Reconciliation Bill has Significant Proposed Changes for Estate, Gift, and Income Taxes

Oct 7, 2021

By Katy Giesecke, CPA – Partner

As part of the $3.5 trillion reconciliation bill being considered by Congress, multiple far-reaching tax proposals were recently addressed by the House Ways and Means Committee. It is important to note that this proposed legislation could have many substantive changes during the reconciliation process. Many of the provisions are expected to go into effect after December 31, 2021, while others will be effective on the date of enactment, the date of the House proposal (September 13th), or would be retroactive to tax years beginning after December 31, 2020. The proposed changes could have a significant impact on trusts, estates, and income taxes. Taxpayers and their advisors should pay attention to the potential developments and update existing estate plans if necessary. Here are the highlights of the House proposal:

Estate and Gift Tax Changes Proposed

  • Effective January 1, 2022, the lifetime federal estate and gift tax exclusions will be reduced from the current $11.7 million exemption to the 2010 level which would be approximately $6 million.
  • Many of the key tax benefits currently associated with the utilization of grantor trusts will no longer be available if the House proposal is passed in its current form. The following provisions would apply to grantor trusts created on or after the date of enactment and to contributions after date of enactment to existing (grandfathered) trusts.
    • Currently, the grantor’s payment of income tax on the trust income is not a taxable gift to the beneficiary, which allows the grantor to continue to reduce their estate. This benefit would be eliminated for new grantor trusts or with respect to new assets contributed to existing grantor trusts.
    • In addition, assets transferred to newly created grantor trusts and any assets added to existing grantor trusts’ assets will be included in the grantor’s estate upon death.
    • If the trust’s grantor status is terminated during the grantor’s lifetime, it will be treated as making a gift of the trust’s assets, which could result in current gift tax or increase the estate tax ultimately paid by your estate.
    • Sales between the grantor and grantor trust will no longer be disregarded for tax purposes and the grantor and the grantor trust will be considered related parties. Consequently, a capital gain will be recognized on such a sale and capital losses will be disallowed.
    • The proposal would apply to intentionally defective grantor trusts (IDGTs), irrevocable life insurance trusts (ILITs), grantor retained annuity trusts (GRATs), qualified personal residence trusts (QPRTs), and others.
    • These provisions could significantly increase your gift or estate tax liability.
    • One example of a potential pitfall of the proposal is that contributions to your existing ILIT after the enactment date (to pay insurance premiums) may cause all or a portion of your existing ILIT to be included in your estate.
  • Valuation discounts applied to transfers of family-owned entities holding non-business assets would be limited by the House proposal. Non-business assets are defined as any passive asset which is held for the production or collection of income and not used in the conduct of an active trade or business, such as funding with marketable securities or passive real estate. The proposal applies to the valuation of entity interests owned at death and to entity interests transferred by gift. The new rules would apply after the date of enactment.

Income Tax Changes Proposed

  • The top marginal income tax rate would increase from 37% to 39.6% for high-income individuals ($450,000 for married individuals filing jointly) and applies to trusts and estates with taxable income exceeding $12,500.
  • Long-term capital gains rates would increase from 20% to 25% for gains realized after September 13, 2021, unless the seller entered into a binding contract before that date.
  • A new surcharge tax would be imposed of 3% on modified adjusted gross income (AGI) higher than $100,000 for estates or trusts ($2.5 million for married filing separately, or $5 million for all other taxpayers). This is in addition to the existing Net Investment Income Tax of 3.8%.
  • Net Investment Income Tax (3.8%) would be extended to cover net investment income from the conduct of an active trade or business for trusts and estates (for unmarried individuals with modified AGI over $400,000 or $500,000 for individuals filing jointly).
  • Qualified business income deduction (QBID) would be amended by capping allowable deductions at $10,000 for estates and trusts ($500,000 for joint returns or $250,000 for married filing separately).
  • Excess business losses (deductions exceeding income) would be permanently disallowed for non-corporate taxpayers, however, any disallowed losses may be carried forward to successive tax years subject to excess business loss limitations, rather than being carried forward as a net operating loss. This provision would be retroactive to tax years beginning after December 31, 2020, if the House proposal is enacted.

What is Not a Part of the Proposed Bill?

  • There is no elimination of basis step-up at death.
  • There is no deemed sale at death.
  • There is no increase in estate tax rates or estate tax rate surcharges for billionaires.

This is welcome news for individuals who may hold appreciated assets until their death.

We anticipate there will be changes to the proposed legislation, however, it appears likely that reforms to estate, gift, and income tax laws may be enacted soon.

If you have any questions or are concerned about how these proposed changes would impact your estate plan and available wealth transfer strategies, please contact the professionals at MichaelSilver. We are ready to help. Contact us at 847.982.0333.