When the Trump Tax Act was enacted in 2017, estate planning attorneys warned their wealthy clients the approximately $11 million lifetime federal estate tax exemption was not going to last forever. It was, and currently still is, scheduled to drop back down to $5 million (adjusted for inflation) on January 1, 2026 barring action by Congress. At the time, 2026 seemed far away and not many people were willing to part with such a sizeable gift in order to take advantage of the expansive estate tax exemption.
However, as the 2020 presidential election took shape and a democratic change of control began to look more likely, estate planning attorneys were inundated last year with clients wanting to make large gifts, mostly through the use of irrevocable trusts. The gifting “frenzy” has continued through 2021 as more people have grown concerned that the $11 million exemption would drop sooner than 2026 (and possibly lower than $5 million), given the government’s need to pay for pandemic related aid and to fund Biden’s new agenda.
They were right to worry. On September 13, 2021, the House Ways and Means Committee released a proposal for tax changes that gives the legislature a framework to work with. While this is just a proposal and nothing is set in stone, there are potentially many changes ahead that could impact longstanding estate planning strategies. Here is what you need to know about the proposal.
· The current $11,700,000 federal estate tax exemption amount would drop to $5 million (adjusted for inflation) as of January 1, 2022. The exemption amount would therefore be approximately $6,020,000 starting in 2022.
· The ability to use irrevocable trusts as a gifting vehicle to hold monies for spouses, children and grandchildren may be greatly impacted by the legislation. Many people make large lifetime gifts to irrevocable trusts for the benefit of family members and retain the ability to pay the income taxes on the trust assets. These so-called grantor trusts become another way to move additional monies to the next generation free of taxes. The proposal would include the assets of these trusts in the estate of the client on his or her death, thereby defeating a primary purpose of the trust. This would be effective for trusts created on or after the enactment date of the legislation. While we do not know if and when the legislation will pass, it could certainly happen this fall or before December 31 of this year. In order to take advantage of the current law, clients will need to create and fund any new gifting trusts prior to the date of enactment.
· Trusts that hold life insurance knows as ILIT’s (irrevocable life insurance trusts) would also be affected by the proposed legislation. The life insurance proceeds of ILIT’s that are signed and funded after the date of enactment would be taxed for estate tax purposes on the client’s death. This would defeat a primary purpose of the trust. Further, gifts to ILIT’s that had been signed prior to the date of enactment but funded post-enactment would see a prorated portion of the insurance proceeds taxed for estate tax purposes on the client’s death. People should consider pre-funding their existing ILIT with enough assets to pay the premiums in order to avoid a portion of their insurance proceeds being taxed on their death.
· When clients gift interests in family entities such as limited liability companies, they often take a discount on the valuation for lack of control or lack of marketability. The proposal would eliminate the availability of valuation discounts for entities that hold nonbusiness assets such as cash, equity and certain types of real estate as of the effective date of the enactment.
· No changes have been proposed to the federal estate tax rate. It would remain at 40%.
· The proposal also does not include an elimination in the step-up in basis at death, which had been widely discussed as a possibility.
While the legislation process has just begun, this proposal gives us a road map to work with. If you want to create a new trust or gift to an existing trust, do it now before any legislation is enacted. If you wait until later in the year, it may be too late.