This question is frequently asked, and the answer varies based on your individual circumstances. Various…
More outwardly, commonwealth transfer strategies for estates have significant impacts due to tax law change proposals on the precipice of being enacted into law. It is too early to know what will become law, the House Ways & Means Committee tax plan draft indicates that change is coming soon. While new details emerge and changes are made to the proposals over the coming weeks, it is critical to understand how these possible tax changes may affect your estate planning.
What are the Major Proposed Changes that Impact Estate Planning?
One of the most significant changes to affect estate planning is that as of January 1, 2022, the federal estate and gift tax exemption is facing a reduction from $11.7 million to approximately $6 million. Ambitious budget and spending proposals require additional sources of revenue. While technically not yet a law, there is little doubt, per the Congressional Budget Office, that this particular estate and gift exemptions will become law. This near certainty provides a small window for individuals to make full use of their 2021 permissible exemption.
Other major change proposals include grantor trusts which may not have until December 31, 2021, to take full advantage of existing planning opportunities. For decades grantor trusts permitted the grantor to be individually liable for income taxes on earned income, yet the grantor trust remained excluded from the grantor’s taxable estate. If the proposed changes take effect, there will be an elimination of grantor’s trusts in estate gift planning.
Under the current rules, existing grantor trusts are exempt from the law change proposal (grandfathered) with one significant limitation. A gift pre-existing proposed grantor trust law change will be exempt; however, the portion attributable post-act contribution is under the new rules. Therefore, that new rule portion is included in the grantor’s taxable estate. Grantor trusts include life insurance trusts. Therefore, pre-funding this trust type with enough cash to pay premiums for several years to ensure its exemption status is required to remain outside the taxable estate. Execution and funding must happen before enacting the proposal to take full advantage of existing grantor trust laws.
Finally, the proposal regulations upend rules regarding the sale of appreciated assets by a grantor to their grantor trust. Today, this action is not an income tax recognition event. The proposal act, however, would deem such a sale as being between unrelated parties. This change means the sale to a grantor trust becomes an income tax recognition event to the grantor. Typically, assets sold to grantor trusts have substantial gains already built-in. Therefore the strategy to sell to a grantor trust largely disappears with the change proposal enactment, and not even losses could have recognition upon such a sale.
Valuation rules such as discounts on ownership interests in passive assets face elimination. Any individual wishing to claim a valuation discount on a gift of interest of an entity must complete the gift before enacting the proposed legislation. Again, the window of opportunity for claiming these types of valuation discounts may close, even long before December 31, 2021.
Understanding Proposed Changes to Tax income Rules
Tax income rules are also under scrutiny and ripe for change. A new surcharge proposal of three percent of a trust’s modified adjusted gross income or an estate above $100,000 is likely to enact into law. Realizing income gains in 2021 rather than 2022 can help to preserve your wealth.
Also, expect individual and capital gains and dividends tax rate increases. Individual tax rates may increase from 37 to 39.6 percent, and the income level threshold for these higher rates will decrease. The current level for higher-income taxpayers’ capital gains will change from 23.8 percent to as high as 31.8 percent. Part of these taxes includes a three percent surtax applying to high-income individuals, estates, and trusts.
The current draft legislation does not propose eliminating the step-up in basis at death or implement a carryover basis at death, nor transfers of lifetime gifts (other than sales to a grantor trust, see above) or upon the death of an income tax realization event. The legislation does not propose setting a minimum term for grantor retained annuity trusts or eliminating zeroed out grantor retained annuity trusts. Nor does the draft legislation increase the estate tax rate from forty percent or create a progressive estate tax rate structure, limit the annual exclusion to trusts or gifts, and finally will not create new limitations on the use of dynasty trusts.
The recently unveiled Build Back Better Act has the possibility of implementing wide-sweeping changes to the US tax code and has drastic impacts on commonly used estate planning techniques. Whether you have an existing estate plan or need to create one, speak with an elder law estate attorney today to understand how these proposed changes may affect your existing or future estate plans. Please contact us at our Forty Fort Pennsylvania office or give us a call at 570-288-1800.