Prioritizing Estate Plans: Proposed Tax Law Changes

On September 13, 2021, the House Ways and Means Committee released its proposal for funding the $3.5 trillion reconciliation package (” Build Back Better Act”), detailing multiple changes to current tax law in order to increase tax revenue. Among these changes are proposals that could significantly modify planning for individuals looking to transfer assets out of their estates.

The proposed changes are not definite, and further revisions are likely to occur if and when the bill makes its way through the reconciliation process. However, some aspects of the proposal are significant enough that individuals may want to seriously consider accelerating transfers they may have been contemplating.

Federal Exemption

First and foremost, the proposal moves up the timeline for the reduction in the federal estate and gift tax exemption, from 2026 to 2022. The current $11.7 million exemption would drop to approximately $6 million. Individuals with estates expected to exceed the proposed $6 million exemption, who have not already used up their current $11.7 million exemption, have the opportunity until the end of 2021 to make additional gifts.

Grantor Trusts

Certain types of grantor trusts allow the grantor to place assets in the trust, considered a gift when funded, with the grantor paying the income tax on taxable income generated by the trust. This allows the assets in the trust to grow outside of the grantor’s estate and for the assets held by the trust to increase in value without a reduction for taxes. The payment by the grantor of the income taxes on the trust’s taxable income is currently not considered an additional gift to the trust.

Another popular estate and gift planning technique affected by the House bill involves sales to grantor trusts. Under this technique, the grantor can sell property to a grantor trust for a promissory note. Since, under current law, the trust is not treated as a taxpayer separate from the grantor, there is no taxable gain or interest income recognized on payments received by the grantor. Any growth in the value of the transferred property in excess of the payments of principal and interest paid on the promissory note to the grantor remains in the trust for the benefit of its beneficiaries.

Finally, the bill proposes eliminating discounts for lack of control and lack of marketability on transfers of interest in entities with non-business assets. Currently, when an interest in an entity such as a partnership or LLC is transferred as a gift or is included in an estate, that interest is valued at its fair market value, a term defined by U.S. Treasury regulations. Under the fair market value standard, appraisers look at the rights of the interest being transferred and consider whether the pro rata value of the interest should be reduced or discounted because it lacks control of the entity and is not liquid. If a holder cannot exercise control over the timing and amount of distributions, or cannot sell or liquidate their interest quickly, various studies prove that a buyer would not pay a full pro rata value for such an interest, and therefore appraisers apply discounts to determine the fair market value.

While the proposed changes to tax law were not completely unexpected, and the reality is they may change further or not pass at all. However, the details released by the House provide enough incentive for individuals to accelerate plans already in process. Hasty planning is not recommended, but for individuals who have been intending to transfer wealth through gifts in the near term, now may be the time to reach out to your Marcum professional or estate planning attorney for advice on how to proceed.