James Philbin, tax partner at Marcum LLP
There are two pieces of proposed legislation in the Senate that, if passed, would limit some estate-planning strategies that real estate owners have used for years. These changes would reduce annual gifting exclusions and increase estate and gift taxation.
The “For the 99.5% Act” would make substantial changes to the federal gift and estate tax rules and would be effective for decedents dying and gifts made after December 31, 2021. The key changes include the following:
A new, progressive rate schedule for the Reduced Lifetime Exemption would be implemented. The federal unified lifetime exemption of $11.7 million per person ($23.4 million for a married couple) would be reduced to $3.5 million per person for estate tax purposes. The gifting exemption would return to the $1 million per person limit that existed before 2011. Estate and gift tax rates now at 40% would climb to 45% for taxable estates between $3.5 million and $10 million and then to as much as 65% for estates exceeding $1 billion.
Current law provides for annual gift exclusions, adjusted for inflation, of $15,000 per donee in 2021, with no limit on the number of recipients. A change to the Gift Tax Annual Exclusion would limit a donor’s annual exclusions to no more than $30,000 for certain transfers with multiple beneficiaries, including transfers made to trusts.
Significant changes to the laws regarding grantor trusts, a common gift and estate planning device, would also be implemented. In an Intentionally Defective Grantor Trust (IDGT), the trust is disregarded for income tax purposes, and its income is taxed to the trust grantor. A properly structured IDGT is excluded from the grantor’s taxable estate. This structure enables the donor to move wealth for estate planning purposes but continue to pay the taxes on the trust’s income during the donor’s lifetime, allowing the trust to grow without a tax burden.
Under the proposed act, grantor trust assets would be includible in the grantor’s taxable estate. Distributions from a grantor trust during the life of the deemed owner would be considered a gift made by the grantor. If the grantor of a grantor trust turns off the grantor trust power, then a gift is made to the trust. This change would limit the wealth transfer effectiveness of IDGTs. While existing trusts would be grandfathered, additional contributions to existing trusts would be subject to the new rules. There would be a significant impact on irrevocable life insurance trusts and family partnerships that often hold real estate.
Another common gift technique is transferring property to a trust with the grantor retaining the right to receive payments from the trust. These Grantor Retained Annuity Trusts (GRATs) are generally structured to produce a zero value on the initial transfer (gift) to the trust. The Act would impose several requirements that would significantly reduce the benefit of the GRAT technique. A GRAT’s term would need to be at least 10 years, and payments to the grantor could not be with in-kind assets of the trust. GRATs would also require a minimum gift upon funding such that the remainder interest could not be less than the greater of 25% of the fair market value of the transferred trust assets or $500,000.
The Sensible Taxation and Equity Promotion (STEP) Act, proposed in the Senate, addresses income tax issues related to gifts and estate transfers. This law, which would be retroactive to affected transfers as of January 1, 2021, would apply to transfers (on death to heirs or by gift to donees) of property with net gain.
The stepped-up basis on death rule (providing a new tax basis to property included in the taxable estate of a decedent, to its fair market value) would be eliminated. The property would be deemed to have sold on the date of transfer (by death, gift or transfer to a non-grantor trust), and income tax would be calculated.
To prevent a permanent avoidance of capital gains taxes using trusts (after the initial transfer), property held in a non-grantor trust would be treated as sold every 21 years following the establishment of a trust.
The Act also provides for a 15-year tax payment related to illiquid assets (such as a farm or business interest) and require additional disclosure to IRS by trusts with assets exceeding $1 million or gross income in excess of $20,000.
Estate planning and gifting in 2021 should be top of mind.
James Philbin
Marcum LLP
Boston, MA
james.philbin@marcumllp
