Transferring your legacy

Proposed Estate and Gift Tax Changes: Why You May Need to Act Now

8 Minute Read

In late March, two bills were introduced in Congress that would dramatically reduce estate and gift tax exemptions and curtail estate planning strategies used by families to pass wealth to future generations. These changes, if enacted, will sharply increase estate and gift taxes families may need to pay.

The first proposal, introduced by Senators Bernie Sanders and Sheldon Whitehouse, is called the “For the 99.5% Act;” the second, introduced by Senator Chris Van Hollen, is referred to as the “Sensible Taxation and Equity Promotion (STEP) Act.”

The following summarizes some of the proposed estate and gift tax changes:

For the 99.5% Act

Lifetime estate and gift tax exemptions reduced and decoupled

The bill would reduce the current federal estate and gift tax exemptions of $11.7 million per person to $3.5 million for transfers at death and $1 million for lifetime gifts.

The changes would be effective beginning after December 31, 2021.

Annual exclusion gifts

Under current law, an individual can give away $15,000 per recipient to an unlimited number of recipients without dipping into the donor’s lifetime gift and estate tax exemption. The bill would limit annual gifts by a transferor to $10,000 per recipient up to a total of $20,000 per year for all recipients.

The change would be effective as of the date of enactment.

Estate and gift tax rate increases

Taxable estates and transferors of taxable gifts currently pay tax at a flat 40 percent rate. The bill would convert this flat rate structure to a graduated rate structure based on the size of the estate or gift, as follows:

• Gifts between $1 million and $3.5 million would be subject to the 40 percent rate;

• Estates and gifts valued:

          — between $3.5 million and $10 million at 45 percent;

          — between $10 million and $50 million at 50 percent;

          — between $50 million and $1 billion at 55 percent; and

          — over $1 billion at 65 percent.

The change would be effective after December 31, 2021.

Elimination of valuation discounts on transfers to family members

The bill would eliminate minority discounts on transfers of business interests to family members if, after the transfer, members of the family control the business or own majority interests in the business. Also, in valuing a business, nonbusiness assets would be valued as if they were transferred directly, meaning no valuation discounts would apply. This presumably would include any investment account not directly tied to the working capital of an active trade or business as well as real estate not actively managed by the family. Assets used in the active conduct of a trade or business, such as inventory and accounts receivables, would be excluded. The change would be effective as of the date of enactment.

Efficacy of Grantor Retained Annuity Trusts (GRATs) eliminated

The bill would require GRATs to have a minimum 10-year term and a maximum term equal to the life expectancy of the annuitant plus 10 years. The remainder interest must not be less than an amount equal to the greater of 25 percent of the trust’s assets or $500,000. This effectively serves to defeat the GRAT strategy for passing wealth to younger generations.

The change would be effective as of the date of enactment.

Efficacy of Intentionally Defective Grantor Trusts (IDGTs) eliminated

The bill would eliminate the effective use of IDGTs in estate planning by requiring: i) assets (for which gift tax exemption was not used or gift taxes paid) in new grantor trusts be included in the grantor’s estate, ii) distributions from a grantor trust during the grantor’s lifetime be treated as a gift, and iii) assets of a grantor trust be a deemed gift if grantor-trust status is turned off during the grantor’s lifetime.

The changes would apply to trusts created after enactment; however, the bill would also implicate transfers made to preexisting trusts after enactment.

Elimination of dynasty trusts

The Act would impose a 50-year term for new trusts and cause existing trusts to “terminate” 50 years after the date of enactment. Therefore, assets that previously could remain in trust for multiple generations without being subject to estate, gift and generation-skipping transfer taxes, would be required to terminate within 50 years (i.e., be included in a recipient’s taxable estate) or be subject to generation-skipping transfer tax at the highest estate tax rate (65 percent proposed) at the conclusion of the 50-year term.

The change would be effective as of the date of enactment.

STEP Act

The STEP Act would impose a capital gains tax on appreciated assets transferred at death, as if the assets were sold for fair market value. Currently, inheritors of appreciated assets receive those assets with a tax-free basis step-up to fair market value, meaning that they can sell the assets immediately after a person’s death and pay no income taxes on the sale. If enacted, the legislation would exempt the first $1 million of asset appreciation from gain recognition as well as the full value of retirement accounts. Transfers to spouses and charities would also be exempt from imposition of the tax. Other exclusions would apply, such as exempting up to $500,000 additional unrecognized gain on the transfer of a personal residence. Notwithstanding these exceptions to the rule, the STEP Act would impose a steep cost to many heirs’ basis step-up allowance.

The STEP Act would apply retroactively to transfers occurring after December 31, 2020.

While these two bills are only proposed at this time and it is unclear whether all or a portion of the proposals will garner the needed votes to pass, momentum for tax change appears to be building.

 

Conclusion

Although introduced by more left-leaning Democrats, many of the proposals put forward were included in wish-lists of more moderate Democrats in the past, such as Barack Obama and Hillary Clinton, which indicates that moderate lawmakers could be supportive. The proposed estate and gift tax changes will impact new and existing planning, so you should consider revisiting your estate plan to understand the impact these changes might have. The effective dates of the provisions vary, so pay close attention to timing if you intend to implement wealth transfer strategies before any changes take effect.

Rely on the team of professionals at The Private Bank to help you navigate these uncertain times. Our comprehensive estate planning services can help you protect the wealth you’ve worked so hard to build while our wealth planning solutions can help you identify, prioritize and achieve your wealth transfer goals.

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Wealth planning strategies have legal, tax, accounting and other implications. Prior to implementing any wealth planning strategy, clients should consult their legal, tax, accounting and other advisers.

Union Bank does not create estate plans, but we can help by working with you and your team of advisors to get the information you need to assist with the development of a comprehensive plan. Any estate plan should be reviewed by an attorney who specializes in estate planning and is licensed to practice law in your state.