A little mentioned curve-ball in the September House Ways and Means Committee proposed tax package which would raise top tax rates on ordinary income to nearly 40 percent (and capital gains to 25 percent), is that there are also considerable estate tax or gift tax changes being proposed. While these are only proposals which could be changed significantly or rejected, if they do pass, the impact on estate tax planning will be extraordinary.
The gift tax exemption: An estate gift or tax gift “exemption” is available for each person, and can be used either during lifetime or at death. The current exemption (per person) is $11.7 million. As we have mentioned in previous articles, that exemption is set to be reduced by 50 percent in 2026. But the new proposal accelerates the date to January 1, 2022 – so taxpayers would basically have three months to use the current exemption.
If the Committee’s tax package is adopted, it’s possible that a 40 percent federal estate tax (in addition to state estate taxes) will be enacted on estates that are above the current exemption. To navigate strategically, an individual would need to make gifts of more than $5.85 million by the end of 2021. Those with sufficient assets would ideally make gifts to obtain the entire $11.7 million exemption.
Elimination of the IDGT: The intentionally defective grantor trust (IDGT), is a highly effective estate tax planning tool. The Committee’s proposal would virtually do away with it. Several trusts applied in estate planning, such as spousal lifetime access trusts (SLATs), are classified as IDGTS. IDGT trusts belongs to the grantor for income tax purposes but are outside of the grantor’s estate for estate tax purposes. The grantor benefits from IDGTs because they can 1) in effect, make tax-free gifts by paying the IDGT’s income tax liability, and 2) sell assets to the IDGT—typically at discounted values—without creating a realization event for income tax purposes. The assets of an IDGT would have to be “brought back” into the grantor’s estate for estate tax purposes under the new proposal, which takes away the useful benefit of the IDGT. IDGTs that are created and funded before the bill is signed into law would be grandfathered, but not with respect to contributions made thereafter.
Valuation discounts: The proposal would wipe out the use of valuation discounts for gifts (other than gifts of interests in active businesses); ultimately eliminating the chance to “leverage” gifts using these discounts.
What should you do now? As mentioned above, so far these are only proposals. But because of the time frames involved, any taxpayers who have plans to make gifts before the exemption is reduced should consider doing so now for the following reasons: 1) to use the extra $5.85 million of exemption before it is gone, 2) to leverage the ability to use an IDGT while it is still allowed, and 3) to use applicable valuation discounts while still available.
Mike Ferrin or Alan Soelberg should you have any questions.