Estate Planning Considerations in Times of Uncertainty

Written by Alan Cox, Director of Estate/Trust Planning and Estate Settlement, and Mike Bleck, Senior Estate Planning Specialist

Recently, the House Ways and Means Committee released draft legislation of tax changes. It’s important to keep in mind that many provisions can change between the release of an initial legislative framework and the ultimate passing of the completed bill. In fact, after the proposal was released for the current tax changes, rumblings of other more adverse provisions were rumored.

You may have also watched some dynamics develop when the progressive members of the Democratic party were able to derail the anticipated vote on the Infrastructure Bill because the Reconciliation Bill was not being voted on as well. There clearly is a divide even among the House Democrats as to the scope and size of the Reconciliation Bill and the continued desire to “tie” the Infrastructure Bill with the Reconciliation Bill. Recently, some have mentioned that an agreement will be a process and that there is no rush, contrary to what seemed to take place. No one knows how quickly or even if a bill will pass.

Although there may be disagreements on the scope and size of any bill, it is clear that there is unanimity among the Democratic-controlled House and Senate and the Administration that the “wealthy” should bear the burden of any tax increase which could impact many high-income individuals and families and high-revenue businesses.

House Ways & Means Tax Proposals

Estate, Gift and Trust Tax Changes

There are several provisions that would significantly impact estate and gift tax planning. The primary provisions with the most impact are summarized below.

Reduction in Gift & Estate Tax Exemption.  The proposal would accelerate the timing of the decrease of the estate and gift tax exemption to January 1, 2022. The current estate and gift tax exemption is $10 million (indexed by inflation) which is set to expire on December 31, 2025.  The proposal would result in the estate and gift tax exemption reverting back to $5 million (indexed by inflation) on January 1, 2022.

Limit the Use of Grantor Trusts.  One of the primary estate and gift planning strategies used for many high-income individuals is the use of a grantor trust. This proposal would significantly limit the use of this strategy going forward. First, the proposal would generally include grantor trusts in the estate of the grantor (exempting certain existing grantor trusts). Second, sales to grantor trusts would be deemed to be a sale between the grantor and a third party and thus subject to capital gain tax.  Third, transfers to grantor trusts would result in a portion of the grantor trust being included in the estate.  This provision would apply to trusts created after the date of enactment or transfers to existing grantor trust made after the date of enactment.

The proposed changes with respect to grantor trusts have a far-reaching impact and will drastically change estate and gift tax planning. These changes would impact irrevocable life insurance trusts (ILITs), intentionally defective grantor trusts (IDGTs) and grantor retained annuity trusts (GRATs) just to name a few.

Elimination of Discounting for Non-Business Assets.  In many instances, estate and gift tax planning will include using entities such as a Family Limited Partnership (FLP) or Limited Liability Company (LLC) with marketable securities or investment real estate designed to facilitate transfers of assets to future generations. In the valuation of the entity interests transferred, current law allows for minority interest and marketability discounts resulting in a lower value for estate and gift tax purposes. However, the proposal would eliminate these types of discounts for “non-business assets.” This provision would be applicable to any transfer after the date of enactment.

Increase in Top Marginal Tax Rate for Trusts.  The proposal includes a provision that would increase the top marginal income tax rate from 37% to 39.6% for trusts. Because of the compressed trust tax rate structure, this top marginal rate would be applicable to trust taxable income in excess of $12,500. This would apply to tax years beginning after December 31, 2021.

Surcharge on Trusts and Estates.  An additional tax equal to 3% of a trust or estate’s modified adjusted gross income over $100,000 would apply under the proposal. This would apply to tax years beginning after December 31, 2021.

Increase in Estate Tax Special Use Valuation.  Under IRC § 2032A, there is a special use valuation benefit for real property used in a family farm. However, this exemption has not been increased for many years and generally provides limited benefit under current law. One positive provision in the proposal is that the special use valuation exclusion would be increased from $750,000 to $11.7 million. This would apply to tax years beginning after December 31, 2021.

Business Income Tax Deduction for Trusts and Estates.  The proposal would limit the qualified business income deduction (i.e. IRC § 199A deduction) to $10,000 for a trust or estate. This would apply to tax years beginning after December 31, 2021.

Individual Income Tax

There is a consistent theme throughout the proposed tax changes to increase tax on the wealthy. The proposed individual income tax changes do just that and the more significant changes are summarized below.

Increase in Top Marginal Tax Rate.  The proposal includes a provision that would increase the top marginal income tax rate from 37% to 39.6% for certain high-income earners (i.e., taxable income greater than $450,000 for a married couple or $400,000 for a single taxpayer). This would apply to tax years beginning after December 31, 2021.

Capital Gain Tax Rate.  The proposal includes a provision that would increase the capital gain rate from 20% to 25% for certain high-income earners (i.e., taxable income greater than $450,000 for a married couple or $400,000 for a single taxpayer) for capital gains incurred after September 13, 2021.

Surcharge on High-Income Individuals.  An additional tax equal to 3% of an individual’s modified adjusted gross income over $5 million for a married couple (or $2.5 million for a single taxpayer) would apply under the proposal. This would apply to tax years beginning after December 31, 2021.

Business Income Tax Deduction for Individuals.  The proposal would limit the qualified business income deduction (i.e. IRC § 199A deduction) to $500,000 for a married couple or $400,000 for a single taxpayer.  This would apply to tax years beginning after December 31, 2021.

Corporate Income Tax

There also are a number of corporate tax changes that are being proposed. However, the change with the most significance is the tax rate change.

Increase in Corporate Tax Rate.  The proposal would include a provision that would implement a graduated rate structure for a corporation as opposed to the current 21% flat corporate income tax rate. The graduated rates would be an 18% tax rate on the first $400,000 of income, 21% on the next income up to $5 million, and then 26.5% on income in excess of $5 million. If a corporation has income in excess of $10 million, a flat 26.5% rate would apply. This would apply to tax years beginning after December 31, 2021.

Retirement Plans

There are a number of provisions related to retirement plans generally designed to limit the amount in retirement plans, thus generating income tax.  Some of the most significant provisions are summarized below.

Roth IRA Conversions of Only Taxable Amounts.  There would be a prohibition on Roth IRA conversions except to the extent the Roth IRA conversion is taxable. This would apply to tax years beginning after December 31, 2021.

Contribution Limit on Certain Retirement Plans.  The proposal would generally prohibit contributions to retirement accounts when the total value of all accounts exceed $10 million or more for high-income taxpayers (i.e., taxable income greater than $450,000 for a married couple or $400,000 for a single taxpayer). This would apply to tax years beginning after December 31, 2021.

Mandatory Distribution on Large Balances.  The proposal would require high-income earners (i.e., taxable income greater than $450,000 for a married couple or $400,000 for a single taxpayer) to distribute 50% of the retirement plan balance in excess of $10 million. If the balance exceeds $20 million, there is a 100% distribution rule and the distribution must first come from Roth IRAs and Roth designated accounts. This would apply to tax years beginning after December 31, 2021.

Taking Action

Although each person’s situation is different, there are several potential estate, gift, and trust planning actions that may be advisable or should at least be considered. Please talk to your Blue Trust Advisor to learn which ones apply to your situation. If you don’t have a Blue Trust advisor but would still like to speak with us, please contact us at 800.987.2987 or email blog@bluetrust.com.

 

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