Senate estate and gift tax proposals offer clues on possible changes

| 5/27/2021
Senate estate and gift tax proposals offer clues on possible changes

President Joe Biden’s American Families Plan (AFP) includes several proposals that would increase taxes on wealthy individuals, including increased estate and gift taxes. The U.S. Department of the Treasury’s much anticipated Greenbook will provide further details on these proposals. However, more progressive members of President Biden’s party have put forward estate and gift tax proposals that will have to be reconciled with the administration’s proposals before legislation can move forward. Two Senate proposals provide insight into the progressive estate and gift tax changes that currently are part of the negotiations between the White House and Congress.

For the 99.5% Act

Sen. Bernie Sanders introduced the For the 99.5% Act in the Senate on March 25. The bill includes many proposals dating back to the 1990s and has Democratic support. Following are highlights of the bill:

  • The bill reduces the estate tax exclusion from the current $11.7 million per person to the pre-Tax Cuts and Jobs Act of 2017 (TCJA) exclusion amount of $3.5 million. The bill also provides that only $1 million of that exclusion can be used during a lifetime against taxable gifts. In addition, the bill increases the tax rate from the current 40% to a top rate of 65%. These changes would apply to estates of decedents dying after Dec. 31, 2021, and to generation-skipping transfers and gifts made after Dec. 31, 2021. 
  • The bill effectively eliminates many currently used estate planning techniques, such as grantor retained annuity trusts (GRATs). If passed, the minimum term for a GRAT would be 10 years, and the minimum remainder interest (taxable gift) would be $500,000. Appreciated assets held in a GRAT are not included in an individual’s estate, and transferring the property to a GRAT does not result in gift tax or use any of the individual’s exclusion amount. Given that GRATs could be severely limited in the future if the bill is enacted, individuals who already have used their entire gift tax exemption should consider whether it makes sense to create multiple GRATs now.
  • The bill includes assets held in an intentionally defective irrevocable trust (IDIT) in the grantor’s taxable estate, effectively ending a common estate planning technique for trusts created after date of enactment. Taxpayers should consider and implement sales to IDITs now in order to take advantage of this planning technique in the event this provision is enacted.
  • The bill changes how the annual gift tax exclusion is determined. Currently, the annual gift tax exclusion is determined solely on a per-recipient basis (currently $15,000). Under the bill, gifts in trust and gifts of interests in a pass-through entity would be limited to no more than two times the annual exclusion ($30,000 per donor). This limitation would affect individuals with irrevocable life insurance trusts, which are trusts that hold life insurance for which the donor of the life insurance makes gifts to the trust to pay the annual insurance premiums.
  • The bill provides for limitations on valuation discounts for lack of control and lack of marketability, which would virtually eliminate discount planning. In addition, the bill eliminates the step-up in basis for assets currently held in an IDIT and limits dynasty trust planning to 50 years.
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Sensible Taxation and Equity Promotion (STEP) Act

On March 29, Sen. Chris Van Hollen and several co-sponsors released a discussion draft of the STEP Act. Currently, appreciated assets transferred at death are not subject to income tax, and the heirs get a step-up in basis for such assets. The STEP Act instead would treat transfers of appreciated assets as lifetime gifts or, at death, as deemed sales, thus creating capital gain recognition for income tax purposes. The proposal includes an exclusion for the first $1 million of gain, although only $100,000 of this exclusion could be used to offset gain on lifetime gifts.

The STEP Act includes exceptions to the general rules including transfers of certain tangible property, gifts, and bequests to the transferor’s spouse, to charity, to disability trusts, or to cemetery perpetual care funds.

The act also provides that property held in a nongrantor trust is deemed to have been sold every 21 years, with no exemption for the first $100,000 or $1 million of gains. In addition, the proposal requires any trust with an aggregate value greater than $1 million or with gross income in excess of $20,000 to file an annual accounting of all trust activities with the IRS. 

Looking ahead

No one can predict what the future holds and whether these proposals will be included in legislation currently being negotiated. However, even if these proposals are not enacted, the current estate and gift exclusion of $11.7 million to $12.6 million is set to return to the pre-TCJA level with an inflation adjustment, or $6.3 million, on Jan. 1, 2026. Therefore, regardless of the potential estate and gift tax changes that could be enacted this year, individuals should consider using this higher exclusion now.

During this period of uncertainty, it might be prudent for a surviving spouse to extend the due date for filing the estate tax return of a deceased spouse if the death occurs before any of the proposed changes to the estate and gift tax are enacted. Typically, no estate tax is due at the death of the first spouse. However, if legislation is enacted to increase estate and gift taxes, opting to pay tax upon the death of the first spouse could reduce overall estate taxes paid by the couple.

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Sally E. Day
Sally Day
Managing Director