Everything Old Is New Again

Proposed Sweeping Changes To The Estate and Gift Tax Laws
by Mark A. Schaum, Esquire, CPA

Over the years, I’ve heard this sentiment expressed with respect to fashion trends. Never have I heard it expressed with respect to tax laws, but it seems that as it relates to the tax bills introduced into the Senate on March 25th (For The 99.5% Act) and March 29th (the STEP” Act) of 2021, this might be the case. Throughout my many years in practice, exemptions have only increased and tax rates have only decreased. Under the proposed bill, this would drastically change. Furthermore, certain assumed tax consequences that have occurred at death, may now be treated in a way similar to how they were treated in years far pre-dating my years in practice. During Donald Trump’s tenure as President, the estate tax exemption was doubled and the Estate and Gift Tax Department of the IRS appeared to be largely gutted because there were significantly fewer estate and gift tax returns being filed. Through a variety of sale and gift techniques permissible under current law, estate planners can help their clients shield vast amounts of wealth from estate taxes. This would drastically change if the proposed bill or some resemblance to it passes.  

Reduction In The Estate Tax Exemption- In 2021, the estate tax exemption is $11,700,000 (a rise from $11,580,000 in 2020 resulting from the exemptions indexing for inflation). Thus, a married couple could shelter twice this amount from estate taxation. While I’ve encountered a lot of successful individuals over the years, the vast majority of them fall under these thresholds. Under the proposed bill, the exemption would be lowered to $3,500,000 each.  

Estate and Gift Tax Rates– Under current law, there is a flat estate and gift tax rate of 40% regardless of the size of the estate or gift. Under the proposed bill, there would be an increase to 45% for states between $3,500,000 and $10,000,000. There be a further increases to a 50% rate for estates between $10 million and $50 million, a 55% rate for estates between $50 million and $1 billion, and a 65% rate for estates over $ billion.  

Reduction In The Gift Tax Exemption- For those clients with the estates above the foregoing thresholds, many of the techniques currently utilized to reduce or eliminate future estate tax exposure involve the utilization of the gift tax exemption and making various types of gifts to trusts that will not be included in the estates of those making the gifts. Currently, gift tax exemption is also $11,700,000 and a married couple has 

twice this amount of exemption available for utilization in a variety of gift and sale techniques. Under the proposed bill, however, this exemption would be reduced to a scant $1,000,000.

Reduction In The Annual Gift Exclusion – Under current law, an individual can make annual gifts to an unlimited number of individuals of $15,000. In certain gift tax strategies, these annual exclusion gifts are used in a way to make annual gifts to trusts for the benefit of remainder beneficiaries who may not actually receive any benefit from such gifts or may not receive the benefits for many years. Under the proposed bill, such annual gifting would be limited to a total of $30,000. As an example, if a person wanted to use his total annual exclusion to make gifts equally to his 3 children, such gifts would be limited to $10,000 each. 

Valuation Discounts – One of the key techniques utilized by estate planners to reduce estate tax exposure has been to intentionally structure assets so that they would be subject to valuation discounts at death. For example, if a person loaned a parcel of real estate whose total value is $1,000,000, he might make gifts of undivided fractional interests in the property. If he or she gifted an undivided one-third (1/3) interest to each of his or her 3 children, the estate planner would seek an appraisal showing that each undivided one third interest was worth substantially less than one-third of $1,000,000. The theory behind this is that if fractional interest and property or entity is worth substantially less than the percentage of ownership multiplied by the total value because of certain limitations and lack of appeal to potential buyer. Typically, a fractional interest discount of 20- 25% would be reflected on the appraisal and ultimately on the gift tax return to be filed. Under the proposed bill, however, transfers of such property or other interests in family–owned entities would be eliminated.  

Generation-Skipping – The generation-skipping exemption is an exemption which allows you to structure a trust that can be passed down through numerous generations, having each generation enjoy the assets during their respective lifetimes, and then pass such assets down to the next generation free of estate taxation. The exemption amount has always been the same amount as the estate tax exemption. Thus, currently the exemption is $11,700,000 per person. Under current Florida law, such a trust could exist for 360 years. Under the proposed bill, however, the exemption would be reduced in the same manner as the estate and gift tax exemptions and would be limited to a term of 50 years. Existing generation-skipping trusts would be deemed terminated 50 years after the passage of the law. 

Stepped-Up Basis – Under current law (IRS section 1014) , upon an individual’s death, most assets receive a new cost basis equal to the value on the date of death. For example, if a person dies owning ABC stock which was purchased for $100,000 but was worth $1,000,000 at death, such person’s beneficiaries (assuming no estate taxes imposed) would receive the stock with a new cost basis of $1,000,000 and could immediately sell the stock without having a capital gains tax imposed. Under current law, such stepped-up is unlimited. As an example, in 2021 beneficiaries could receive $11,700,000 of assets from a deceased individual without the imposition of either an estate tax or income tax on the unrealized capital gain. Under the proposed bill, such stepped-up would be limited to a scant $1 million exemption. Furthermore, for assets in excess of this amount, unrealized capital gains above the exemption amount would be

taxed at death. In certain situations, such as businesses and f arms, the bill would allow up to 15 years to pay the tax. In the cases where an estate tax would be due, there would be a credit for such taxes payable.  

Grantor Trusts – One of the essential tools of an estate planner looking to reduce the estate tax exposure of his or her clients has been the use of grantor trusts. Trusts are structured so that the trust maker (“the Grantor”) retains certain specified “grantor trust powers”, the grantor will continue to be considered the owner of the assets in the trust 

for income tax purposes even though he has given the assets away for estate tax purposes. This technique is commonly referred to as an “intentionally defective grantor trust”. With a defective grantor trust, the grantor pays the tax on the income generated by the trust (as long as the grantor remains alive or until these powers are otherwise removed) and this essentially allows the grantor to make additional tax-free gifts in the amount of income tax paid. This benefits the downstream beneficiaries by allowing the trust to essentially grow tax-free. In other words, the continuing payments of the trust’s income tax are not counted against the grantor’s unified credit. Recently, because of the large size of the estate tax exemption, transactions are being structured with parents to create upstream inclusion of assets in an elderly parent’s estate primarily to obtain a step-up in low basis assets held by their children at the elderly parent’s death. Under the new tax bill, the use of such “Defective Grantor Trusts” would be ineffective as holding such powers would cause inclusion in a Grantor’s estate for estate tax purposes. It appears that this would also apply to the beloved Irrevocable Life Insurance Trust-probably the most popular technique among estate planners for addressing estate tax exposure. Trusts executed and funded prior to the change in law will be grandfathered-but additional assets or new sales to such structures would be prohibited. 

GRATs – Grantor Retained Annuity Trusts -another beloved technique utilized by estate planners is the short-term GRAT. Under current law, using this technique, a person can create a trust whereby a grantor can shift the future appreciation of assets above the currently very low Section 7520 rate (120% of the federal midterm rate) to future generations utilizing little or no gift tax exemption. The original principal along with this low rate of return is typically returned to the grantor over a short period of time in the 2 to 5 year range. Under the proposed bill, such scraps must have a minimum term of 10 years and generate a taxable gift on funding of at least $500,000 or 25% of the fair market value of the assets transferred to the GRAT. This would add tremendous risk to the utilization of this technique if there is a reasonable possibility of the assets declining in value. In such case, the limited gift tax exemption would be utilized and would produce no benefit if the value of the assets declined during the GRAT term.  

Effective dates– If enacted as is, these changes would apply to transactions and deaths occurring after January 1, 2022 with the exception of the proposed changes to the step-up in basis and taxation of unrealized gains which are proposed to be effective for deaths occurring after January 1, 2021. 

Conclusion- Wow! These proposed changes are very significant. At this juncture, no one can predict what will happen. It is pretty certain that it will not get the support of a single Republican. If that is the case, such legislation would have to be enacted using the reconciliation process similar to what Congress did with the tax changes made 

under the Trump administration and such changes would sunset after a period of time. For those seeking to take advantage of current law to reduce future estate tax exposure, now may be the time to effectuate certain gifts and sale transactions.  

Mark A. Schaum of Mark A. Schaum, P.A. has his office in Boca Raton. He is Board Certified in Wills, Trusts, and Estates Law and is also a CPA.- April, 2021.