A variety of significant tax proposals have been introduced in 2021 that may have tremendous bearing on your estate plan. There are three primary proposals thus far:
- “For the 99.5% Act” (Senator Bernie Sanders),
- “Sensible Taxation and Equity Promotion Act” (Senator Chris Van Hollen), and
- “American Families Plan” (President Joe Biden).
Senator Sanders’ proposal is a variant of his prior proposal. But the proposals put forward by President Biden and Senator Van Hollen are completely new and could be game changers.
These various bills lay out explicit, sweeping changes to current tax policy, but their full impact is uncertain. For example, the proposals create potential unintended income tax consequences for individuals with irrevocable trusts.
Below, I will briefly outline these tax proposals and explain some of their most important provisions. After you review them, I urge you to call me to set up a meeting as soon as possible to discuss whether we need to make changes to your estate plan.
The Sanders Proposal
Bernie Sanders’ proposal focuses on changes to the gift, estate, and generation skipping transfer (GST) tax rules. Here are just a few key points:
- The exemption amounts for estate and GST taxes will be reduced from the current $11.7 million to $3.5 million.
- The exemption amount for gift taxes will be reduced to $1 million.
- Valuation discounts may be reduced or, in some instances, eliminated.
- Transfer tax rates could increase from 40% to 65%.
- Annual exclusion gifts to trusts could be limited to $30,000, which will affect life insurance trusts at a minimum.
- Valuation discounts on LLCs, partnerships, and other closely-held entities for transfer tax purposes may become unavailable.
- GST-Exempt trusts (aka Dynasty trusts) would only remain exempt for 50 years. Currently, GST-Exempt trusts can remain exempt as long as state law allows the trust to remain in existence.
- Grantor Retained Annuity Trusts (GRATs) would have significant limitations that reduce or virtually eliminate their versatility.
Pro Tip: Bernie’s larger plan alters two broad categories: trust planning and asset protection, on the one hand, and estate tax brackets and gift tax exemptions, on the other. I dug into the details of Bernie’s proposal in a separate post when the bill was first proposed at the end of March. READ MORE
The Van Hollen Proposal
Senator Van Hollen’s proposal focuses on reclassifying gifts and other transactions such that they would trigger taxable events. Importantly, his proposal would be retroactive to January 1, 2021. Here are some key points.
- Most gifts during lifetime and at death would be treated as a sale of property, which is subject to capital gains tax.
- Transfers into grantor trusts (trusts that are treated as owned by the grantor for income tax purposes) could trigger capital gains tax if the assets in the trust are not included in the grantor’s taxable estate at death.
- Every 21 years, non-grantor trusts would be subject to gain recognition events. In other words, every 21 years the trust would have to pay capital gains tax as if it sold all of the assets.
- There no longer will be a step-up in basis at death.
Capital gain recognition is problematic here because the assets are not actually being sold—the sale is simply deemed to have occurred. This means that there may not be enough cash to pay the income tax.
For transfers at death, Senator Van Hollen has proposed a payment plan that is available to the estate in some circumstances. That payment plan is not available to lifetime transfers or to trusts that have the gain recognition event every 21 years.
President Biden’s Proposal
President Biden’s proposal is part of his larger 2022 fiscal year budget plan. Similar to Van Hollen’s plan, Biden focuses on capital gain recognition and not estate taxes.
The specifics of President Biden’s proposal are not as clearly defined as the other two proposals. But we do know some aspects that directly impact estate planning.
- Capital gains would be taxed at ordinary income rates, if adjusted gross income exceeds $1 million. Plus, this rate might increase with the 3.8% net investment income tax and the imposition of state and local taxation. (N.B. This part of the proposal would be retroactive to some time in 2021 (TBD)).
- Gifts and transfers at death would be subject to capital gain recognition.
- Transfers in and out of trusts, partnerships, LLCs, and other non-corporate entities would be subject to capital gain recognition.
- Trusts, partnerships, or other non-corporate entities would be subject to a gain recognition event every 90 years.
- The termination of a trust or transfer from one trust to another could be treated as a gain recognition event.
- There no longer will be a step-up in basis at death.
What Actually May Happen?
Of course, I do not have a crystal ball, and I cannot predict exactly what the final bill will be. We may end up with one of the bills as written, a mix of provisions from each bill, an even stronger bill that combines all of the various bill provisions, or nothing at all. There is simply no way of knowing.
The Biden and Van Hollen proposals create sweeping new capital gains events that directly impact estate plans and would be in addition to estate, gift, and GST taxes. Yes, there should be a deduction for the estate and gift tax on the income tax calculation, but I cannot guarantee anything taxpayer-friendly will be included in the final legislation.
Moreover, the entire Van Hollen proposal would be retroactive to January of 2021, and the capital gains rate in the Biden proposal also is retroactive to sometime in 2021. Creating retroactive tax legislation is challenging but not impossible.
No Guarantees but Death and Taxes
I cannot guarantee what will or will not happen in the coming months. I also cannot guarantee that any changes we make will be a panacea. The potential tax law changes represent a complete paradigm shift in tax planning, so there is still tremendous uncertainty as to the full impact they could have.
With that said, doing nothing may be incredibly harmful to you, so it is important to promptly examine what your current circumstances are, how the array of changes could impact you, and what you can to do to minimize the negative effects of these changes.
What Should You Do?
While I certainly sympathize with many people’s instinct to wait and see, in this case that may not be the best option given the retroactive nature of certain proposals and the time required to implement the changes necessary to counteract them.
At the end of the day, it comes down to risk management. Only you know what level of risk you are comfortable with when it comes to your estate and wealth. However, without professional advice on these complex topics you risk making very costly mistakes—this is especially true for anyone with irrevocable trusts.
Most importantly: You need to act quickly. Unfortunately, time is a finite resource, and very few, if any, changes can be implemented overnight. To help you in this regard, I’m offering complimentary estate plan reviews during July and August. Call or email me to schedule a meeting so we can:
- Review your current estate, asset protection, and trust planning strategies,
- Review your current gifting and tax mitigation plans, and
- Identify areas to update or revise in response to the proposed laws.
Reach out now. Especially if you have an irrevocable trust, schedule an estate plan review by mid-August at the latest. If you wait until the end of the year, I cannot guarantee that the changes can be completed in time.