Proposed Tax Legislation Could Significantly Impact Your Estate Plan

Estate Tax Law

Recent news stories have been published about two bills introduced in the Senate that, if enacted, could have a significant impact on many estate plans. These bills include proposed changes that many estate planning professionals anticipated based on the 2020 election results and the increase in revenue requirements due to the pandemic and infrastructure proposals. Below we provide some additional information on these proposals and the effect they may have on estate plans.

The Proposals

The two bills currently under consideration are commonly referred to as “For the 99.5% Act,” which was introduced by Senators Sanders and Whitehouse, and the “Sensible Taxation and Equity Promotion Act of 2021,” or “STEP Act,” introduced by Senator Van Hollen and others. Each bill proposes several technical changes to the Internal Revenue Code. The details of these proposals are too extensive to cover in this newsletter, but below we offer a summary of what we think are some of the more notable changes. Please note that these proposals are separate from and in addition to the “Made in America Tax Plan” recently outlined by the Biden administration. That plan primarily deals with corporate income tax and is not discussed in detail in this newsletter.

Proposed Changes Affecting Estate Plans

Both the Sanders and Van Hollen bills propose changes to the federal tax law that not only may disrupt existing estate plans, but could significantly impact future estate planning as well. These changes, if enacted, would not only affect the amount that each U.S. citizen is able to pass free of estate tax at death (commonly referred to as the “estate tax exemption”) and the corresponding estate tax rates, but would also decrease the effectiveness of many common estate planning techniques.

Estate Tax Exemption and Rates

The Sanders bill proposes to decrease the estate tax exemption amount to $3.5 million. That would reduce the exemption amount by more than $8 million (the current exemption is $11.7 million). In addition, the Sanders bill would increase the estate tax rates, creating a graduated series of rates with a top tax 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 $4.7 million in federal estate tax, unless that same individual had “inherited” an exemption from a previously deceased spouse, or the estate passed in a way that qualifies for an estate tax deduction (e.g., to a surviving spouse or charity).

If a decrease in the exemption amount is enacted, most families will need to reevaluate the effects of the federal estate tax when making decisions regarding their estate plans.

Lifetime Gifts

In addition to changing the estate tax exemption, the Sanders bill also proposes to reduce the exemption for lifetime gifts to $1 million. Currently, the gift tax exemption amount is the same as the estate tax exemption amount, essentially allowing an individual to use all or a portion of the $11.7 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. This reduction in the gift tax exemption would limit the effectiveness of many lifetime gifting strategies.

The Sanders bill would also place limitations on certain types of gifts that qualify for the gift tax annual exclusion (currently $15,000 per beneficiary), limiting each donor of an annual gift to a cumulative amount equal to twice the annual exclusion. This would apply to gifts to irrevocable trusts or to other transfers of property that cannot immediately be liquidated by the donee. These changes could disrupt estate plans that include a pattern of annual gifting to trusts, particularly irrevocable life insurance trusts.

Gain Recognition on Death Assets for Certain Trusts

Under the existing tax laws, property that is included in an individual’s estate for federal estate tax purposes receives what is known as a “step up” in basis for income tax purposes. This means that the beneficiaries inheriting the property are not required to pay income tax on any capital gain built into the property, and a beneficiary’s basis in the inherited property, for income tax purposes, is adjusted to the fair market value at the time of death. This essentially eliminates any such capital gain at the time of death, so that the beneficiary only has to pay income tax on gains accruing after the date of death.

The Van Hollen bill would cause the estate to recognize the gain on property passing at death, as if the property had been sold, causing the gain to be subject to income tax at that time. The bill would also cause gain recognition on property transferred by lifetime gift (either outright or in trust) and would require certain trusts to pay capital gains tax on trust property on a periodic basis.

Other Changes: Grantor Trusts, GRATs, Valuation Rules, Generation Skipping Transfers

The bills include a number of other changes relating to particular estate planning techniques, including grantor retained annuity trusts (GRATs), trusts often referred to as “grantor trusts,” and the rules relating to the valuation of family-owned corporations, LLCs, and partnerships for gift and estate tax purposes. The Sanders bill also proposes changes to the application of the Generation Skipping Transfer (GST) tax exemption. It is not possible to cover the details of these proposals here, but be aware that they could substantially decrease the effectiveness of certain estate planning techniques in many cases.

When Will These Changes Occur?

At this time, it is not possible to know with any certainty whether and when these changes may occur. Neither of these bills has passed the Senate. It is possible that they may never pass, or that they will be amended before passing and moving to the House for consideration. It is important to note that certain changes are drafted to apply retroactively, to January 1, 2021. However, the proposed reduction in the gift and estate tax exemptions, as currently drafted in the Sanders bill, would not apply until January 1, 2022. If that bill is ultimately enacted into law bearing that effective date with respect to those exemptions, it would provide an incentive to take advantage of the current higher exemption amount by making gifts before the end of this year (although, on account of the Van Hollen bill, it may be best to carefully consider the type of assets used in making these gifts, so as not to transfer property with significant unrealized gain).

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 in the Sanders and Van Hollen bills, and the uncertainty as to whether they will pass, with or without amendment, it is not possible to make a general statement as to how individuals should react to these proposals. Estate planning always requires analysis of each client’s individual situation and goals, but that is especially true with respect to this proposed legislation. It stands 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.

If you anticipate that any of these changes could affect your estate plan, we encourage you to contact one of our trusts and estates attorneys here at Manatt so that we can discuss the potential impact of these proposals on your particular plan and any changes you may wish to make now.



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