“Ending a Rigged Tax Code: The Need to Make the Wealthiest People and Largest Corporations Pay Their Fair Share of Taxes.” This is the title given to the Budget Committee hearing presided over by Senator Sanders on March 25, 2021, out of which emerged the proposed For the 99.5% Act. This proposed new legislation purportedly targets the wealth accumulated by the families of Jeff Bezos, Elon Musk and Mark Zuckerberg, who are called out by name. In reality, the impact of this new law will be felt not just by the nation’s billionaires, but also by families that most would not consider to be ultra wealthy. Some of the main highlights are summarized below. For those potentially affected, we are up against the clock to mitigate the effects of the new law. With January 1, 2022 being targeted as the effective date of the legislation, that leaves less than 9 months to plan; and with some of the measures possibly coming into effect sooner than that, the time crunch is actually much tighter.
Estate Tax Exemption to be Slashed
This has been a key component of the Biden tax plans for several years now, but the proposed legislation has formalized the intention to lower the estate tax exemption from its current level of $11.7 million to $3.5 million.
The rate of taxation is also slated to increase from the current rate of 40% to a range of 45-65% depending on the level of assets to be taxed.
To give a couple of examples: individuals with a net worth of $5 million currently can leave those assets to their family without any estate tax being due. Under the proposals, the family would pay almost $700,000 in tax. If leaving behind $10 million, tax would be around $3 million, whereas currently it would be zero. Married couples have double the exemption of an individual. Currently a married couple can leave $23 million to their family with no estate tax payable. The new laws would create a tax bill of around $8 million.
The gift tax exclusion is to suffer an even more dramatic cut: from $11.7 million to just $1 million.
Making gifts to irrevocable trusts has traditionally been one of the key tools for transferring assets out of someone’s estate and thereby reducing the potential estate tax bill to be paid by their family. If the exclusion falls to $1 million that will significantly hamper our ability to implement gifting strategies. Families who could potentially be affected by these new laws should start thinking now about how to structure gifts between now and the end of the year while the gift tax exclusion remains at $11.7 million.
Taking Aim at the Tax Reduction Toolbox
For decades, estate planning attorneys have used all kinds of tools to help clients navigate the tax landscape:
- Valuation discounts: there are ways to transfer a $1 million asset to an irrevocable trust and only use up, say, $600,000 of your gift tax exclusion. These valuation techniques have been specifically targeted and, effectively, eliminated, in the Act.
- Grantor Retained Annuity Trusts have been an effective way to transfer wealth out of an estate without using up too much gift tax exclusion. The new law will make GRAT planning far more difficult and, potentially, obsolete, due to the imposition of minimum gift amounts and minimum terms.
- Grantor Trusts: these are trusts where income is taxed to the trust creator but assets in the trust are nevertheless considered to have been transferred out of his estate for estate tax purposes. These trusts have been a cornerstone of estate planning for decades. With the stroke of a pen, the new Act will deem assets in grantor trusts to be part of the trust creator’s estate for estate tax purposes. This is a very significant change that forecloses the use of one of the most important planning tools in our arsenal.
- Irrevocable Life Insurance Trusts (ILITs): this has hitherto been an invaluable technique for pushing life insurance out of your estate so that life insurance proceeds are not subject to tax. A number of my clients are currently implementing ILIT based strategies for this very reason. The new Act would subject such life insurance proceeds to tax. It is therefore critical to ensure that ILIT planning is completed as soon as possible this year.
The proposed legislation, if enacted, would amount to the most sweeping shift in the tax landscape in a generation. We do not know whether the legislation that is ultimately passed will be as currently proposed or a watered down version. However, even a watered down version would bring far more families into the estate tax net and would curtail the use of our favored planning tools to reduce that exposure. Some of the changes will come into effect on the “effective date” (possibly 1/1/2022), while others are to come into effect on the date of “enactment” of the legislation (ie some time during 2021). Time is therefore of the essence. If your family may fall within the scope of these proposed new laws, the time to act is now.