The Build Back Better Act is inching closer to a vote. While we anticipate the final version will have some compromises, the opportunities for tax planning are beginning to take shape.
A lot has changed in the few months since we analyzed the US Treasury’s “Green Book” proposals in June.
Here we review the current version of the proposed tax legislation and interpret what it means for you and your estate tax planning.
Estate Tax
Reduced Lifetime Gift and Estate Tax Exclusion
The proposed lifetime exclusion amount for 2022 is expected to be $6,020,000, a significant reduction from the current $11,700,000 exclusion in 2021. The Tax Cuts and Jobs Act (TCJA) of 2017 doubled the lifetime exclusion from $5,000,000 to $10,000,000. The exclusion is indexed for inflation. The increased exclusion was scheduled to expire after 2025. The proposed legislation would accelerate the expiration to December 31, 2021.
The IRS has confirmed that gifts made during the higher exclusion years will not be “clawed back” into a decedent’s taxable estate when the exclusion amount is reduced.
All prior years’ gifts count toward your lifetime gift and estate exclusion. If your current aggregate gifts are less than the then current exclusion amount (proposed to be $6,020,000 in 2022) you can make future gifts up to the then current limit.
Deceased Spousal Unused Exclusion (DSUE)
The DSUE, sometimes referred to as “portability’’, is the unused portion of a decedent’s lifetime exclusion. An estate can elect to transfer the unused exclusion to the surviving spouse. If your spouse died while the higher exclusion amount was in effect, the portion transferred to you would not be affected by the current exclusion amount. For example, if your deceased spouse’s unused exclusion was $10,000,000, and you timely filed Form 706 to claim the DSUE, you would have a total estate exclusion of $16,020,000 in 2022 under the new proposal.
Stepped Up Tax Basis at Date of Death
The current version of the proposal does not change the basis step up provision. Inherited assets will continue to have a new tax basis equal to their fair market value at date of death. The loss of basis step up was highly unpopular and would have been difficult to administer.
Estate and Gift Tax Rate
There is no proposed change to the estate and gift tax rate. The top rate applicable to taxable estates is expected to remain at 40%.
No Gain Recognized at Time of Death or Transfer
The proposal does not require gain recognition at time of death or on transfer of assets. Assets gifted during life will retain the original owner’s tax basis. Assets held at death will not be subject to capital gains tax on their unrealized gains.
No 90-Year Gain Recognition
The current proposal does not include a tax reassessment on untaxed appreciation in legacy trusts. Initial drafts called for taxing unrealized gains held in trusts every 90 years. This proposal is not included in the tentative legislation.
Trust Tax
Grantor Trust Limitations
The estate tax planning benefits of grantor trusts would be limited under the proposed tax law changes. Grantor trusts are used to remove assets from a taxpayer’s estate while retaining control and paying the tax on the income generated. Proposed limitations include:
- Assets held in the grantor trust would be included in the decedent’s taxable estate.
- Distributions from the trust would be treated as taxable gifts.
- Termination of grantor status would be treated as a taxable gift.
- Sales between a grantor trust and the grantor would be treated as a taxable transaction.
These proposed changes are expected to go into effect as of the date of enactment. Trusts already in existence and gifts completed prior to the date of enactment would be grandfathered in.
The new law would apply to trusts created and transactions completed after the effective date. We suggest speaking with your estate attorney immediately to discuss whether your trust funding and distribution plans should be revised before these proposals are enacted.
Loss of Valuation Discounts
Discounts for lack of control and lack of marketability are frequently used to reduce the value of fractional interests in investment partnerships and LLCs. Under the proposed legislation, valuation discounts would no longer be available for transfers of non-business assets.
The proposed legislation would apply to future transfers of interests regardless of when the Family Limited Partnerships (FLPs) or other investment entities were created. Transfers made after the date of enactment would be valued at full fair market value to the extent that they include passive assets held for the production or collection of income.
Discounts would still be available for assets used in an active trade or business. Discounts claimed on transfers completed prior to the date of enactment would be allowable.
Trust Income Tax Surcharge
The proposal includes an additional 3% tax surcharge applicable to trusts reporting modified adjusted gross income above $100,000. The additional tax would apply to income taxed at the trust level for tax years beginning after December 31, 2021. Trust income that is ultimately taxed on an individual return, either through a revocable trust or a K-1, would not be subject to the surtax at this income threshold.
Next Steps
We reiterate our recommendation to reach out to your estate attorney to discuss how these proposed changes might affect you and what actions you should take, or be prepared to execute quickly, should the legislation be enacted. Congress has indicated they intend to vote on these proposals this month.
Please contact us if you have any questions.
