuation discounts for certain nonbusiness assets, effective as of the date of enactment. High-income taxpayers may wish to discuss with their financial advisors other proposals contained in the House Committee Proposal, including increases in the top marginal income tax and long-term capital gains rates and new limitations on IRA contributions.
The provisions described below are only legislative proposals – they still need to be approved by the U.S. House of Representatives and reconciled with the Senate’s legislative proposals before a final bill can be sent to the President for signing into law.
Decreased Estate, Gift and GST Tax Exemptions
The House Committee Proposal reduces the federal estate and gift tax exemption amount and the GST tax exemption amount from $10 million, indexed for inflation (currently $11.7 million), to $5 million, indexed for inflation (estimated to be $6.02 million in 2022). These reduced exemption amounts would affect gifts made on or after January 1, 2022, and the estates of individuals who die on or after January 1, 2022.
High net worth individuals should consider making gifts now to take advantage of the current exemption amounts before they are repealed. To benefit from the current higher exemption, however, an individual’s total lifetime gifts must exceed the new lower exemption amount (so, for example, if the exemption falls to $6.02 million, total gifts prior to the decrease must exceed $6.02 million to make use of the currently higher exemption). The IRS has stated that gifts made during the time period when the higher exemption is in effect will be protected from federal estate and gift tax upon the death of the donor.
Elimination of Certain Grantor Trust Benefits
The House Committee Proposal includes proposals that would eliminate tax benefits of so-called “grantor trusts.”
Irrevocable grantor trusts are commonly structured such that: (i) the donor is the “deemed owner” of the trust for income tax purposes and pays the taxes on trust income; (ii) contributions to the trust are completed gifts for gift tax purposes, requiring either use of a portion of the deemed owner’s remaining gift tax exemption, if any, or the payment of gift tax by the donor at the time of contribution; and (iii) trust assets are not included in the donor’s taxable estate. Currently, sales and other transactions between a grantor trust and its deemed owner are not gain realization events for income tax purposes. Many types of trusts commonly used by estate planners are grantor trusts, including spousal lifetime access trusts (“SLATs”), irrevocable life insurance trusts (“ILITs”), grantor retained annuity trusts (“GRATs”), and qualified personal residence trusts (“QPRTs”), among others.
The House Committee Proposal contains the following proposals affecting (i) grantor trusts created on or after the House Committee Proposal’s enactment and (ii) contributions made to existing trusts (or sales or exchanges with existing trusts) on or after the House Committee Proposal’s enactment:
- The value of the assets in a grantor trust created and funded after enactment would be included in the deemed owner’s taxable estate and contributions to a pre-enactment grantor trust would result in a portion of that trust being included in the deemed owner’s taxable estate. Because post-enactment contributions to pre-enactment grantor trusts will cause estate tax inclusion concerns, contributions to existing ILITs for purposes of paying insurance premiums or the direct payment of insurance premiums on behalf of the trust would be problematic. In the event the House Committee Proposal is enacted, please reach out to Goodwin before making contributions to an ILIT or paying premiums for policies held in an ILIT. Donors of existing insurance trusts should consider whether there are any steps to take prior to enactment to lessen the impact on the trust if the House Committee Proposal becomes law.
- Distributions from a grantor trust would be deemed to be gifts from the deemed owner to the beneficiary, thus requiring use of a portion of the deemed owner’s remaining gift tax exemption, if any, or requiring payment of gift tax by the donor at the time of the distribution, unless (i) the distribution is made to the owner’s spouse or the owner, or (ii) the distribution is in discharge of a legal obligation of the owner. If grantor trust status is terminated, the owner would be deemed to have made a taxable gift of the trust assets. This rule would only affect pre-enactment grantor trusts to the extent of contributions made on or after the House Committee Proposal’s enactment. This proposal has the effect of taxing the transfer of an asset from the donor to a trust beneficiary when the asset’s value is likely to be higher (the time of distribution from the trust) rather than lower (the time of contribution to the trust).
- A sale or exchange between a grantor trust (other than the deemed owner’s revocable living trust) and its deemed owner would become a gain realization event for income tax purposes, requiring payment of capital gains taxes by the owner. Further, a grantor trust and its deemed owner will be considered “related parties,” thus disallowing losses generated by the sale or exchange of assets between a grantor trust and its deemed owner.
If you are considering making gifts in excess of $6.02 million, less the portion of your exemption amounts you have already used, you should consult Goodwin or your tax advisor and consider making those gifts as soon as possible. In the event that the House Committee Proposal is enacted, please do not make contributions to grantor trusts, including for purposes of paying insurance premiums on any policy owned by an ILIT, without first contacting us to discuss.
Elimination of Valuation Discounts for Nonbusiness Assets
The House Committee Proposal would eliminate valuation discounts on transfers of certain entities that hold “nonbusiness assets,” including cash, stocks, bonds and real property not used in an active trade or business. These entities, such as family limited partnerships, would be valued as if the transferor had transferred the asset directly to the transferee for full fair market value. The House Committee Proposal includes a look-through rule stating that assets held by a subsidiary entity would be treated as owned directly by the parent entity if the parent entity owns 10% or more of the subsidiary entity. This proposed change to the valuation rules would apply to all transfers made on or after the date of enactment.
This proposal would affect any post-enactment gift or sale of an interest in an entity such as a partnership or limited liability company which holds nonbusiness assets, including to a trust for the benefit of the donor’s spouse or descendants. These entities would no longer qualify for valuation discounts for a lack of marketability or lack of control.
If you would like to discuss planning options in light of the House Committee Proposal, we recommend that you contact our Trusts & Estate Planning practice to determine if any action is advisable at this time.
Mary-Kathleen O'ConnellPartnerCo-Chair, Trusts & Estate Planning
Susan L. AbbottPartnerChair, Tax Exempt Organizations, Co-Chair, Trusts & Estate Planning
Lisa A.H. McChesneyPartner