On March 25, the Senate Budget Committee Chairman, Bernie Sanders, formally proposed the “For the 99.5% Act” that would make consequential changes to the current estate and gift tax system.
The bill was co-sponsored by Democratic Senators Kirsten Gillibrand, Sheldon Whitehouse, Jack Reed, and Chris Van Hollen, and appears to have widespread support in both the Senate and House. Additionally, over 50 national groups and organizations have publicly acknowledged their support for the legislation.
While we can’t say whether the proposed law will be enacted as is or undergo substantial revisions, it seems best to “plan for the worst and hope for the best.” Given the unpredictable political climate and the potent impacts that even a watered-down version of this bill would have, taking proactive steps now is absolutely vital.
What’s in Sanders’ “For the 99.5% Act” Bill?
The bill takes aim at wealthy individuals on multiple fronts. But the top-level proposals of the bill include:
- Reduction of individual estate tax exemption from $11.7M to 3.5M (70% decrease),
- Reduction of lifetime gift tax exemption from $11.7M to $1M (108% decrease),
- Graduated increase in estate tax rates to 45% ($3.5–10M), 50% ($10–50M), 55% ($50M–$1B), and 65% ($1B and up),
The tougher news for many clients is that some of the primary tax and trust planning strategies that they’ve have used in the past will not be available after President Biden signs the bill into law.
Generation and Dynasty Trusts
These long-term trusts allow assets to be set aside for the benefit of multiple generations. Importantly, the financial benefits to these future generations have been exempt from the generation-skipping tax (GST).
The proposed bill requires that these multi-generational trusts be taxed occasionally as generations change. The GST would now apply with no exclusion to any trust set up to last more than 50 years. Moreover, pre-existing Dynasty Trusts will be deemed “terminated” 50 years after the passage date of the bill.
Grantor Retained Annuity Trusts (GRATs)
GRATs are effective because funds transferred to the trust are not considered taxable gifts and the earnings arising from the trust’s assets can pass to family members tax free. Short-term GRATS (so-called “Walton GRATs”) have been found to be a particularly effective tax planning strategy. The arrangement involves placing stock into a two-year trust with annual distributions. What remains after the two-year term can transfer tax free to children and heirs.
The Sanders proposal would impose a minimum 10-year term on any GRAT. It would also require that a portion of the initial funding be considered a gift for tax purposes. As written, the gift would amount to either 1) 25% of the fair market value or 2) $500,000.
Defective Grantor Trusts
As of now, these trusts provide a number of income and gift tax benefits because the trust is both exempt from federal estate taxes and considered owned by the grantor for income tax purposes. The payment of income taxes on trust earnings are not considered a gift. Alternatively, one can transfer assets to the trust in exchange for long-term, low-interest promissory notes, set up a Private Annuity arrangement, or exchange assets with the trust, all on an income tax–free basis.
The proposed bill would make these trusts be subject to federal estate tax on the death of the Grantor, if the trust was created, funded, or transacted with after the new law was enacted. In effect, this means any and all Defective Grantor Trusts must be fully funded before this bill passes.
At present, couples can place assets into a co-owned LLC. Each person then transfers 49% ownership of the LLC to an Irrevocable Trust in exchange for note. The value of the transfers would receive a valuation discount to account for the lack of control and resale value of the minority ownership (typically, 33.3%).
Should the new tax bill pass, the value of an entity’s ownership interest in another entity will be equal to the actual ownership percentage, with no discount for minority interests. As written, the bill imposes this rule on any ownership interest of 10% or more. So, for example, a 15% ownership interest would be valued at 15% of the total asset value of the entity.
Once the bill is passed, whether as is or in a revised form, you will not be able to fund or have assets sold to Irrevocable Trusts that will be disregarded for income tax purposes. Nor will families be able to use valuation discounts or Grantor Retained Annuity Trusts (GRATs) in most circumstances.
Any Good News?
Yes, there is good news.
All of these provisions—the reduction of the estate tax exemption amount from $11.7M to $3.5M, the reduction of the gift tax allowance to only $1M, the increased estate tax rates between 45%–65%, the limitation on per donor gifts to $30K per year, the elimination of valuation discounts—would not occur until January 1, 2022.
More critically, as the law is presently written, those planning arrangements that are in place before the new law is passed will be grandfathered, as long as they are not added to or altered after the law is passed.
What Should I Do?
If your individual assets exceed $3,500,000 or your combined married assets exceed $7,000,000, you may be negatively impacted. Moreover, if you plan to sell ownership interests in a family business, your time to effect such transactions is limited. You need to take a serious look at your present planning situation to determine whether to take immediate steps to avoid estate and gift taxes.
Pro Tip: Many people I talk to vastly underestimate the total value of their estates. After we review their asset portfolios, they are often surprised both how large their estates actually are and how many assets they had originally overlooked. If you think your personal or married assets might be anywhere near the $3.5M or $7M thresholds, we should conduct a comprehensive asset review. Don’t let a poorly informed and rash assumption cost you!
Don’t wait until it’s too late. Remember, many of these vital planning strategies take time to implement because they involved multiple parties. Proactive planning is the best way to avoid “Feeling the Bern.”
Ready to Fortify Your Wealth and Financial Legacy?
Each individual and family situation is different. As such, we believe that your asset protection and estate plans should be unique as well. They should fit you like a well-tailored suit, with them changing to accommodate you, not the other way around.
When you work with our office, we take the time to get a full, 360-degree view of your assets and to understand your particular financial goals so that we can give you the best advice and build the most effective and efficient estate tax and asset protection plan.
Anyone who has worked hard enough to amass significant assets and wealth should have plans in place to ensure those assets and wealth don’t get stripped away by a disaffected creditor or siphoned off through taxes.
Especially with the unusual challenges presented by the COVID-19 pandemic and the proposed changes to estate and gift tax policies, creating your first asset protection plan or reviewing and revising an existing plan is more critical than ever.
When you are ready to take proactive measures to protect your wealth, assets, and financial legacy, call us to schedule a Financial Legacy Review.