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Alert

Potential Tax Law Overhauls in 2021: Summary and Planning Recommendations

Advance planning in light of the proposed tax law changes included in the For the 99.5 Percent Act, STEP Act and the Biden Administration’s Green Book.

By Jennifer Jordan McCall, Matthew Perotti, George E. Martin, Christopher B. Lacaria

Alert

By Jennifer Jordan McCall, Matthew Perotti, George E. Martin, Christopher B. Lacaria

Takeaways

Proposed tax law changes introduced this year provide valuable insight for individuals and families seeking to do their planning in advance of possible enactment of new laws.
Now is the time to address estate and tax planning updates and to consider the use of the gift and generation-skipping transfer exemptions.

06.24.21

Tax planning takes on increased significance when federal and local governments begin announcing proposals to raise revenues in advance of enacting legislation aimed to increase taxes. This year, we are seeing a continued effort at a federal level to tax those deemed “wealthy,” including the proposed For the 99.5 Percent Act, and STEP Act, along with the Biden Administration’s revenue proposals in the recently released Green Book. These proposals, as well as planning recommendations in light of potential tax law changes, are described below.

For the 99.5 Percent Act

On March 25, 2021, Senator Bernie Sanders released his proposed estate and gift tax reform legislation. Titled the For the 99.5 Percent Act, the legislation targets a multitude of common estate planning devices, while also increasing the estate tax rate. While some of the proposed changes will become effective once the bill, if passed, is signed into law by the President, structures put in place before then, or in other cases before 2022, will seemingly be recognized and not disallowed. The decrease in the estate and gift tax exemption amounts will be effective at the beginning of 2022. A brief summary of the key provisions of Senator Sanders’s proposed law is as follows:

  • Reduce the estate tax exemption amount to $3,500,000, minus past reportable gifts (a steep decrease from the current 2021 exemption amount of $11,700,000 per person);
  • Limit the gift tax exemption to $1,000,000 (currently at $11,700,000, minus any past gifts made above the annual exemption amount, currently at $15,000 per donee);
  • Create progressive estate tax rates, including a top rate of 65 percent on estates of more than $1 Billion (currently a flat 40 percent rate);
  • Limit valuation discounts for the transfer of family-owned business interests;
  • Treat grantor trusts as if they are owned by the grantor for estate tax, not just income tax, purposes;
  • Require Grantor Retained Annuity Trusts (GRATs) to have a minimum 10-year term and a 25 percent minimum value for the remainder interest;
  • Provide no step up in basis at death for assets held in certain grantor trusts;
  • Apply generation-skipping transfer (GST) tax to trusts lasting longer than 50 years; and
  • Limit use of the current annual $15,000 per donee gift tax exemption.

Sensible Taxation and Equity Promotion (STEP) Act

On March 29, 2021, Senator Chris Van Hollen introduced his proposed tax legislation, the Sensible Taxation and Equity Promotion (STEP) Act. The legislation, if enacted, would fundamentally alter the income tax environment for estate planning. The proposed Van Hollen legislation would be retroactively effective as of January 1, 2021 if enacted.

The following are some of the proposed provisions in the STEP Act:

  • Eliminate the step-up in the tax basis of a decedent’s assets at death (closely mirroring the Green Book’s proposal, as discussed below);
  • Trigger capital gain tax on unrealized appreciation of assets whenever transferred by gift and at death (note, however, that transfers to a spouse or charity would not trigger capital gain tax under the STEP Act);
  • Tax unrealized appreciation of trust assets every 21 years; and
  • Limit exemptions and exclusions, including a $1,000,000 lifetime exemption from capital gain tax on unrealized appreciation of assets transferred by gift and at death (with an additional $500,000 exclusion for personal residence, and more limited exemption for tangible property).

Green Book

On May 28, 2021, the U.S. Department of the Treasury released the “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals” (the so-called “Green Book”). The Green Book is a detailed explanation of the Biden Administration’s revenue proposals contained in the Fiscal Year 2022 Budget. The items contained in the Green Book and Biden’s budget are not determinative, as Congress will ultimately decide which (if any) of the proposals to move forward legislatively. The budget passed by Congress is often a modified or revised version of the President’s proposals, negotiated between Congressional Republicans and Democrats.

However, the Green Book may offer valuable insight for those individuals and families looking for opportunities to plan ahead of potential tax law changes. Special attention should be made to the effective dates of the proposals, as they may impact the planning opportunities available for the balance of the calendar year 2021. The following are some of the key proposed items in the Green Book:

  • Increase the top marginal individual income tax rate to 39.6 percent from the current 37 percent;

- The top rate would apply for incomes over $452,700 for single filers and $509,300 for joint filers;

- This proposal would be effective for the tax year beginning after December 31, 2021;

  • Increase the rate applicable for long-term capital gains and qualified dividends to the extent of adjusted gross income exceeding $1,000,000 to 39.6 percent;

- This proposal would be effective for gains required to be recognized after the date of announcement;

  • Eliminate the cost basis step up at death, with gain recognized as taxable income at death;

- The proposed gain recognition would apply to gains in excess of $1,000,000 per individual;

- The proposal also requires recognition of any unrealized gain held in a trust or partnership for at least 90 years;

- Transfers to a U.S. spouse or a charity would be excluded, in addition to gains on tangible personal property, a principal residence, and certain small business stock;

- This proposal would be effective for gains on property transferred by gift, and on property owned at death of a decedent dying, after December 31, 2021, and on certain property owned by trusts, partnerships and other non-corporate entities on January 1, 2022;

  • Tax gain from a partner’s share of an investment services partnership interest (so-called “carried interest”) in an investment partnership as ordinary income to the extent taxable income exceeds $400,000;

- This proposal would be effective for the tax year beginning after December 31, 2021;

  • Eliminate IRC Section 1031 like-kind exchange deferral of gain recognition for exchanges over $500,000 of gain for single filers and $1,000,000 of gain for joint filers;

- This proposal would be effective for exchanges completed in the tax years beginning after December 31, 2021;

In addition to the proposed changes to the tax laws, the Green Book details the Biden Administration’s proposal to increase funding for the IRS enforcement and compliance programs. The proposal increases IRS funding by $6.7 billion in discretionary funding and increases the IRS funding to $72.5 billion in mandatory funding. In addition, the Green Book proposes an increase of $417 million for 2022 in enforcement and compliance initiatives and investments. Additional resources would be provided for enforcement against individuals earning more than $400,000. These proposals indicate that the Biden Administration will be seeking to increase taxpayer compliance and will be pushing for greater resources to do so, hoping to get a net increase in tax revenue as a result.

Summary and Recommendations

While the foregoing proposals are concerning, they primarily indicate the need to review your planning now. The current ability to make tax-free gifts and long-term GST exempt trusts provides a valuable opportunity to avoid transfer tax on substantial assets. While the legislative proposals may cause us to proceed with caution and take steps to protect against possible changes (some of which could be retroactive), recent developments provide indications that the gift exemption and long-term GST exemption may not be reduced for transfers completed during 2021. Therefore, now is an important time to contact your Pillsbury team to address estate and tax planning updates that may be appropriate for you. Finally, consider some of the following opportunities this year while also addressing your possible use of the gift and GST exemptions:

  • Complete gifts in 2021 to use available exemptions, particularly generation-skipping transfer (GST) tax exemption for gifts into a long-term dynasty trust. In light of certain proposals to decrease the estate, gift and GST tax exemption amounts and taking into consideration the proposed effective dates, it may make sense for those individuals who have exemptions available to make gifts prior to year-end 2021.
  • In connection with making gifts in 2021, giving a fractional interest in the property (such as an interest in an LLC or real estate) may be beneficial as the value for gift tax purposes may be reduced by certain discounts, such as a discount for lack of control and/or lack of marketability.
  • Another planning consideration is to use a “savings clause” in a deed of gift. There are different forms of a savings clause designed to limit the amount of a gift, for example in the case of retroactive changes to the tax law. However, please note that savings clauses may be viewed with disfavor by the IRS and may be challenged as ineffective, depending on their form and the particular facts of each case.
  • Consider disclaimer planning for gifts into trusts. For individuals and families who wish to plan ahead of potential tax law changes, but may be concerned that significant changes will not be enacted in the short-term, disclaimer planning may be useful to modify the plan without further adverse tax consequences. Please note that disclaimers need to be executed carefully to comply with the requirements under state law and federal tax laws.
  • For married couples, consider establishing an inter vivos marital trust. Contributions into the trust will qualify for the unlimited marital deduction for gift tax purposes, so any reduction in the gift tax exemption amount should not affect those gifts. Please note that the trust must be structured so that it meets certain requirements and limitations for the contribution to qualify for the marital deduction.
  • Consider a spousal lifetime access trust (SLAT) to take advantage of the current high gift and GST exemptions, while retaining some access to the trust assets at the spousal level.
  • In light of some of the proposals noted above concerning recognition of gain on death or after a specific time period (90 years), giving cash or assets with a high cost basis may be beneficial to reduce the tax consequences of any gain recognition event.
  • For those families who are charitably inclined, consider charitable planning such as charitable remainder unitrusts and charitable lead annuity trusts.
  • For individuals and families who do not have a significant amount of estate and gift tax exemption available but wish to reduce their overall estate, consider a sale to a trust in exchange for a promissory note. If structured properly, since the transaction is a sale, it will not be treated as taxable gift and the assets sold to the trust will be excluded from the estate of the grantor/contributor.
  • As noted above, some of the proposals seek to limit the benefits of an IRC Section 1031 like-kind exchange. For individuals and families who own real estate for investment purposes and are interested in entering into a like-kind exchange, 2021 might be the optimal time to do so. The effective date for any changes to the laws concerning like-kind exchanges should be carefully monitored as some of the proposals require that the exchange be completed before the enactment date.
  • Consider use of a trust or trusts for Qualified Small Business Stock (QSBS), to take advantage of substantial exemptions from federal income tax on capital gains.
  • The foregoing is for illustration purposes. You should reach out to your legal advisor before undertaking any tax or estate planning to determine if it is appropriate for your situation.

Pillsbury’s Estates, Trusts & Tax Planning (ETTP) team advises individuals, families, family-owned businesses and charitable foundations in the planning and administration of complex trusts and estates, and in U.S. and international estate, trust and tax planning. Our ETTP lawyers develop cutting-edge, customized transfer tax and estate plans, utilizing trusts, wills, various entity structures, such as partnerships and LLCs, and domestic and cross-border plans, to preserve and enhance our clients’ wealth for current and future generations. Serving clients globally, we maintain a strong bicoastal presence in the U.S., particularly in San Francisco, Silicon Valley, Los Angeles, New York, Washington, DC, and Palm Beach, FL.

To connect with one of our Estates, Trusts, and Tax Planning team members, please click here.

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