On Monday, September 13, 2021, the House Ways and Means Committee released the text for proposed tax changes to be incorporated in a budget reconciliation bill called the Build Back Better Act (the “Act”). The 881-page text includes several significant changes to income and transfer taxes that could drastically change estate, gift and individual income tax planning if made into law.

The following is a brief summary of several of the most significant proposed changes.

Elimination of “Bonus” Estate and Gift Tax Exemption 

The proposal eliminates the increased estate and gift tax exemption brought about by the 2017 Tax Cuts and Jobs Act that doubled the exemption. As a result, beginning January 1, 2022, the estate and gift tax exemption (that would remain unified) would be reduced to $5 million, adjusted for inflation. This change merely accelerates the reduction that was to occur under current law beginning January 1, 2026.

Inclusion of Grantor Trust Assets in Taxable Estate

Significant changes are proposed with respect to treatment of assets transferred to a “grantor trust.” Grantor trusts are trusts where the creator of the trust, or grantor, is deemed owner of the trust assets for federal income tax purposes. As a result, the grantor reports and pays taxes on trust income and is permitted to enter into transactions with the trust without causing a taxable event for income tax purposes. Grantor trusts are an important and frequently used planning tool used for lifetime wealth transfers.

Under the proposal, assets transferred to grantor trusts created after the date of enactment of the Act would be included in the grantor’s estate for federal estate tax purposes upon the death of the grantor.

If during the life of the grantor, the grantor ceases to be treated as the owner (i.e., the trust becomes a non-grantor trust), all assets would be treated as a transfer by gift by the grantor. Any distribution from such a grantor trust (other than to the grantor or his or her spouse) would also be treated as a gift for federal gift tax purposes.

With respect to sales by the grantor to the grantor trust, such transfer would be deemed to be a sale or exchange and subject to income taxation.

The grantor trust changes, if enacted, could significantly impact the use of common planning tools such as grantor retained annuity trusts (GRATs) and installment sales to grantor trusts. Also, strategies such as asset swaps that previously allowed the grantor to pull low-basis assets out of a trust in exchange for high-basis assets and cash to achieve a basis step up for the low-basis assets at death, would be significantly reduced or even eliminated. Funding of future premiums on life insurance held in life insurance trusts will also need to be considered, leading to possible prefunding before enactment of the Act or split dollar arrangements.

The grantor trust rules would apply to trusts created on or after the date of the enactment of the Act and to any portion of a trust established before the date of the enactment of the Act that has contributions made to it on or after such date. Thus, existing trusts would be grandfathered. However, additional contributions would result in a portion of the trust being subject to the new rules.

Elimination of Valuation Discounts for Transfers of Nonbusiness Assets

The proposal also includes new rules that seek to limit valuation discounts available for transfers of interests in business entities. Currently, if a person transfers an interest in a closely held business, certain discounts may apply to determine the fair market value of the interest. These discounts take into consideration such things as the interest being a minority interest or for lack of marketability due to the inability to easily liquidate the interest.

Under the proposal, the valuation of an interest in a closely held business entity would generally be determined in two steps. First, the value of “nonbusiness assets” held by the business entity is to be determined as though such assets were transferred directly to the transferee (i.e., no discounts should apply). Then, the interest in the business entity is valued without consideration of the nonbusiness assets (with discounts possibly applying). The purpose of the changes under the Act is to reduce or even eliminate the ability to obtain discounted values on the transfer of interests in entities that hold highly liquid/passive investment assets that are not part of working capital.

The valuation changes would apply to transfers occurring after enactment of the Act.

Other Estate and Tax Planning Considerations

The proposal does not include several changes that were considered in earlier proposals. The highest marginal estate tax rate would remain 40 percent. No changes are made with respect to the generation-skipping transfer (GST) tax. However, the GST tax exemption would be reduced to $5 million adjusted for inflation because it is currently tied to the estate and gift tax exemption amount. Also, there is no change with respect to the limits on annual exclusion gifts.

More importantly, there is no mention in the proposal of death triggering gain as seen in earlier proposals or the elimination of basis step up at death.

Income Tax Changes

The proposal also includes a variety of income tax changes. A few highlights are as follows:

• The top marginal individual income tax rate would be increased to 39.6 percent. This marginal rate would apply to taxpayers who are married filing jointly with income over $450,000, separate taxpayers with income over $400,000, and to estates and trusts with income over $12,500.
• The highest long-term capital gain rate would be increased from 20 percent to 25 percent, with transition rules that would apply the 20 percent rate to gain recognized during the year prior to September 13, 2021, or with respect to transactions that closed after September 13, 2021, with a binding agreement prior to such date.
• A 3 percent surcharge would be imposed on Modified Adjusted Gross Income (MAGI) of taxpayers in excess of $5 million, $2.5 million for taxpayers that are married filing separately and $100,000 for trusts and estates.
• The 75 percent and 100 percent gain exclusion under 1202 for qualified small business stock would be unavailable, on or after September 13, 2021, for individuals who have adjusted gross income of $400,000 or more, or if the taxpayer is a trust or estate, unless a binding contract was in place on September 12, 2021. The 50 percent gain exclusion would continue to apply.

Retirement Plan Changes for High-Income Taxpayers

The proposal includes changes to retirement plans for high-income taxpayers:  

• Contributions to traditional and Roth IRAs would be prohibited if the value of accounts exceeds $10 million, for taxpayers with income over $450,000 for married filing jointly, and $400,000 for single taxpayers and married filing separately.
• If the prior year traditional and Roth IRA and defined contribution account balances exceed $10 million, the taxpayer would be required to take a required minimum distribution (RMD) of 50 percent of the excess. If the total exceeds $20 million, then the excess would need to be distributed from Roth IRAs and designated Roth accounts up to the lesser of the amount required to bring the total to $20 million or the remaining balances in Roth IRAs and designated Roth accounts.
• The proposal also prohibits Roth conversions for taxpayers with income over $450,000 for married filing jointly, or $400,000 for single taxpayers and married filing separately.

Though the text released by the House Ways and Means Committee is merely a proposal and may not be passed in its current form, it gives a strong indication of things to come and must be considered for planning during the coming months.

For more information or if you wish to discuss how this proposal could impact your plan, please reach out to an attorney in our Trusts & Estates practice group. 

In Congress’ ongoing fight against fraud, corruption, terrorism financing and money laundering, lawmakers passed the Corporate Transparency Act (CTA) on January 1, 2021, as part of the 2021 National Defense Authorization Act. The CTA contains significant new federal reporting obligations and imposes heavy civil fines and criminal penalties for noncompliance. It may have an especially onerous impact on estate planning clients who accomplish their planning goals through the use of one or more business entities.

Beginning January 1, 2022, beneficial ownership information must be reported to the Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) for a business entity that is deemed a “reporting company.” Unless expressly excluded under the CTA, a “reporting company” includes a corporation, limited liability company, limited partnership, limited liability partnership, limited liability limited partnership, family limited partnership, or other similar entity that is:

1. created by filing a document with a state’s secretary of state or similar office under the laws of a state or Indian tribe; or
2. formed under the law of a foreign country and registered to do business in the United States by the filing of a document with the secretary of state or similar office under the laws of a state or Indian tribe.

At this time, sole proprietorships, trusts, some general partnerships, and other entities that do not obscure an individual’s identity are not included as a reporting company. However, based on ongoing beneficial ownership reviews and reports provided to Congress, these types of entities may be included in future legislation.

Beneficial ownership information includes the full legal name, date of birth, current residential or business street address, and a unique identifying number such as a driver’s license number or passport number for an individual who, directly or indirectly, through any contract or other arrangement, exercises “substantial control” or owns or controls 25 percent or more of the “ownership interests” of a reporting company. A “beneficial owner,” however, does not include a minor, when a parent of the minor is reporting; individuals who serve as nominees, intermediaries, custodians or agents; an individual whose control is solely derived through employment by a reporting company; an individual whose only interest is through a right of inheritance; or a creditor of the reporting company, unless the creditor is a beneficial owner. At a minimum, a reporting company must identify one individual to report as a beneficial owner if no one individual controls more than 25 percent of the ownership interests.

Upon the effective date, a beneficial owner of a reporting company that has been previously formed or registered will have up until two years to report to FinCEN as prescribed under the CTA. For a reporting company formed or registered after the effective date, a beneficial owner will be required to report at the time of formation or registration. All updates to beneficial owner information must be reported within one year of a change. Civil penalties for noncompliance include fines of up to $500 for each day the violation continues and criminal fines of up to $10,000 per day and/or imprisonment for up to two years.

In conclusion, for those who use business entities as part of their estate planning strategy, meeting the obligations of the CTA will be important, given the potential civil and criminal penalties that may be assessed for failing to comply. Please contact an attorney in our Trusts & Estates Practice Group if you have questions about the new obligations and how to ensure compliance.

How many times have you prepared your income tax returns for the previous year, only wishing you knew then what you know now, so you could go back and make more advantageous tax decisions?  In most cases, you are stuck with the decisions you made before the new tax year began, even though you may not have all the relevant tax information available to assist with those decisions until several months into the new tax year.  Too bad for you, says the IRS, unless you are an estate or trust.

65-Day Rule Trust Distribution

Under Section 663(b) of the Internal Revenue Code, any distribution by an estate or trust within the first 65 days of the tax year can be treated as having been made on the last day of the preceding tax year.  For example, a distribution of $500 of trust income by the trustee to a beneficiary on January 30, 2021, can be treated as having been made in the 2020 tax year or the 2021 tax year.  In most years (including 2021), the last day for a distribution to be applied to the previous tax year is March 6 (in leap years, the last day is March 5).

The election to treat the distribution as being made in the previous tax year must be made by the fiduciary on a timely filed income tax return (including extensions) for the tax year to which the distribution is meant to apply.  A fiduciary may make the election for only a partial amount of the distribution(s) within the 65-day period, but the election is irrevocable once it is made.

The primary advantage of this tax rule is that it may provide an opportunity for tax savings.  An estate or trust pays income taxes at graduated rates, similar to individuals, with the top tax rate in 2020, 37 percent, applying to income in excess of $12,950.  However, married couples filing jointly pay the top tax rate only when income exceeds $622,051 (or $518,401 for single filers).  In some cases, an additional 3.8 percent Medicare surtax (also known as the Net Investment Income Tax) on the net investment income of the estate or trust may also apply, resulting in a total marginal tax rate of 40.8 percent. 

To minimize paying tax at compressed rates, income from the estate or trust may be distributed to a beneficiary. The beneficiary, rather than the estate or trust, will then pay any income taxes associated with the distribution at the beneficiary’s individual tax rate.  For example, a beneficiary who pays income taxes at a rate of 24 percent would pay less income tax on the distribution amount than a trust being taxed at the top tax rate of 37 percent (or even 40.8 percent).  In cases of an estate or trust with a large amount of taxable income and beneficiaries in lower tax brackets, the tax savings can be significant.

State income tax consequences may also apply to distributions made from a trust or estate, and there may be limitations on the amounts of distributions a fiduciary can apply using the 65-day rule.  It is recommended that you discuss all possible consequences with your tax advisor before trying to apply the rules discussed above.     

Now that the new year has arrived, it is a good time to catch up on the latest tax rates for estate and trust income tax brackets and exemption amounts for estate, gift and generation-skipping transfer (GST) taxes in 2021. The Internal Revenue Service adjusts these figures annually for cost-of-living increases.

Below is a summary of the 2021 figures. The original news release from the IRS may be found here.

2021 Gift, GST and Trusts & Estates Income Tax Rates

Gift tax: The lifetime gift tax exemption for gifts made during 2021 is $11.7 million (increased from $11.58 million in 2020). The top marginal rate remains 40 percent. The gift tax annual exclusion amount remains $15,000. The annual exclusion for gifts made to noncitizen spouses in 2021 is $159,000 (increased from $157,000 in 2020).

GST tax: The GST tax exemption amount, which can be applied to generation-skipping transfers (including those in trust) during 2021, is $11.7 million (increased from $11.58 million in 2020). The rate remains 40 percent.

Income tax: The tax rate schedule for estates and trusts in 2021 is as follows:

This holiday weekend, you may have tackled your holiday shopping with deals from Black Friday, Small Business Saturday and Cyber Monday. Now, you may wish to join Giving Tuesday and add charitable giving to finish your holiday shopping! 

This year, thanks to the CARES Act, there are unexpected benefits to your charitable gifts.

Even if you do not itemize your income tax deductions, you may wish to make a gift to your favorite charity again. This is because the CARES Act includes a provision for those claiming the standard deduction. Starting in the 2020 tax year, an individual is eligible to claim $300 for cash contributions to charities in addition to the standard deduction. Although the CARES Act does not specifically mention married couples filing jointly, if the deduction is per individual, the hope is that there is $600 charitable deduction for a married couple.

Individuals who itemize their deductions and make substantial charitable giving can be limited in the deductible amount available for charitable contributions made during a calendar year. These limits are typically determined by a percentage of the individual’s adjusted gross income (AGI). For individuals who itemize, the CARES Act removes the 60 percent of AGI limitation for qualifying cash contributions to public charities made in 2020. Taxpayers may now deduct up to 100 percent of their 2020 AGI for qualifying cash contributions.  Importantly, this applies only to contributions made up to Dec. 31, 2020.

For both charitable giving incentives, one must give cash, as it does not apply to donations of stock, real estate or other non-cash types of property (such as cars). Thus, these cash contributions are best made by check or credit card.

To take advantage of these benefits under the CARES Act, the contributions must be to public charities – not private foundations supporting organizations or donor-advised funds. For a sizable gift, it is a best practice to confirm whether the entity to whom a gift would be made is a public charity. 

Lastly, even though the CARES Act removed the requirement for many to take their Required Minimum Distributions.  You may still wish to make a Qualified Charitable Distribution to your favorite charity.  For individuals who are over 70½, with a Qualified Charitable Distribution, you can make a charitable donation up to $100,000 directly to your favorite public charity from your IRA without being taxed on the distribution.

In 2020, the estate/gift and generation-skipping (GST) transfer tax exemptions are each $11.58 million per person, and the tax rate for each is 40 percent. These exemptions will be reduced to $5 million (indexed for inflation) on Jan. 1, 2026, assuming Congress does not change the exemptions sooner.

Given the increasing national debt due to 2020’s numerous challenges and a looming election that could potentially see a change in control of Congress and the White House, many believe these exemptions may be reduced before 2026. The problem with a wait-and-see approach is the possibility that any new federal tax law passed later in 2021 could be enacted retroactively to Jan. 1, 2021.

Although Democratic presidential nominee Joe Biden has not announced specific plans for estate/gift or GST tax reform if he is elected, he has referred to returning the estate tax to 2009 levels. In 2009, the estate and GST exemptions were each $3.5 million, the gift exemption was $1 million, and there was a 45 percent tax rate. If the estate tax exemption is reduced from $11.58 million to $3.5 million, then that difference (based on a 45 percent tax rate) will cause an additional $3.6 million of tax. In other words, if you use all of your current exemption through gifting before it is reduced to $3.5 million, then your heirs could inherit an additional $3.6 million (or $7.2 million if you are married) as a result of your planning.

It is anyone’s guess as to whether the estate/gift or GST tax exemptions will be reduced, what the new exemptions might be, and whether the change will be retroactive. The important point is that there is a chance your ability to take advantage of the current exemptions may expire soon (many think on the last day of the year).

If you have a taxable estate (currently over $11.58 million for an individual or $23.16 million for a married couple), then making a gift to utilize your exemption is likely a good tax decision, even if the exemption is not reduced at the end of the year. However, this decision is more complex for families who may need access to the gifted assets in the future. If you to decide to use some portion of your remaining exemption, keep in mind the benefits of utilizing discounted assets and a “grantor trust” to save further taxes.  

The older you are, the more it makes sense to use your remaining exemption now. Younger clients will likely live to see the estate tax laws change many more times, lessening the urgency of any planning.

Whether you initiate end-of-year planning may come down to how important it is to save additional taxes for your children and how likely you think it is Congress will pass a retroactive law decreasing the estate tax exemption.

For the parents of students entering college this fall, there are some unique challenges in store. In navigating all the changes related to the pandemic’s effect on college students, it’s possible you are missing one of the most important items: Having your child sign durable powers of attorney.

Why is this important?

Once your child turns 18, you will no longer have the right to make medical or financial decisions on his or her behalf, regardless of the fact that you are paying tuition, carrying him or her on your medical insurance and providing other financial assistance. Therefore, every adult, including your college-age child, should have, at minimum, a current medical directive and durable power of attorney for health care decisions as well as a durable power of attorney for financial matters in place. These documents allow your adult child to appoint someone trusted to make medical and financial decisions on his or her behalf in the event he or she is unable to do so (even temporarily). If your child has assets in his or her name, a will or revocable trust may also be appropriate.

Whether a routine surgery is needed or something catastrophic occurs, the durable powers of attorney will ensure medical decisions are made and financial transactions are carried out seamlessly and without lengthy, expensive court proceedings. Whether your college student is studying online or in a faraway location this Fall, with a little planning, you can ensure his or her immediate needs can be met if and when life gets off track.

Durable power of attorney for health care decisions/medical directive: This is simply a document that states an individual’s desires concerning health care treatment, including “heroic” measures such as artificial nutrition and hydration, and resuscitation, in the event a qualified physician determines that the individual is either in a “terminal” medical condition or is unlikely to regain consciousness. The document also designates one or more agents who are authorized to consent to, or direct the withholding of, health care measures. These agents can also access the individual’s medical records and speak with the medical providers, which can give a parent peace of mind should something happen to his or her adult child at school.

Durable power of attorney for general financial matters: This designates one or more individuals, having broad powers relative to financial, business and other transactions. Customarily, these durable powers of attorney for college-age children are immediately effective. The adult child designates a parent or other trusted individual as the “attorney-in-fact” to make financial and related decisions on his or her behalf, pay bills and deal with landlords. A durable power of attorney that is effective immediately can also allow a parent to access the adult child’s college financial records and manage student loans.

There is never a better time to sign durable powers of attorney than right now — well before they are ever needed or the unexpected takes place. While this is always true, the continued presence of COVID-19 makes it more relevant than ever. The peace of mind and protection these simple yet powerful documents offer make them well worth the minimal costs incurred to create them. 

Read more about durable powers of attorney during the pandemic in our recent post “Planning During a Pandemic: How an Estate Plan Can Give You Peace of Mind.”

Link to COVID-19 Resources page

The IRS has posted an Economic Impact Payment Information Center that addresses many frequently asked questions regarding the stimulus payments authorized by the CARES Act. However, like many things related to the act, there are remaining questions and gray areas not contemplated by the act or fully addressed at this time by the IRS. One of these questions is how to address the receipt of a payment for a deceased individual.

Many individuals have received direct deposits or jointly issued checks for their deceased spouses, while others have received checks sent to the last known address of their deceased loved one. Some of these checks have even had a “DECD” designation in the address, which indicates the IRS was aware that the individual was already deceased when it mailed the payment. There are also directions on the envelope of physical checks indicating that “if deceased,” to check the box on the envelope and drop it in a mailbox.

On May 6, 2020, the IRS published additional guidance to the Information Center with Question 10, “Does someone who has died qualify for the Payment?” This guidance was then updated on May 26, 2020. These new guidelines request the return of payments sent to any deceased individuals. This includes the direction for a partial return of $1,200 for payments made to married couples in error, as well as the return of the relevant physical check to the IRS for individual payments. The IRS then answers that the check should be returned for anyone who “died prior to the receipt of the payment.” Instructions for the return of the check or funds are included in a newly added Question 54.

The spouse or family member of a deceased individual may have received a check they have been able to deposit into a personal or joint bank account. The IRS is still directing that these payments should be returned. Likewise, a deposit into an estate or trust account appears to also be prohibited by the CARES Act because the definition of “eligible individual” specifically excludes an estate or trust.

Although not addressed in the act, the newly added guidelines state that the funds must be returned if the individual passed before the receipt of the check. In practice, this means funds directly deposited into an account the day before an individual passed would not need to be returned, but a check received in the mail one day after that individual passed would be subject to the instruction to return it to the IRS.

The IRS has not yet published any information on the possible penalties for the failure to return an improperly issued payment, nor is this addressed in the CARES Act.

For more information about what to do if you have received a joint or individual payment addressed to a deceased individual, please contact our Trusts & Estates group.

Link to COVID-19 Resources page