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Legacy Matters
BlogsPublications | November 3, 2021
5 minute read
Legacy Matters

Update on Proposed Tax Changes Affecting Estate Planning

In September, we posted on the sweeping tax changes proposed by The Ways and Means Committee of the House of Representatives. Following weeks of negotiations between President Joe Biden and congressional Democrats, the White House released a retooled framework for the Build Back Better Act on October 28. This is essentially a scaled-down version of the President’s original $3.5 trillion spending package. Absent from this smaller $1.75 trillion package are some of the tax proposals that would have made fundamental changes to estate planning strategies.

Notable aspects of the Biden framework for the Build Back Better Act that will affect estate planning include:

Estate and Gift Tax Exemptions

The Biden framework does not include lowering the current estate, gift and generation skipping transfer (GST) tax exemptions before the previously scheduled sunset date of December 31, 2025. Estate, gift and GST tax exemptions will remain at $11.7 million, with increases allowed for inflation in 2022-2025.

Grantor Trusts

Grantor trusts – trusts whose taxable activity and income are reported on the income tax returns of the persons who created the trusts – have been a target of proposed legislation this year. The earlier proposal from the Ways and Means Committee would have greatly limited and restricted the use of grantor trusts, which have become widely used and extremely popular tools.

However, the Biden framework for the Build Back Better Act does not include any changes to tax laws related to grantor trusts.

Assuming none of the previously proposed changes make it back into the legislation, this is good news for those who have created, or wish to create in the future, grantor retained annuity trusts (GRATs), spousal lifetime access trusts (SLATs), irrevocable life insurance trusts (ILITs) or any other grantor trusts.

Valuation Rules

Also not included in this version of the Build Back Better Act are changes that would eliminate valuation discounts for entities owning passive assets. This is good news for those who hold, give or make intra-family sales of corporations, limited liability companies and limited partnerships owning assets such as real estate and marketable securities.

New Surtax on High Earners

The news is not all good. Replacing the dropped proposals are other revenue-raising proposals. The Biden framework includes new surtaxes that would negatively impact high-earning individuals and especially those who will earn over $10 million during a tax year. The framework includes the following:

  • A proposed surtax of 5% on modified adjusted gross income (MAGI) over $10 million for a single person or married persons filing jointly.
  • An additional surtax of 3% on MAGI over $25 million for a single person or married persons filing jointly (bringing the total surtax for this group to 8%).

The surtax could hit sellers of businesses or other highly appreciated assets hard. The surcharge would essentially create a top federal marginal tax rate of nearly 45% on taxpayers earning over $25 million. Note that this surcharge also applies to long-term capital gains and qualified dividends, making the top marginal rate 28% for these. In addition, after factoring in the 3.8% net investment income tax, high earners will pay 31.8% as a top marginal rate on capital gains and qualified dividends.

New Surtax on Trusts

The Biden framework would extend the new surtaxes to non-grantor trusts at relatively low levels of income. The framework includes the following:

  • A proposed surtax of 5% on MAGI of non-grantor trusts over $200,000.
  • An additional surtax of 3% on MAGI of non-grantor trusts over $500,000 (bringing the total surtax on these trusts to 8%).

Extension of Net Investment Income Tax to Certain Business Income

The existing 3.8% net investment income tax would be extended to apply to active business income of individuals, including passthrough income from S corporations and partnerships, unless the income is subject to FICA or self-employment taxes. The tax would apply to business income over $400,000 for individuals, $500,000 for married people filing jointly, and to trusts and estates.

Other Items Not Included in This Proposed Legislation

  • Limitations on the number and size of the annual exclusions from the gift tax were not included.
  • Proposals to limit the duration of dynastic-style trusts, which had been proposed earlier this year, were not included.
  • There is no provision to eliminate the “step up in basis” that occurs upon an individual’s death. Current law allows assets included in a decedent’s gross estate for estate tax purposes to receive an adjustment to their income tax basis equal to fair market value at the date of death, effectively eliminating unrealized gains and preserving more of a decedent’s assets for transmission to heirs and beneficiaries.
  • The top income tax rate of 37% and the top tax rate of 20% on investment income was not raised (except for those subject to the surtaxes).
  • Tax rates for C corporations were not raised.
  • None of the items included in this proposal would be retroactive to earlier in 2021. All items would be effective after December 31, 2021.

Negotiations Are Continuing

As of our publication date, the Build Back Better Act is still being debated and has not yet passed the House of Representatives or the Senate. As with any proposed legislation, we cannot predict whether this bill will pass both houses of Congress, nor can we predict what will be added, modified or deleted in regards to these proposals as they move through Congress.
If this proposed legislation moves forward in its current form, it provides clients more time to use traditional estate planning techniques. If you have questions about any of the proposals mentioned above, please contact your Warner estate planning attorney.