Dear Clients and Friends:

The House Ways and Means Committee (the “House”) recently released 881 pages of proposed legislation aimed at paying for its spending initiatives.  There are many changes aimed at filling loopholes and raising taxes on the “wealthy” (those earning over $400,000 per year, as pledged).  These proposals differ from versions proposed in the Senate and by the Biden Administration, released through the Treasury Department.  Nevertheless, the theme of closing so called “loopholes” exploited by the wealthy is inherent throughout.  This Alert is simply to advise you of those provisions that most directly or indirect affect your estate and tax planning, and it is not comprehensive in nature.  Some provisions are effective on enactment (signature by the President) , while others are not effective until January 1, 2022.  Nothing is certain, as the House proposals will be debated by the Senate and through reconciliation, where most agreed and recommended budget proposals are eventually adopted. Effective dates could change, making planning all the more difficult and complicated.

Decrease of Estate, Gift, and Generation Skipping Tax Exemptions: This House proposal reduces the unified credit against estate and gift taxes, and corresponding generation skipping tax exemption, to 2010 levels, which lowers them from $11.7 million to approximately $6 million in 2022 ($5 million, indexed for inflation since 2010). The Biden Administration through the Treasury Department had not sought to reduce the estate, gift, and generation skipping tax exemptions, perhaps recognizing that under current law they were automatically set to fall to 2010 levels ($5 million per individual, indexed for inflation) in 2026.  This House proposal is consistent with Bernie Sander’s For the 99.5% Act, except that Act lowered the exemptions to $3.5 million. Senate and House finance and ways and means leaders had focused more on taxing unrealized gains at the time of death or gift, in an effort to close the so-called “basis step-up loophole.”  Nevertheless, once the House and Senate meet in Reconciliation to work through compromise, any combination of reform could occur.  The good news is that, as proposed, the reduction of the estate, gift, and generation skipping tax exemptions aren’t proposed to be effective until January 1, 2022, leaving some time to act. That said, the proposed grantor trust rules explained below present a new challenge that is effective on date of enactment, further complicating planning for spouses.

Grantor Trust Rule Changes: Grantor trust status offers significant estate planning advantages, because of the asymmetry between their status under two different bodies of tax law: the income and estate tax. Most irrevocable trusts where a spouse of a grantor is a beneficiary are grantor trusts for these purposes.  For income tax purposes, a donor can be viewed as owning the assets transferred to a trust while the transfer is viewed as a completed gift for estate and gift tax purposes.  This income tax neutral status has historically permitted sales to trusts without capital gain recognition; the leveraging of low interest rates to enhance trust asset growth out of a taxable estate without tax on the interest; and the payment of income tax on trust income by the donor (rather than the trust) so that growth can be tax free. Furthermore, grantor trust tax status can be argued to permit assets that are outside of a taxable estate to receive a step-up in basis on the death of the grantor, creating a loophole that this Firm has used on many occasions- neither estate tax nor capital gains tax on assets within a properly constructed grantor trust. Recognizing these and potentially other unintended consequence of grantor trust tax status, the House has taken an axe to the Internal Revenue Code by proposing to add two new Code provisions: Code §§ 1062 and 2901.  The results of these two provisions if enacted would be:

1. Any trust property that is held in a grantor trust would now be included in the gross estate of the grantor and subject to estate tax;
2. Any distribution of property from a grantor trust to a beneficiary would be considered a taxable gift (possibly taxing the same property twice);
3. Any termination of the trust during the life of the grantor would be a taxable gift to the beneficiaries, just like a distribution; and
4. Any transfer of property between a grantor trust and a grantor for income tax purposes, would now be subject to normal, non-grantor trust income tax regimes.

Importantly, these changes would apply to any trusts created after the date of enactment, and to the portion of any pre-enactment grantor trust that is attributable to contributions made after the date of enactment. Therefore, and since most trusts created for spouses are considered grantor trusts, it is important that spousal lifetime access trusts (“SLATS” or nonreciprocal spousal trusts) are created and funded prior to enactment. Furthermore, it is important to evaluate insurance trusts, where post-enactment contributions of premiums may be required to maintain the integrity of life insurance policies.  In this regard, contributing amounts to life insurance trusts in advance to cover premium payments for the foreseeable futures may be advisable. Otherwise, a portion of the death benefit of life insurance could be taxable in an estate.  It is important to note that the insurance lobby is actively seeking to clarify and eliminate the impact on insurance of these proposed rules and the grantor trust changes. Furthermore, it is possible to loan money to insurance trusts to avoid making a contribution by gift, should advance funding not be feasible.

Basis Step-Up at Death: Surprisingly, the House proposals did not seek to address the elimination of unrealized capital gains at death by either requiring gain recognition or causing historic cost basis to transfer to heirs. This so called “loophole” was a major focus of the Biden Administration proposal (Treasury Department “Green Book”) and also the Van Hollen (D-Md) bill (STEP- the Sensible Taxation and Equity Promotion Act) , backed by many Senators- such as Sanders, Warren, and Booker.  As such it is likely the step-up in basis at death loophole will remain a target as the House proposal is considered by the Senate and through the reconciliation process.  There these proposals will also be met by the Chairman of the Senate Finance Committee, Ron Wyden (D-Or), who like Warren and others, is seeking to tax unrealized gains on a more frequent basis by imposing an annual wealth tax.

Miscellaneous: Much is uncertain at this time, and there is little time for procrastination.  There are many areas of tax reform changes, very few of which are discussed in this Alert.  Planning was complicated and has gotten even more complicated, given the uncertainty surrounding a number of different reform proposals.  Income tax rates across many types of taxpayers and at many levels are rising, and trusts where wealth resides are in particular a Congressional focus for raising revenues to cover increased spending.  Once again, it is impossible to predict what will ultimately be enacted and when.

We are pleased to be of service and if you have any questions or comments, please feel free to contact us. For further information on the various bills recommending tax reform measures, please see prior client alerts at:

Joe Kempe

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