Income and Transfer Tax Changes Are A Comin’

By: Randall A. Denha, J.D., LL.M.

With new administration in the White House, upcoming changes have the potential to affect your 2021 estate planning. President Biden’s proposal includes many changes that may have estate tax planning implications. The tax changes are expected to be substantial and far-reaching, and to include corporate, individual and capital gains tax rate increases; international tax changes; and estate and gift tax changes. Each new administration since Jimmy Carter’s has passed tax legislation within the first year of taking office, and without a divided Congress there is a significant chance that more clients will face the prospect of a taxable estate.

Why are estate taxes a likely source of revenue? First, super-rich dead people aren’t a large or a vocal constituency. Second, most Americans believe that the tax is applied to estates with a value lower than the exemption proposed by the Biden administration (pre-2018, or $5.5 million). In a large recent survey, Harvard professor Stefanie Stantcheva finds that Americans believe the estate tax exemption is $2 million of wealth and that 364 in 1,000 pay the tax (not the 1 in 1,000 that pay currently). If Americans already think the tax is higher than the proposed increase, the political cost of lowering the exemption to $5.5 million may be modest.

Major changes introduced are to reduce the estate tax lifetime exemption from the current $11.7 million per taxpayer to $3.5 million, which would not be adjusted for inflation. The gift tax lifetime exemption would be reduced to $1 million. While the $15,000 per person per donee annual exclusion will not be reduced in general, gifts to irrevocable trusts and certain family entities, and gifts of assets subject to prohibitions on sale and those that cannot immediately be liquidated will be subject to a limit of $30,000 per donor annually.

Congressional committees in the House and Senate are already working on tax and budget proposals that will become part of a second budget reconciliation bill. President Biden’s fiscal year 2022 budget is being released this month. The House and then the Senate will craft and approve a budget resolution to serve as the vehicle for the reconciliation process. Most expect committee action to begin in early May, with ultimate enactment in the fall. Only 51 votes are needed to pass budget reconciliation legislation in the Senate. The effective dates of the newly enacted provisions generally are expected to be Jan. 1, 2022, but certain provisions may have proposed effective dates as early as the date of enactment.

What does all of this have to do with estate planning? Depending on a taxpayer’s specific circumstances, significant tax savings may be achieved by those who anticipate the expected changes and take steps now to take advantage of existing tax provisions and rates. This alert addresses only a fraction of the tax changes expected to be enacted by this fall, with a focus on those changes most relevant to 2021 individual and estate planning opportunities.

The rate of the estate tax would also be increased from the current flat 40 percent to a progressive rate as follows:

• 45 percent for taxable estates between $3.5 million and $10 million
• 50 percent for estates between $10 million and $50 million
• 55 percent for estates between $50 million and $1 billion
• 65 percent for estates over $1 billion.

There are several other proposals being floated, such as:

• Including the value of assets held within Intentionally defective grantor trusts (IDGTs) that are created, funded, or transacted with after the date of enactment in a grantor’s gross estate for federal estate tax purposes.
• Eliminating valuation discounts for assets held in family entities, such as limited liability companies (LLCs).
• Establishing that Grantor retained interest trusts (GRATs) would have to be held for a minimum of 10 years and would be subject to a gift of the greater of 25 percent of the fair market of assets placed in the GRAT or $500,000.
• Taxing dynasty trusts to the generation-skipping transfer (GST) tax after 50 years.
• Taxing for estate tax purposes all Grantor Trusts considered to be owned by a grantor for income tax purposes to federal estate tax upon the death of the grantor.
• Treating distributions from grantor trusts to be considered as gifts from the grantor. This will essentially end planning for gifts and installment sales to IDGTs.

What about our beloved 1031 exchanges? If the entire Biden tax plan is adopted, the tried and true strategy of Section 1031 exchanges until death, and then a stepped-up basis may no longer be feasible for many taxpayers. Investors should evaluate their tax situations to determine if a change in plans is warranted. Although each taxpayer’s situation is unique, and we don’t yet know the exact tax changes, some strategies to consider include:

• Gifting assets to take advantage of current high estate tax exemption rates
• Changing depreciation strategy during the hold period to minimize gains upon sale
• Accelerating disposition plans and complete Section 1031 exchange before any tax changes take effect
• Not doing a Section 1031 exchange and paying long term capital gains rates now on gains
• Installment sales to spread out income from dispositions
• Section 1031 exchanges into several smaller assets or tenant-in-common or Delaware statutory trust investments, so Section 1031 will be available upon disposition.

What should taxpayers be doing now? As long as these proposals, if enacted into law, are not retroactive, taxpayers should consider using their full lifetime exemptions from estate tax by making gifts or sales to IDGTs or other irrevocable trusts, make annual exclusion gifts this year to irrevocable trusts and family entities, and create GRATs where appropriate.

Other techniques that should be considered, and that will still be available if the proposal passes, are low-interest rate promissory note sales between family members, self‑cancelling installment notes, and charitable lead annuity trusts (CLATs).

Now is not the time to delay! Remember, if you do not take advantage of the current laws, you can miss out on some very effective estate planning techniques and could also lose your current lifetime estate tax exclusion.