By Ruder Ware Estate Planning Attorneys
February 14, 2022
You likely are aware, from the news and our prior communications, that Congress currently is considering proposals that may have a significant impact on many estate plans. Although we still cannot be certain which, if any, of the proposed changes will become law, we want to provide you with an overview of their potential effect on many estate planning situations.
You may have heard about two proposals introduced in Congress last year. One is a bill sponsored by Senators Sanders and Whitehouse commonly referred to as “For the 99.5% Act.” The other is the “Sensible Taxation and Equity Promotion Act of 2021,” or “STEP Act,” submitted as a discussion draft by Senator Van Hollen and others. A summary of each of those proposals is included below.
After the Sanders and Van Hollen proposals were introduced, the White House released its “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals.” This document, similar to documents released by prior administrations, is often referred to as the “Green Book” and, while it has no force of law, it provides insight into the Administration’s agenda for revenue-generating changes to the federal tax laws.
Congress is in the process of establishing the fiscal year 2022 budget, and we do not know whether or to what extent it will incorporate the Sanders, Van Hollen, or Green Book proposals. However, given the potential impact of these proposals on estate planning, we believe it is best to be aware of them so that you can consider whether to take action to change your estate plan now.
Summary of Proposed Changes
The following is a high-level summary of some of the provisions in the Sanders, Van Hollen, and Green Book proposals and how they might affect your estate plan.
Estate tax exemption and rates
The Sanders bill proposes a decrease in the estate tax exemption to $3.5 million, down from the current $12.06 million exemption. That would reduce the exemption amount by roughly $8.5 million. In addition, the Sanders bill would increase the estate tax rates, creating a graduated series of rates beginning with a 45% rate (as opposed to the current flat rate of 40%) with a top rate of 65%. The following example illustrates the impact of these changes:
The estate of a person who dies today leaving assets valued at $11 million would not pay any federal estate tax under the current law (assuming the person had made no prior taxable gifts). Under the changes proposed by the Sanders bill, that person’s estate would pay approximately $3.4 million in federal estate tax, unless the person had “inherited” exemption from a previously deceased spouse, or the estate passed in a way that qualified for an estate tax deduction (e.g., to a surviving spouse or charity).
If these changes are enacted, many more families will need to consider the effects of the federal estate tax when making decisions regarding their estate plans.
Unlike the Sanders bill, neither the Van Hollen proposal nor the Green Book includes a reduction in the estate tax exemption or an increase in estate tax rates. However, these have been targets for change in order to increase revenue in recent history, and it is still possible that changes to the exemption and rates could make their way into budget legislation.
In addition to changing the estate tax exemption, the Sanders bill also proposes a reduction in the exemption for lifetime gifts to $1 million. Currently, the gift tax exemption is the same as the estate tax exemption, essentially allowing an individual to use all or a portion of the $12.06 million exemption on gifts made during life rather than waiting to use it at death. Lifetime gifting strategies can be an effective and efficient way to use the exemption amount, if properly implemented with the right assets. The reduction in the gift tax exemption would limit the effectiveness of several lifetime gifting strategies.
The Sanders bill would also place limitations on gifts that qualify for the gift tax annual exclusion (currently $16,000 per beneficiary), limiting each person to a cumulative amount equal to twice the annual exclusion for certain types of gifts, including gifts in trust. These changes could disrupt estate plans that include a pattern of annual gifting to trusts, particularly irrevocable life insurance trusts.
Neither the Van Hollen proposal nor the Green Book includes changes to the gift tax exemption or the gift tax annual exclusion but, as indicated in the section above relating to the estate tax exemption and rates, such changes may well be included in any legislation ultimately adopted.
Gain Recognition on Death for Gifts and Property in Trust
Both the Green Book and the Van Hollen draft propose an elimination of the “step up” in basis for property passing at death. Under current law, as a general rule, property passing by reason of a person’s death receives a step up in income tax basis to fair market value at the time of death (with an important exception for interests in retirement plans, such as IRAs). This essentially eliminates any built-in capital gain existing at the time of death, so that the beneficiary receiving the property only has to pay tax on gains accruing after the date of death if and when the property is sold.
Both the Van Hollen and the Green Book proposals would eliminate the basis step up and would instead cause the estate to recognize the gain on property passing at death as if the property had been sold, causing the gains to be subject to income tax at that time.
In addition, the Van Hollen and Green Book proposals would cause gain recognition on property transferred by lifetime gift and would require certain trusts to pay capital gains tax on trust property on a periodic basis. The Green Book proposal would also require such periodic gain recognition for property held by partnerships and other non-corporate entities. The change in basis rules is especially important to consider in connection with another Administration proposal: taxing long-term capital gain as ordinary income (the same as short-term capital gain).
Other Changes: Grantor Trusts, GRATs, Valuation Rules, Generation Skipping Transfers
The Sanders and Van Hollen proposals include a number of other changes relating to particular estate planning techniques, including trusts often referred to as “grantor trusts” and grantor retained annuity trusts (GRATs). Both proposals also change the rules relating to the valuation of family-owned corporations, LLCs, and partnerships for gift and estate tax purposes. The Sanders bill includes a provision limiting the use of the generation skipping transfer (GST) tax exemption.
When Will These Changes Occur?
As mentioned, it is not possible to know with any degree of certainty which, if any, of these changes may occur, and when they will occur, if at all. It is important to note that while certain changes in the Van Hollen proposal were drafted to apply retroactively to January 1, 2021, neither the elimination of the step up in basis described in the Green Book proposals nor the proposed reduction in the gift and estate tax exemptions as drafted in the Sanders bill would apply until January 1 of the year of enactment. This could provide an opportunity for individuals who can afford to and wish to take advantage of the current exemption to do so by making gifts before the effective date of any law change. However, given that the Van Hollen proposal is drafted to be effective at the beginning of the year of enactment, using the gift tax exemption with appreciated property runs the risk of gain recognition. Many do not think any such proposal relating to gain recognition will be retroactive, as the Administration’s Green Book does not suggest a retroactive effective date for its similar proposal, but it is important to be aware of this risk.
In addition, other proposals relating to grantor trusts, GRATs, and valuation rules are currently drafted to be effective immediately after the date of enactment and (in the case of certain proposals relating to grantor trusts) may provide “grandfathering” for trusts created prior to the date of enactment. Accordingly, in some cases, individuals who could benefit from these estate planning arrangements may wish to consider implementing them before any new legislation is enacted.
What You May Wish to Do
Given the number of proposed changes, and the uncertainty as to which proposals ultimately will become law, it is not possible to make a general statement about how individuals should react to them. Estate planning always requires analysis of each client’s situation and goals, but that is especially true with respect to these proposed law changes. They stand to have a disparate impact on any particular individual or family, depending on their level of wealth, the assets involved, and the extent to which a prior estate plan has been put in place.
We encourage you to contact any member of our Estate Planning Team so that you can discuss the potential impact of these proposals on your estate and financial plans. We can also discuss, if you wish, what options you have if you want to take advantage of the current more favorable rules before they change.
The content in the following blog posts is based upon the state of the law at the time of its original publication. As legal developments change quickly, the content in these blog posts may not remain accurate as laws change over time. None of the information contained in these publications is intended as legal advice or opinion relative to specific matters, facts, situations, or issues. You should not act upon the information in these blog posts without discussing your specific situation with legal counsel.
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