“The law of survival of the fittest will apply to cause many wealthy families to lose a great portion of their net worth to estate tax, while smarter and properly situated families may have little to no estate tax.  The train may be leaving the station very soon, leaving much wealth exposed for lack of follow through on the part of many clients. Planners may want to concentrate on getting simple trusts that can be better defined by use of Trust Protectors or powers of appointment into place without delay to help the last survivors of any estate tax Titanic into whatever lifeboats can be set up in time.”

Alan S. Gassman and Brandon Ketron provide members a section-by-section analysis of the major proposed changes and effective dates of the Ways and Means Committee bill, as well as thoughts relating to actions to take and not to take. Alan and Brandon are presenting a LISI Webinar on these new rules on Wednesday, September 22^nd at 3 p.m. EST titled “Estate Tax and Related Planning for Wealthy Clients in View of the House Ways and Means Committee Proposed Legislation,” which can be registered for by clicking here Alan/Brandon. Webinar attendees will receive easy-to-use spreadsheets that can help them see how taxpayers may come out under the new exemption amounts by putting present net worth, annual net savings and asset value growth rates for both single individuals and married couples, as well as a Qualified Personal Residence Trust (“QPRT”) Estate Tax Savings Calculation Spreadsheet that we have recently developed. 

Alan S. Gassman, J.D., LL.M., is a partner in the law firm of Gassman, Crotty & Denicolo, P.A., and practices in Clearwater, Florida. He is a frequent contributor to LISI, and has published numerous articles and books in publications such as BNA Tax & Accounting, Estate Planning, Trusts and Estates, and Interactive Legal and is coauthor of Gassman and Markham on Florida and Federal Creditor Protection and several other books. His email address is agassman@gassmanpa.com. Alan is presenting with a panel at the 46th Annual Notre Dame Tax & Estate Planning Institute on the subject of termination of charitable trusts. More information on the 46th Annual Notre Dame & Estate Planning Institute, which will be held as a virtual conference on Thursday, October 29, and Friday, October 30, can be viewed by clicking Here. Please join us!

Brandon L. Ketron, CPA, JD, LL.M. is a partner at the law firm of Gassman, Crotty & Denicolo, P.A., in Clearwater, Florida and practices in the areas of Estate Planning, Tax and Corporate and Business Law. Brandon is a frequent contributor to LISI and presents webinars on various topics for both clients and practitioners. Brandon attended Stetson University College of Law where he graduated cum laude, and received his LL.M. in Taxation from the University of Florida. He received his undergraduate degree at Roanoke College where he graduated cum laude with a degree in Business Administration and a concentration in both Accounting and Finance. Brandon is also a licensed CPA in the states of Florida and Virginia. His email address is brandon@gassmanpa.com.

Here is their commentary:    

EXECUTIVE SUMMARY:

A great many wealthy taxpayers were given a not so welcome jolt of energy and fear last week when the Democrats on the House of Representative Ways and Means Committee  released their 881 page proposal on how to raise over $3,000,000,000 in taxes from wealthy families and high earners, causing a great many phone calls and e-mails from taxpayers who have put off making proper use of the $11,700,000 exemption and the opportunity to fund and sell to Grantor Trusts, form and fund Grantor Retained Annuity Trusts, fund Qualified Personal Residence Trusts and use other planning techniques that may be gone in just a few days.

For many planners the issue of the hour is how to fund LLC’s and Limited Partnership and other entities with assets that will be indirectly gifted while qualifying for lack of marketability and lack of control discounts without getting stymied by the Step Transaction Doctrine that the IRS may Senda (pronounced “Send Ya ” and named for the Senda case) if the newly added assets are not held for a sufficient time before the entity interests are transferred.  Nominee Agreements will be more popular than ever this week and next week where retitling may provide difficult and cumbersome.

While providing a comprehensive and extensive summary or analysis of the full 881 pages of proposed new laws would prove to be cumbersome, especially since the terms of any bill can be expected to be materially different than the House bill, we are able to cover many of the primary changes, points of confusion, and effective dates provided in the proposed legislation as relates to estate tax planning, along with some key planning ideas.

Those affected will be pleased to hear that only a few of the new rules would impact transactions or transfers made before the new Act would be enacted. Further, many of the provisions would not become effective until January 1, 2022, but those who are being advised to transfer significant values to irrevocable “Grantor Trusts” that are disregarded for income tax purposes  before their exemption amounts are cut in half must act by the day that the law is enacted.  Alternatively, based on the plain language of the bill, potentially affected individuals may plan to gift such amounts to individuals or entities other than grantor trusts, if they do this after the date of enactment and before year end.

The law of survival of the fittest will apply to cause many wealthy families to lose a great portion of their net worth to estate tax, while smarter and properly situated families may have little to no estate tax.  The train may be leaving the station very soon, leaving much wealth exposed for lack of follow through on the part of many clients. Planners may want to concentrate on getting simple trusts that can be better defined by use of Trust Protectors or powers of appointment into place without delay to help the last survivors of any estate tax Titanic into whatever lifeboats can be set up in time.  

Below is a section-by-section analysis of the major proposed changes and effective dates, and thoughts relating to actions to take and not to take while we wait to see what changes are made to the Bill, and if any substantial bill will be passed this year.  While all of this is subject to change as the Senate gets involved, but we do not expect to see anything more severe or taxpayer unfriendly than the House bill, and it could be a lot worse.

COMMENT:

First in priority on the list of action items for many wealthy American families is to get their houses into order in preparation for increased federal estate taxes.  After months of being presented  with the prospect of a lower estate tax exemption, and the possibility that the exemption would come down before there was time to make large gifts, the reality of what is proposed must now sink in for a few days, and then action may need to be taken.  Chicken Little Estate Planner, who has been encouraging such conduct may now seem more credible, or is it Noah Estate Planner, who  is asked to build an Arc when it is already starting to rain?  

Use It or Lose It-  Estate/Gift Tax Exemption Cut in Half Effective January 1, 2022

The good news on this front is that the reduction of the estate and gift tax exemption from $10,000,000 as adjusted for chained inflation (presently $11,700,000 per person) will be intact through the end of 2021, but will be reduced to one half of the applicable amount amount effective January 1^st, 2022.  This means that the “use it or lose it” gifting decisions for wealthy individuals can be made up through the end of this year, but most well advised wealthy families will be better off making such gifts before such legislation is passed, because of the Grantor Trust and discount rules that would be changed as of the date of enactment. 

The $2,800,000 Mistake

As an example, Grandma has  used $700,000 of her estate and gift tax exemption from prior gifting, and therefore has an $11,000,000 exemption remaining that she may wish to use prior to the end of the year.  If she has a $21,000,000 estate and makes an $11,000,000 gift, this her estate will be $10,000,000.  If Grandma then dies in 2022, or thereafter, she would have no exemption remaining, and the estate tax will be $4,000,000 ($10,000,000 x 40% = $4,000,000).  Fortunately, the proposed law would not increase the estate tax rate the way that the Bernie Sanders bill would have.

Alternatively, if Grandma does no gifting in 2021 and dies in 2022, or thereafter, when the exemption would be based upon one half of $11,700,000 ($5,850,000) adjusted for inflation to perhaps $6,000,000, then her estate will be $21,000,000 reduced by her remaining exemption amount of $5,300,000 ($6,000,000 less prior gifts of $700,000), and estate taxes of $6,280,000 ($15,700,000 x 40% = $6,280,000) will be owed to Uncle Sam 9 months after her death. It will not feel good to stroke that check for $6,280,000 when it could have been $4,000,000, and the $2,280,000 difference does not take into account that growth on assets would be expected to make the difference greater.  

Suppose however that Grandma does not make the gift but is on her death bed on December 31^st, 2021, thinking about using the Living Will, while hoping for a miraculous recovery and a few more years in the very nice retirement home where she lives.  Would you want her children or best friend to make her health care decisions at that time? One day of life could cost $2,280,000. We would bet on the best friend being less likely to pull the plug in this situation!

It is important to note is the fact that there will be no “clawback” for use of the increased exclusion amount, meaning that Grandma will not be penalized for gifting $11,000,000 of assets if she passes away in a year when the applicable exclusion amount is $6,000,000. 

Use Less Than Half and Uncle Sam Gets a Laugh

Another factor that warrants consideration is that in order to use the temporary increased exemption, gifts must exceed what the exemption will be reduced to.  For example, if Grandma were to gift $5,000,000 in 2021 when the applicable exclusion amount is $11,700,000 and then pass away in 2022, or thereafter, when the applicable exclusion amount is only $6,000,000, Grandma’s applicable exclusion amount would only be $1,000,000. Therefore, in order to take full advantage of the increased exemption, Grandma will need to gift all $11,000,000 of her remaining exclusion. That being said, those who decide that they cannot afford to gift the full $11,700,000 may still be well advised to gift what they are comfortable with to get future growth in value out of the estate and to gift limited liability company or partnership interests when possible in order to lock in discounts that may not apply once the new Act is passed, and to make the gifts to Grantor Trusts while there is time to do so.  

The good news is that families will have until the end of this year to make large gifts if the law passes.  The bad news is the loss of very important vehicles that we commonly use for gifting and estate tax planning that may occur below then. 

Is A Grantor Trust Really A Must?

Grantor Trusts can be separate and apart from the Grantor and contributor of the trust for estate tax purposes while still considered as owned by the Grantor for income tax purposes. Because  the Grantor is considered to be the owner of the trust for income tax purposes, transactions between the trusts and the grantor are “disregarded,” meaning that assets can be sold or exchanged with the trusts and the trusts can pay interest on low interest notes owed to the Grantor without triggering any income tax consequences.

The majority of well positioned wealthy clients who have engaged in estate planning have established these trusts, which permit the Grantor to pay the income tax on the trust assets on behalf of the beneficiaries, and also allow the Grantor to sell assets that may qualify for a discount, such as non voting LLC interests for long term low interest notes without paying any income taxes on the sale.  The numbers can be quite advantageous where instead of owning a valuable asset that may have income and growth at 7% or more the client has a note bearing interest at 2% that will not grow in value. An additional benefit of the Grantor Trust, is that the Grantor continues to pay the income taxes associated with the Trust’s assets, and the payment of income taxes is not considered a gift to the trust, allowing the trust to grow income tax free and further reduce the Grantor’s estate. 

Our hypothetical Grandma from the examples  above could place $14,000,000 of investments into an LLC and after waiting a proper amount of time gift the 99% non-voting membership interest in the LLC to a Grantor Trust for her descendants.  Due to the discounts mentioned above this might result in an $11,200,000 gift (assuming a 20% discount applies).  Grandma can pay the income tax on the income from the investments for her remaining lifetime, which will further reduce estate taxes for her family upon death, but only if she acts before the date of enactment of the new bill, if it passes. 

A favorable provision of the new proposal allows Grantor Trusts established and funded before the enactment of the new law to be grandfathered, as would promissory notes in place at the time of enactment, so a great many estate tax planners expect to be very busy completing trusts and sale arrangements that are in progress now, and remain uncertain of how many more they have the capacity to handle given the short time frame Congress is providing us with here.

Potential Impacts on Discounts and Other Estate Planning Tools

In addition to preventing the use of post enactment contributions to  Grantor Trusts for estate tax purposes, the new bill would also eliminate discounts after the date of enactment unless the asset gifted or sold is an “active trade or business.”

The language and effect of the new bill may also cause us to lose other very powerful tools in our toolbox, such as Grantor Retained Annuity Trusts (GRATs), Qualified Personal Residence Trusts (QPRTs), and lifetime Grantor Charitable Lead Annuity Trusts (CLATs) depending upon how the bill is applied and interpreted.  The bill may also change how life insurance trusts will be funded and structured in the future, but we expect that the life insurance lobby will do what it takes to preserve its status as a favored child of Congress.

The following discussion of what is available now that may not be available after a law is enacted is as follows.     

Bye Bye QPRTs

A Qualified Personal Residence Trust (“QPRT”) allows a homeowner to transfer his or her primary residence or a vacation property into a Trust that enables the Grantor to make use of the property at no rent charge for a term of years, and to report the gift of the ownership interest in the home to be less than the full value of the home because of the discount attributable to the present value of the free use possessory term.

Nevertheless, after the death of the Grantor, the entire value of the property held under the Trust escapes estate tax, and the Grantor will pay rent after the possessory term of years lapses, which further reduces the Grantor’s estate and enables the Grantor to continue to use the property.

The QPRT can be drafted to be disregarded for income tax purposes, both during and after the possessory term, so that rent paid for use is not taxable to the Trust, and the property is treated as owned by the taxpayer in the event of sale, to qualify for the $250,000 or $500,000 exclusion for the sale of a primary residence.

Reading the newly proposed act literally, QPRTs that are entered into and funded by deed before the date of enactment will be grandfathered to receive the above benefits, but those that are executed and funded by deed after the date of enactment will lead to gain being recognized as if the property was considered to have been sold to the trust upon contribution, and then considered to be a gift by the Grantor following the possessory term when the property is transferred to the beneficiaries, although a credit may be received for gift taxes paid on the initial transfer when the second transfer occurs.

So Long and Farwell to GRATs

Similar to a QPRT, a Grantor Retained Annuity Trust (“GRAT”) is an arrangement whereby an individual can transfer property to a trust which provides for payments back to the individual over a term of years in fixed dollar amounts that are sufficient to cause there to be no gift for gift tax purposes.

Nonetheless, if the assets in the GRAT appreciate in value by more than approximately 1.0% a year, based upon present rate  for GRATs entered into this year, the excess value remaining after the term of years can pass estate and gift tax-free.

A GRAT is treated as a Grantor Trust while the Grantor is receiving annual payments, and can be considered to be a Grantor Trust thereafter, if drafted to facilitate that result.

Under the proposed new rules, the funding of a GRAT after the date that the law would be enacted could cause income tax to be imposed on the excess of the fair market value of the assets placed into the GRAT over the tax basis of such assets. Further, the excess value remaining after the GRAT term may be considered a gift when distributed, notwithstanding that Internal Revenue Code Section 2702 maintains under present law that no gift results when the actuarial value of the annual payments made to the Grantor equals the value of assets placed into the Trust.

While 2, 3 and 4 year GRATs have been most common, longer term GRATs will lock in values for a longer period of time and should be more popular before the new law passes.  Most planners will prefer to use long term installment sales to Grantor Trusts, for this reason, but GRAT’s will normally be used when the risk of gift tax is high, or the value of assets is above what would typically fit under an installment sale.  

I Must Form My Income Tax Deductible CLAT In Nothing Flat

A Charitable Lead Annuity Trust (“CLAT”) functions in a manner similar to a GRAT, except that the fixed annual payments will go to a charity, and assets remaining  in the CLAT after the term of years can be held for to family members without being considered to be a gift.

A Grantor CLAT is a variation of a CLAT that is drafted to be disregarded for income tax purposes to allow for an income tax deduction on funding, which causes the Grantor to be subject to income tax on the CLAT’s income during the charitable payment term.

Unfortunately Grantor CLATs that are funded after the date of enactment may trigger income tax on the excess of the fair market value of the assets placed in the GRAT over the income tax basis, with the remainder interest passing to descendants being subject to federal gift tax when the payments to charity end.

The above analysis of the impact of the newly proposed rules on QPRTs, GRATs and CLATs may not be accurate or what the Ways and Means Committee is intending, and guidance with respect to this will likely be forthcoming in any legislation that would pass, or before or immediately after passage. Nevertheless, individuals and families who are considering the use of QPRTs, GRATs or Grantor CLATs should proceed without delay.

Although the loss of the vehicles and planning techniques reviewed above seems more than formidable, other techniques will continue to exist.  Regardless, estate tax planners will feel like carpenters who have lost their hammers, nails and pliers, and have significant construction to do somehow without those tools.  The result for wealthy families will be increased exposure to pay much more in estate taxes.

How About Some Good News?

We were pleased to find the absence of a number of items on the bill that had been tossed around by lawmakers, including the following:

         1.      No “capital gains tax on death” was included, or any rule that would detrimentally affect the present tax laws that permit the assets of a deceased individual to be considered to have been purchased for the fair market value thereof on the person’s date of death to eliminate capital gains taxes attributable to appreciation and depreciation taken up through the date of death.

         2.      Proposals that would have imposed a tax on placing appreciated assets into separately taxed trusts, or transferring appreciated assets out of separately taxed trusts are also thankfully not mentioned.

         3.      Proposals which would have reduced the amount of annual gifts using Crummey withdrawal powers that an individual or married couple could have made to irrevocable trusts or otherwise were not included.

         4.      Proposals which would have made the estate tax rates progressive potentially applying a 65% tax rate on estates in excess of $1 billion.  Thankfully under the current proposal the estate tax remains at a flat rate of 40%. 

         5.      Proposals to decrease lifetime gifting allowance to as low as $1,000,000.  Under the current proposal the estate and gift tax exemption remains the same, although reduced to one-half of what would have otherwise applied. 

         6.      Specific provisions that would eliminate a step up in basis for assets held by a Grantor Trust.  While it is unclear under present law if a step up in basis applies to assets held by Grantor Trusts, many practitioners take the position that a step up in basis does apply since the grantor is considered to be the owner of the assets for income tax purposes, and the inclusion of the elimination of step up in basis for Grantor Trusts in prior proposal further supports this proposition. 

         7.      Proposals to apply generation skipping taxes via a deemed termination of Generation Skipping dynasty trusts every 50 years. 

The good news for estate tax advisors is that there are very few proposed new rules in this arena under the new bill, so the changes will be relatively easy to learn and implement, and grandfathering will allow us to be proud of and continue the structures that have been put into place and properly maintained. The bad news is that if our spouses were upset because we have been working late up until now, then they have not seen anything yet!

Conclusion

Times like these call for courage, calmness, and smart thinking by planners who have much more work than they can do to help clients finish building their arcs before the hard rain begins.  We must first make sure that we have the resources and client cooperation to complete projects that have been started, and notify clients that it will be too late if they do not act immediately.  General non estate tax planning can be pushed off or not taken in over the next few days as we size up our workload, and how to simplify and implement what we can while we can, while still hoping that none of these changes will come to fruition. Clients will remember that we were there for them and did our best, and in many cases those who would not have done the proper planning will do so, and be helped regardless of whether the laws change or not. Let’s take a deep breath and enjoy the experience for what it is worth, while working in the intensive care style environment that we find ourselves in.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Alan Gassman

Brandon Ketron

CITE AS:

LISI Estate Planning Newsletter #2906 (September 20, 2021) at http://www.leimbergservices.com, Copyright 2021 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI