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On March 25, Senator Sanders (I-VT) and Senator Whitehouse (D-RI) proposed a bill that would make very sweeping changes to the current estate and gift tax system. A similar bill is likely to be proposed in the House. Adding to the mix is another bill proposed by Senator Van Hollen (D-MD), which would greatly damage capital gains taxes and estate taxes.

While the changes have Democratic support, they have no support amongst the Republicans, so it is unlikely that the proposed changes will be passed in total.

With respect to the best interest of our clients, hopefully, the changes are not passed at all.

Having said that, we realize that there might be some energy and movement toward making changes. With this in mind, it serves us to prepare for the unlikely worst-case scenario. Even a watered-down version is not likely to be favorable to our clients.

Since something is likely to happen in this arena, it makes sense to act with some urgency. Here is an abbreviated summary of each bill so that you can make decisions accordingly.

The Sanders/Whitehouse Proposals

The proposals from Sanders and Whitehouse are dubbed the “For the 99.5% Act” and the “Corporate Tax Dodging Prevention Act”.

Foremost is a reduction in the lifetime gifting exemption from $11.7 million per person to $3.5 million, taking effect in 2022.

At the same time, the gift tax allowance would be reduced from $11.7 million to only $1 million, which means that people will not be able to gift more than $1 million after 2021 without paying gift tax.

A proposed increase from 40 percent to 45 percent in the estate tax rates on the first $10 million would also take effect in 2022. As well, there is a proposed increase to 50 percent on the increment of taxable estates over $10 million. At $1 billion in estate value, the next dollar would be taxed at 65 percent. In short, the Sanders/Whitehouse proposal would turn estate tax into a progressive tax.

Annual gifts will be allowed up to $15,000 per year per person but will also be limited to $30,000 per donor per year for gifts to irrevocable trusts or of interests in certain “flow through entities.” This rule, too, would begin in 2022.

Some of the features of the bill would take effect immediately upon President Biden’s signature, including:

  • Prohibition of asset sales to irrevocable trusts that are disregarded for income tax purposes (DNGs).
  • Limitations on use of valuation discounts.
  • Severely limiting the use of grantor retained annuity trusts (GRATs).

Multigenerational dynasty trusts would be limited to fifty years.

Mind you, existing structures are likely to be grandfathered.

The Von Hollen Proposal

The so-called Sensible Taxation and Equity Promotion (STEP) Act amounts to a supplemental system to the estate tax system.

Gifts of property would be treated as if sold at fair value when transferred by gift or bequest. In other words, the concept of step-up would be out the window. (Step-up means this: When an asset is inherited upon an original owner’s death, and later sold by the heir, capital gains taxes are calculated based on the value of the asset at the time of the original owner’s death. This helps heirs avoid huge capital gains bills.)

In general, transfers would require payment of income tax. The first $1 million unrealized gain on death would be excluded. Gifts would be afforded small relief in that the first $100,000 of unrealized gain would not be taxed. You would then be able to exclude only $900,000 upon your demise.

The tax on the gain on asset transfers that are not actively traded assets could generally be paid over a 15-year period. Interest would be due on the unpaid amounts. Should the transferred asset be liquidated, the entire amount of the unpaid tax would be due.

The proposal eliminates the technique of transferring assets to defective grantor trusts, which are trusts recognized for transfer tax purposes but unrecognized for income tax purposes.

Also severely limited would be dynasty trusts, which are a long-term trust for passing wealth from generation to generation without incurring transfer taxes.  Trusts established before 2005 would be deemed transferred by 2026 and therefore taxable. Trusts established after that time would be considered “realized” 21 years after establishment.

Finally, the income tax paid by reason of the law would be credited against any estate tax paid by the decedent’s estate.

Senator Von Hollen did cut wealth-holders a little slack: The legislation provided that if the tax on unrealized gain is due, no penalty for underpayment of tax would be due on taxes paid by reason of the transfer.

Our Recommendations

If you are an individual with $3.5 million in assets or a couple with $7.0 million in assets, we recommend you assess your planning, and quickly.

In particular, clients who have irrevocable trusts may want to act without delay to:

  • Extend any notes that may be owned by them to the longest period practical,
  • Sell assets that may go up in value, and
  • Exchange for assets that may be more suitable to be owned by these trusts, given that exchanges and changes made after a new law is passed may not be possible.

Given these potential changes, expect a rush of folks who want to complete planning, so contact your attorney as soon as possible to get in the queue.

We don’t believe that Von Hollen’s bills will pass. If it does, the effective date will be retroactive. That said, we do believe something will pass—perhaps akin to the Sanders/Whitehouse proposal, though not likely as extreme. (Perhaps the lifetime gifting exemption will drop from $11.7 million per person to $5 million per person, or the state tax rate will increase to 45 percent, but no go any higher.) Point being: A at the best, taxpayers have approximately nine more months to plan accordingly for these changes and take advantage of the current laws.

Keep in mind, too, that if the Sanders/Whitehouse legislation passes, beginning January 1, 2022, the $15,000-per-recipient gift-tax exemption will be limited to $30,000 per donor with respect to certain transfers. This knowledge might alter your 2021 gifting plans as you can gift $15,000 tax-free to an unlimited number of recipients, but come 2022, you will have a gift-tax problem upon gifting $15,000 to two people.

There will be much discussion in the accounting and legal profession about these proposed bills, and you might see a cascade of other proposed tax changes. One thing is for sure: Things are bound to change.

And, our standard disclaimer exists: The foregoing is not all-inclusive. Rather, it is a highlight of what has been proposed. Please call us, your trusted advisor, or attorney if you want to understand more.

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