Let’s Dance the 2-Step!
Tax advisors and affluent Americans have been working hard to place ownership interests in LLCs and other entities holding their investments under specially designed irrevocable trusts, as gifts or in exchange for promissory notes, in order to have arrangements in place well before the signing of a new estate tax law that may prevent, or greatly curtail, the benefits associated therewith.
Both the Bernie Sanders proposed legislation, and the September 13th House of Representatives Ways and Means Committee bills, would have drastically reduced the $11,700,000 per person estate and gift tax exemptions, and the most popular and effective estate tax techniques, but would grandfather in what is completed before these proposed new laws were signed.
For many of us, it was beginning to feel like loading people into life rafts on the Titanic, because there were many more families and assets than there were resources, such as lawyers and hours in the day, given the many thousands of Americans whose families would become subject to a 40% federal estate tax, if they did not act promptly enough.
The situation has been exacerbated by a rising stock market and swelling real estate values.
The primary threats have been the reduction of the estate tax exemption from $11.7 million to approximately $6 million next year, the inability to make transfers to a trust that would be disregarded for income tax purposes, and the inability to value partial or non-voting ownership interests in LLCs and other entities at a discount.
Only a day or so ago, it was expected by many that there would be a billionaire tax instead, but maybe the billionaires communicated with their Senators and Congressmen (“their” as meaning the Senators and Congressmen where they live, as opposed to ownership, but I am not sure which is which), causing us to think that a uniform haircut for all taxpayers having over $6 million a person might be expected.
Then, just as time seemed to be running out, and as we waited with bated breath to see what President Biden would say today, and in particular, whether he would have 50 Senators cooperate with any of the estate tax exemption legislation, we heard……………………nothing.
President Biden did not mention estate taxes, so thousands of tax professionals, and families, did not know whether to breathe or not, or to maybe breathe easier, but not as easy as hoped for, but we can breathe easier now because a “Build Back Better Framework” document was released by The White House Briefing Room providing a few pages of summary documentation on tax increases that do not include any of the formerly proposed federal estate tax rule changes described above, or the other proposed changes that would have done away with Grantor Retained Annuity Trusts, certain Charitable Lead Annuity Trusts, Qualified Personal Residence Trusts and exchanging assets tax-free between grantors and trusts they have established. Spousal Limited Access Trusts (“SLATs”) became a household word, and will continue to be very popular. [ See Forbes Blog Estate Tax Law Changes – What To Do Now, September 14 2021, https://www.forbes.com/sites/alangassman/2021/09/14/making-the-right-steps-in-view-of-yesterdays-estategift-tax-proposals/?sh=61dce730382f ]
This does not mean that this cannot be brought in later, but at this time it is at least unexpected.
Many families used what is known as the “Biden 2-Step,” by making a relatively small gift to an irrevocable trust and then selling LLC or other interests to the trust in exchange for a long-term low interest rate promissory note. That was Step 1. Step 2 would be to forgive the note immediately before passage of an estate tax exemption balance reduction, or whenever the donor was ready to do so. Now Step 2 may not have to happen, and the donor can retain the note, and a higher degree of personal financial stability having future growth in value outside of his or her estate, while he or she pays the income tax on the income earned by the trust, and receive small income tax-free interest payments from the trust.
So now there are thousands of high wealth family trust plans in place, or being put into place, that will still be needed when the estate tax exemption comes down to half of the otherwise applicable level in 2026, or before that, or when their asset values rise above the limits, even if they do not come down.
Instead, we have new Medicare taxes on high earners who use S corporations and partnership entities to shield themselves from this 3.8% tax, a surtax on those individuals who have income exceeding $400,000 a year, a reduction in the loopholes available for companies and individuals who use foreign companies to avoid or defer income, and limitations on business loss write-offs, to name a few items.
The latest version of the Build Back Better Act was released today by the House Ways and Means Committee, and all 1,684 pages of it can be viewed be clicking here.
I will be discussing the above situation and other issues with Brandon Ketron in a free live Webinar on Saturday, October 30th, at 11:00 a.m. EST, and we will answer questions from the audience at that time. You can e-mail to info@gassmanpa.com for a free invite and replay link.
Thanks to all readers who have asked us great questions about estate and gift tax planning. I can now schedule a vacation with Marcia and the dogs, to be canceled if the flavor of the day becomes estate tax increases again.
Thanks to Brandon Ketron, CPA, J.D., LL.M for his input on this post.