UPDATE: Proposed Changes To Federal Tax Code Affecting Tax And Wealth Management Clients – Tax

Update (11/8/21). Welcome to the legislative roller coaster! For now, we can all breathe a collective sigh of relief. On November 3, 2021, the U.S. House of Representatives Rules Committee (the “Committee”) released a third version of the Rebuilding Better Bill, which includes updated guidelines that significantly narrow the scope of previously proposed changes to federal tax law.

For more details see – https://rules.house.gov/sites/democrats.rules.house.gov/files/BILLS-117HR5376RH-RCP117-18.pdf

In particular, the newly revised proposal rescinded the provisions of the previous proposal that would:

• Lower the federal estate and gift exemption effective January 1, 2022 (although “sunset” for the federal estate and gift tax exemption is still scheduled for the end of 2025).
• The way donor funds are treated for income and estate tax purposes has changed.
• Valuation rules for the transfer of non-trading assets have been changed.
• Higher capital gains and higher marginal income tax rates.

Version 3 of the commission’s proposal still includes a potential 5% surcharge on adjusted gross income over $10,000,000 for individuals and over $200,000 for estates and trusts, plus a 3% surcharge on adjusted gross income that Over $25,000,000 for individuals and over $500,000 for real estate and trusts.

For individuals who earn more than $400,000 annually and have more than $10,000,000 held in retirement accounts, this version of the proposal would also (i) prohibit such individuals from making contributions to retirement accounts and (ii) require these individuals to make 50 annual withdrawals % of the total value of their retirement accounts in excess of $10,000,000. Additionally, if the same individual’s retirement accounts exceed $20,000,000, the individual will be required to annually withdraw from any designated Roth IRA and Roth less than (i) the amount required to reduce the total retirement account balance below 20, $,000,000 and (ii) the full balance of Roth IRAs and Roth Designated Accounts. Both the proposed changes to retirement account withdrawals and contributions will become effective after December 31, 2028.

We’re providing this update to keep you informed, and we’ll let you know more as the legislative process continues. Although nothing is definitive at this time, it is good to see the cancellation of many previous tax proposals.

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Original Alert (12/21/10)

On September 13, 2021, the US House of Representatives Committee on Ways and Means (the “Committee”) released draft proposed changes to federal tax law, including significant changes affecting trusts, estates, gifts, and tax rates, among other proposals.¹. The most relevant modifications are presented below. Individuals are likely to require immediate legal assistance to make appropriate adjustments in response to these anticipated changes.

Exemption from inheritance and gifts

Currently, individuals are exempt from the federal gift and estate tax in the amount of $11,700,000 (or $23,400,000 for spouses), minus any taxable gifts given during life. The Skip Transfer Tax Credit (“GST”) amount equals the Gift and Estate Tax Credit amount. These exemptions are increased each year for inflation.

The current law is set to expire at the end of 2025, at which time the estate, gift, and GST exemptions will be reduced to about half of the current amounts as of 2026. The commission’s proposal speeds up that sunset and reduces the exemptions to approximately $6,020,000 per person. (or about $12,040,000 for spouses) beginning in 2022. For individuals who do not use all of the current available exemptions of $11,700,000 through 2021, approximately $5,700,000 may be lost from The proposed reduction in these exemptions is in perpetuity.

Trustee Transactions

Some of the most important changes in the committee’s proposal deal with trusts that are “donor funds” for income tax purposes. Grantor trusts are those trusts that are not included in the estate of the originator (or grantor) for estate tax purposes but treat the grantor as the owner for income tax purposes. Under the proposed changes, assets transferred to the grantor’s fund created or financed after the enactment of the new law will be subject to the possibility of (i) being included in the grantor’s ownership for estate tax purposes and (ii) recognition events for income tax purposes. In addition, a distribution from the grantor’s trust to persons other than the grantor or the grantor’s spouse will be treated as a taxable gift by the grantor during the life of the grantor.

Existing donor trusts will not be subject to these rules. However, to the extent that there is a contribution made to the existing grantor’s trust after the date of enactment of the proposed legislation, the portion of the trust assets attributable to the contribution will be subject to the new rules of the grantor’s trust. These contributions are supposed to include a gift or sale, and possibly other transactions. These rules will significantly reduce, if not eliminate, the use of trusts such as Spouse Lifetime Access Trusts (commonly referred to as “SLATs”).

The proposed rules would also significantly change the income tax for grantor-retained annuity funds (“GRAT”). Specifically, under current law, when an annual salary is paid to the grantor from GRAT, there is no income tax consequence. However, under the proposed changes, there will be a recognition event for income tax purposes every time annual GRAT payments are made using the assessed property. In other words, each time GRAT makes a required annual payment to the grantor, the grantor is liable for income tax on the distribution as if the distribution were a sale (unless the distribution was made in cash).

Valuation rules for transfers of non-commercial assets

The Committee also proposed eliminating the lack of marketability discounts and partial benefit assessment discounts for interests in entities owned upon death or granted during the life of the transferor when such entities own non-commercial or passive assets, including cash, shares, personal property and other similar assets. Real property will also be treated as a passive asset unless the transferor “substantially participates” in the management of the business.

Other tax changes

• The capital gains rate will increase to 25% (effective from September 13, 2021).
• The highest marginal income tax rate would be 39.6% for individuals who earn more than $400,000, and for married couples who make more than $450,000.
• An additional 3% tax will be levied on individuals with adjusted gross income of more than $5,000,000 and on estates and trusts with adjusted gross income over $100,000.
• Individuals with retirement accounts totaling more than $10,000,000 and who earn more than $400,000 (or $450,000 for married couples), will be (i) prohibited from making additional contributions to their retirement accounts and (ii) required to withdraw their annual accounts From 50% of value over $10,000,000 and 100% of value over $20,000,000.

What actions should individuals take?

Depending on the proposed changes, individuals should consult with their trust and estate attorneys to better understand what steps need to be taken now, and how the commission’s proposal might affect their current estate planning. Many of the proposed changes will become effective immediately upon the conversion of the Commission’s proposal into law. For example, many of the changes under consideration will affect individuals who are considering using their existing exemptions in 2021. Rather than waiting to see what changes are eventually adopted in the tax code, immediate consultation is advised at this point.

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1. This was the original proposal: https://waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/documents/NEAL_032_xml.pdf

The content of this article is intended to provide a general guide to the topic. It is recommended to take the advice of specialists in such circumstances.