A Tax Proposal Worth Monitoring

As you may have heard, the House Ways and Means Committee recently released its proposed 2022 budget legislation known as the Build Back Better Act. This proposed bill includes various tax proposals affecting both corporate and individual taxes, and impacting both the income and estate and gift tax regime. Some of those tax proposals were previously included in the tax plan released by President Biden as part of his Green Book in April; others were not included in that proposal and are likely the product of months of negotiation.

Currently, this is only a committee proposal that still must pass House negotiations and vote, as well as Senate negotiations and vote. Therefore, it seems likely that the final bill will differ somewhat from the current proposal. Nevertheless, the potential scope of the changes is large; therefore, many people will want to consider taking action before the new law goes into effect.

For purposes of this summary, we will focus only on the parts in this legislation that affect the estate and gift tax laws.

Most notably, the proposal would cut the available estate and gift tax exemption in half by eliminating the increased exemption amount, which was enacted in 2017. The increased exemption amount was previously going to sunset on December 31, 2025. However, this proposal would eliminate the increased exemption as of January 1, 2022. This means that the current exemption of $11.7 million would essentially be 50% less in 2022. Because of the annual inflation adjustment, the estate and gift tax exemption would likely be approximately $6 million per person in 2022. Therefore, those wishing to avail themselves of the increased exemption amount through lifetime gifting may need to act prior to the end of 2021.

Additionally, the proposed bill would severely restrict the use of grantor trusts. A grantor trust is a trust that is treated as being owned by the creator of the trust for income tax purposes, even though the assets in the trust have been transferred for gift and estate tax purposes. Essentially, under the proposed bill, the creator of the grantor trust would continue to be treated as the owner of the trust assets for gift and estate tax purposes. This means that such trusts would be included in the grantor’s estate at the time of death. If this change occurs, grantor trusts would no longer serve as a viable tool for transferring assets. The proposed law provides that the grantor trust changes would become effective for trusts created on or after the date of enactment and for contributions to existing trusts that are made on or after such date. Various types of grantor trusts, including GRATs, QPRTs, ILITs, and SLATs, may all be impacted by this legislation. Therefore, those considering the use of these vehicles may need to accelerate their decisions so that the assets are transferred to existing or newly created trusts prior to enactment. 

The final major proposed change in the bill that affects gift and estate tax laws is the elimination of valuation discounts for nonbusiness assets held by closely held businesses. Currently, the value of an interest in a closely held business is typically subject to discounts for lack of control and lack of marketability. The availability of such discounts has been an additional incentive for many people to form closely held entities for business purposes that may not be defined as “active” business purposes. Moving forward, if this bill becomes law, no discounts would be applicable to such assets for estate and gift tax purposes if such assets are not necessary for the active conduct of the trade or business.

While the bill includes various provisions that would serve to increase the transfer tax liability owed by many families, it is worth noting that certain provisions that had been anticipated were not included. First, the proposed bill does not provide for a loss of the step-up in basis, which currently applies at death. The president’s prior Green Book tax proposal included this provision, and many people feared the loss of the step-up in basis that has been a fixture of tax law for many years. Second, the bill does not increase the transfer tax rate beyond the current rate of 40%. There had been some discussion of this rate being increased for larger estates, but no such adjustment was included. Additionally, the bill does not affect your ability to use all of your available exemption through lifetime gifting. There had been some discussion of only allowing people to use $1 million of their exemption through gifting. Again, such provision was not included in this proposal; therefore it seems the full $6 million exemption could be used during one’s lifetime. Finally, the proposed bill does not remove the ability of the surviving spouse to preserve the unused exemption of the first spouse to die—a concept known as portability. Therefore, married couples essentially are able to double their exemption amount with regard to assets being transferred by the marital unit. 

At this point, it is wise to continue monitoring the progress of this proposed legislation. While there will likely be some modifications to the proposals discussed above, it seems likely that some changes to the gift and estate tax laws are coming in the near future. For those who have been considering doing some lifetime gifting in order to transfer assets out of their estates, we would highly recommend moving forward with such planning prior to the enactment of any legislation.