In recent weeks, we have seen several pieces of proposed tax legislation introduced in Congress. Although no tax legislation has yet been enacted in 2021, these bills suggest a growing momentum by Congress to overhaul the existing transfer tax and wealth tax regime.
Three bills worth highlighting and briefly summarizing are the “For the 99.5 Percent Act,” the “STEP Act,” and the “Ultra Millionaire Act of 2021.”
For the 99.5 Percent Act
Senator Bernie Sanders (I-VT) and Senator Sheldon Whitehouse (D-RI) introduced the “For the 99.5 Percent Act” on March 25, 2021. If passed, the Act would dramatically change the current estate planning paradigm. Namely, the Act would:
- reduce the federal estate and gift tax exemption amounts;
- increase the estate, gift, and GST tax rates;
- dramatically reduce the availability of valuation discounts;
- prohibit the use of certain advanced estate planning techniques such as short-term GRATs and zeroed-out GRATs;
- eliminate perpetual GST tax-exempt “dynasty” trusts;
- eliminate a basis step-up at the grantor’s death for certain assets held in grantor trusts;
- treat distributions from grantor trusts as taxable gifts; and
- dramatically reduce an individual’s ability to make “annual exclusion” gifts.
The bill includes grandfathering provisions. Therefore, it is important to note that there are still opportunities to capitalize on current gift tax rates, current gift tax exemption levels, and currently available planning techniques such as short-term and zeroed out GRATs, by making gifts in 2021. We may find ourselves in a “use it or lose it” situation when it comes to the current exemption levels and tax rates, so the urgency to making gifts in 2020 continues in 2021.
The following is a summary of the proposed changes under the Act.
A Decrease to the Estate, Gift, and GST Tax Credits:
The estate, gift and generation skipping tax exemption of $11,700,000 would be reduced to $3,500,000 in the case of estates and $1,000,000 in the case of gifts. The gift tax exemption would not be indexed for inflation, while the estate tax exemption would continue to be indexed for inflation.
The changes would be effective for decedents dying and gifts made on or after December 31, 2021.
An Increase to the Transfer Tax Rates:
Currently, the maximum gift, estate, and generation skipping tax rate is 40%. The Act changes the rate structure so that estates over $3,500,000 and up to $10,000,000 will be taxed at 45%; over $10,000,000 and up to $50,000,000 will be taxed at 50%; over $50,000,000 and up to $1,000,000,000 will be taxed at 55%; and over $1,000,000,000 will be taxed at 65%.
Because the GST tax is assessed at the highest applicable federal estate tax rate, a 65% tax will be imposed on generation skipping transfers.
The rate structure is effective for deaths, gifts, and generation skipping transfers occurring after December 31, 2021.
Restriction of Valuation Discounts:
The Act introduces new rules designed to minimize the use of valuation discount planning. First, with respect to the transfer of assets not used in an active trade or business (such as marketable securities), intermediary business entities are disregarded for purposes of determining whether a valuation discount would be appropriate. In other words, transferring marketable securities to an LLC or FLP would not garner a valuation discount for lack of control or lack of marketability.
Second, no valuation discounts are permitted for lack of control or for lack of marketability where an entity is controlled or majority-owned by members of the same family. This would be true even where the entity owns assets that ARE used in an active trade or business.
A “member of the family” means with respect to any individual, (1) the spouse, (2) an ancestor, (3) a lineal descendant, (4) the spouse of an ancestor or lineal descendant, or (5) a parent of the spouse or any lineal descendant.
There is an exception for real estate activities where there is material participation, generally meaning more than 750 hours of active and continuous engagement in the enterprise. The exception, however, would not apply to triple net leases.
This provision would be effective for all transfers made after the date of enactment of the Act.
Elimination of Short-Term and Zeroed-Out Grantor Retained Annuity Trusts (“GRATs”):
The Act requires that a GRAT have a minimum term of ten years and a maximum term of the life expectancy of the annuitant plus ten years, and the remainder interest must not be less than an amount equal to the greater of 25% of the fair-market value of the trust assets or $500,000.
The Act effectively eliminates the two most effective ways to utilize GRATs in estate planning—short-term rolling GRATs and zeroed-out GRATs.
The GRAT rules are effective for GRATs funded after the date of enactment.
Elimination of Perpetual Dynasty Trusts:
Many states have repealed their state laws relative to the Rule Against Perpetuities so that assets can remain in trust forever while remaining exempt from GST tax at each generation.
The Act seeks to eliminate the perpetual nature of these trusts by imposing a 50-year term. Any trust created after the date of enactment which has a term of more than 50 years will have an inclusion ratio of one (meaning that the Trust is fully subject to GST tax). The Act even applies to existing trusts, which will be deemed to have an inclusion ratio of one after 50 years.
The effective date of this section will be the date of enactment.
Elimination of Step-Up for Assets Held in Intentionally Defective Grantor Trusts (“IDGTs”):
The Act makes it clear that any asset in an intentionally defective grantor trust (“IDGT”) will not receive a step-up in basis upon the death of the grantor unless the property is includible in the taxable estate of the grantor.
It is worth noting that very few practitioners have taken the position that assets in an IDGT receive a step-up in basis notwithstanding exclusion from the grantor’s taxable estate. The Act clarifies that the minority position (which was an aggressive one) will no longer hold water.
The effective date of this section will be the date of enactment.
Inclusion of IDGT in the Grantor’s Taxable Estate and the Treatment of IDGT Distributions as Taxable Gifts:
The Act requires that (1) assets in an IDGT be included in the grantor’s estate (unless the trust is grandfathered); (2) distributions from an IDGT during the lifetime of the grantor be considered taxable gifts; and (3) the value of the entire IDGT be deemed a taxable gift if the grantor status is toggled off during the lifetime of the grantor.
This section of the Act would apply to trusts created after enactment, as well as to transfers made to preexisting trusts after enactment.
There is an exception to the grantor trust estate tax includability rules for assets in the grantor trust subject to gift taxes by either paying a gift tax or using the transferor’s gift tax exemption.
Dramatic Change to Annual Exclusion Gifts:
Under current law, an individual can give away $15,000 per year to any number of donees without any gift tax consequences. There is no cap on the number of donees to whom an individual can make these $15,000 “annual exclusion” gifts. In other words, if an individual had 10 grandchildren, she could make a gift of $15,000 to each of her 10 grandchildren—for a total of $150,000 in gifts—without reporting the gifts on a federal gift tax return, paying any federal gift tax or utilizing any of her lifetime exemption from federal gift tax. If she was married, her spouse could also make a separate gift of $15,000 to each of the 10 grandchildren—for a combined total of $300,000 in “annual exclusion” gifts.
The Act changes this paradigm. Under the Act, an individual can only gift $20,000 (in the aggregate) each year, and of that $20,000 a maximum of $10,000 can be given to any one individual. In other words, using the same example as above, the grandmother could only give $2,000 to each of her 10 grandchildren (or she could pick her favorite two grandchildren and give them $10,000 each). If the grandmother was married, her spouse could also give $2,000 to each of the 10 grandchildren (or $10,000 to the two favored grandchildren). Instead of the grand total in combined “annual exclusion” gifts equaling $300,000 as it would in our example under current law, under the Act, the grand total in combined “annual exclusion” gifts would equal $40,000.
The effective date of this section is any calendar year beginning after the date of enactment.
Another Notable Legislative Proposal—the STEP Act:
Senator Chris Van Hollen (D-MD), joined by Senators Cory Booker (D-NJ), Bernie Sanders (I-VT), Sheldon Whitehouse (D-RI), and Elizabeth Warren (D-Mass.), introduced the Sensible Taxation and Equity Promotion (STEP) Act on March 25, 2021. The Act would tax unrealized capital gains on assets at the owner’s death. Under this Act, assets would no longer receive a tax-free step-up in cost basis upon the owner’s death. However, under the Act, the first $1 Million in unrealized capital gains would be excluded from tax.
The effective date of this Act would be 1/1/2021. In other words, the Act would be retroactive.
A Third Bill—The Ultra-Millionaire Tax Act of 2021:
Senator Elizabeth Warren (D-Mass.), joined by Representative Pramila Jayapal (D-WA-07) and Representative Brendan Boyle (D-PA-02), introduced the Ultra-Millionaire Tax Act on March 1, 2021. The Act would levy a 2% annual tax on the net worth of households and trusts between $50 million and $1 billion and a 3% overall tax on households and trusts over $1 billion.
The Act includes robust anti-evasion and avoidance measures, including:
- Rules that combine the values of trusts that have substantially the same beneficiaries and combine the values of trusts where a decanting has occurred within the calendar year;
- A $100 billion investment to rebuild and strengthen the IRS, ensuring the agency has the resources to hire and train additional personnel, modernize IT systems, and implement the new asset valuation, reporting, and enforcement requirements for the Ultra-Millionaire Tax;
- A 30% minimum audit rate for taxpayers subject to the Ultra-Millionaire Tax;
- A 40% "exit tax" on the net worth above $50 million of any U.S. citizen who expatriates;
- New valuation tools to better enable the IRS to determine the value of hard-to-value assets;
- Systematic third-party reporting that builds on existing tax information exchange agreements adopted after the Foreign Account Tax Compliance Act; and
- Penalties for underpayment
This Act would be effective for calendar years ending after December 31, 2020. In other words, the Act—if passed—would be effective for 2021.
Conclusion
While none of the bills summarized above –the “For the 99.5 Percent Act,” the “STEP Act,” or the “Ultra-Millionaire Tax Act of 2021”—has been enacted, the plethora of proposed legislation evidences a momentum for changes to the transfer tax and wealth tax regime. It is important to understand the proposed changes and to take appropriate action now by making gifts and “grandfathering” in certain techniques, exemption levels and/or rates that may no longer be available after 2021.
At WMS Partners, we work alongside your attorneys and other tax professionals to implement strategies that align with your family’s goals and objectives. We will continue to monitor this and other relevant proposed legislation. In the meantime, please contact your WMS Advisor with any questions or concerns.