After passing a $3.5 trillion budget resolution earlier this year, Congress tasked the House Ways and Means Committee with a monumental assignment: Come up with the money to pay for it! On September 13th, the House Ways and Means Committee Chairman introduced its budget reconciliation recommendations, and by September 15th, the Committee approved the same, which now go to the House Budget Committee to be added to the rest of a $3.5 trillion reconciliation bill. It is important to remember that these recommendations may never become law in their proposed form. However, seeing as some sort of tax changes are highly anticipated this year, and given the fact the Committee’s recommendations have officially laid the groundwork for possible reforms, we must all remain vigilant as this legislative process moves forward. Those who anticipate the tax changes and are prepared to be proactive in order to take advantage of the existing tax laws stand to achieve significant tax savings, and those who do not do so at their own peril.
The following is a brief overview of some of the estate and gift tax related proposals made by the Committee:
Estate, Gift and Generation-Skipping Transfer Tax Exemptions
For gifts and estate of individuals dying after December 31st of this year, the Committee has proposed a reduction in the combined lifetime gift / estate tax exemption to $5,000,000 adjusted for inflation with the base year being 2010. Some commentators and analysts have estimated this adjusted exemption amount will be around $6,000,000 per person; a near 50% reduction from the current amount of $11,700,000. While the current tax law provides for this same reduction to occur as of January 1, 2026, this proposal is a clear and aggressive acceleration of that provision.
On the bright side, however, the Committee’s proposal does not recommend the elimination of portability (i.e., a surviving spouse’s ability to “inherit” their deceased spouse’s unused exemption), nor is there any mention of eliminating or modifying the cost basis adjustment at death provisions of the existing law. Seeing as some change to the cost basis adjustment rules was previously proposed by President Biden himself, however, we may very well see this issue resurrected in future legislation.
Changes to Grantor Trust Rules
Grantor trusts, often considered the bread and butter of sophisticated estate planning professionals and used in a variety of estate tax “freeze” techniques such as installment sales without recognition of gain on appreciated assets, as well as family gift planning techniques where the grantor can remove assets from their taxable estate while still retaining responsibility for the payment of income taxes incurred from those assets at no additional gift tax cost, have also found themselves on the chopping block as a result of the Committee’s proposal. Under the Committee’s recommendations, for transfer tax purposes:
1. Upon the death of a deemed owner of a grantor trust, the assets of the grantor trust will be included in the gross estate of the deemed owner;
2. If a distribution is made from a grantor trust, the distribution will be treated as a gift for gift tax purposes (unless the distribution is to the deemed owner or the deemed owner’s spouse, or discharges an obligation of the deemed owner); and
3. If the grantor trust status is terminated during the deemed owner’s lifetime, the deemed owner will be treated as having made a gift of the assets of the grantor trust.
The effect of this proposal appears to subject the appreciation of any asset transferred to the grantor trust to estate and/or gift tax, as applicable.
In addition, for income tax purposes:
1. Where there is a transfer of property between the grantor trust and the deemed owner, unless the trust is fully revocable by the deemed owner, the grantor trust rules are ignored in determining whether the transfer is a sale or exchange for income tax purposes;
2. A deemed owner and the grantor trust will be considered related parties, effectively disallowing any loss resulting from a sale or exchange between the deemed owner and the grantor trust.
Since these rules only apply to sales and exchanges between the deemed owner and the grantor trust, we may optimistically assume that a deemed owner and a grantor trust can enter into other transactions, such as rental arrangements or loans, which will continue to be disregarded for income tax purposes.
These proposals, if enacted, will apply to trusts created on or after the date of enactment of the new tax law, as well as to any portion of a trust established before the date of enactment that is attributable to a contribution on or after the date of enactment.
Valuation Rules for Non-Business Assets
Under this recommendation, when valuing an individual’s ownership interest in a privately-held entity for transfer tax purposes:
1. Any non-business assets owned by the entity will be disregarded;
2. The non-business assets will thereafter be valued separately (as if the individual had transferred those assets directly to the transferee); and
3. No valuation discount will apply when valuing the non-business assets.
For purposes of this proposal, a “non-business asset” is any passive asset that is held for the production or collection of income and which is not used in the active conduct of a trade or business (with certain exceptions for real property used in the active conduct of a real property trade or business in which the transferor materially participates, as well as passive assets held as a part of the reasonably required working capital of a trade or business).
The provisions of these proposals would apply to any and all transfers occurring after the date of enactment.
Contact John R. Tullio, Jr. at 216.472.4619, or [email protected].