TRUST & ESTATE PLANNING

2021 Guide to Potential Tax Law Changes

05.12.2021 - Gerard F. Joyce, National Head of Trusts and Estates

DOWNLOAD 2021 GUIDE TO POTENTIAL TAX LAW CHANGES

Federal tax law changes impacting wealthy individuals and families may become a reality. While the substance and timing of these changes is uncertain, the major proposals being considered would significantly change the tax planning landscape and how certain Americans will approach financial planning.

Key Takeaways
  • The top individual federal income tax rate could increase from 37% to 39.6%
  • Long-term capital gains tax rate could increase from 23.8% to as high as 43.4%, when including the net investment income tax of 3.8%
  • Cost basis ‘step up’ could be removed for gains of over $1 million on inherited assets
  • The federal estate tax rate could increase on a progressively sliding scale for assets transferred over $3.5 million
Current tax planning opportunities for wealth transfer could be limited Now more than ever, the potential tax law changes emphasize the importance to:

  1. Run the numbers on your estate and financial plans to understand how you are positioned to achieve your financial goals.
  2. Consider your options for using your full estate and gift tax exemption of $11.7 million before the exemption amount can decrease.
  3. Know the details of all trusts for your family and how they fit into your estate and financial plans.
  4. Identify opportunities to realize capital gains and accelerate income into 2021.
Income Tax Proposals
Increase the Top Income Tax Bracket and Limit Deductions
Who may be affected?
  • Taxpayers with income over $400,000
Tax proposal
The proposed income tax changes would increase the top income tax rate from 37% to 39.6%. There also could be an expansion of Medicare Taxes for taxpayers with over $400,000 of income in certain circumstances.

In addition, discussions continue over the fate of the current $10,000 limit on deductions for state and local taxes (SALT), which has a significant impact for taxpayers in high tax states like New York and California.

Actions to consider
The tax rate increase could require adjustments to your financial plans to reflect the new rates. You may consider accelerating income like bonuses or deferred compensation if the changes take effect with the new year. For deductions, you may want to accelerate or defer depending on what you can deduct this year and how any future limits may apply. Lastly, if the numbers line up to support converting your traditional IRA to a Roth IRA, now may be the time to do it before rates have the potential to increase.

The Proposals Would Increase Taxes for High Income Taxpayers and Allow Fewer Deductions

Source:  Fact Sheet: The American Families Plan; Scheduled Sunsets of Tax Cuts and Jobs Act.

Increase Long-Term Capital Gains Tax and End Carried Interest “Loophole” and Tax-Free Exchanges
Who may be affected?
  • Taxpayers with over $1 million in income
  • Hedge fund managers with carried interest
  • Real estate investors with over $500,000 of gains
Tax proposal
The current maximum rate on long-term capital gains is 23.8% on the sale of assets held over 12 months. The tax proposal nearly doubles this tax to 43.4% on gains for taxpayers with over $1 million in annual income.

The proposals would also end capital gains treatment for income based on a carried interest. And tax-free exchanges of real estate (1031 Exchanges) would only be possible for up to $500,000 of gains.

Actions to consider
If you are planning a sale of a major asset, such as a home, business or investment position, consider completing your sale as soon as possible this year.

You also may want to evaluate future sales you may be contemplating to decide if the potential tax savings of accelerating the sale could be worthwhile. Going forward, strategies to defer or spread out income over multiple years, such as installment sales and Charitable Remainder Trusts, may become essential planning.

Proposals Would Increase the Top Capital Gains Rate

Source:  Fact Sheet: The American Families Plan.

Remove Capital Gains ‘Step up’ for Assets Transferred at Death
Who may be affected?
  • Taxpayers with significantly appreciated assets
  • Beneficiaries inheriting assets with unrealized gains over $1 million
Tax proposal
Currently, your basis is the value of assets on the date when the person from whom you inherited died. So, when you sell the asset, you’ll only pay capital gains tax on any appreciation that happens after the date of death.

The tax proposal would remove this “step up” of income tax basis for gains over $1 million on inherited assets (or totaling over $2 million if inheriting from a married couple). This could require you to pay additional tax when you sell assets you inherit. Alternatively, the gains could be deemed realized when you inherit the assets, creating an immediate tax liability on any gift or inheritance.

Actions to consider
You will need to review your estate plan to understand the tax burden this would have on your heirs. You may also want to revisit your strategy around low-basis assets you perhaps have not sold in anticipation that the capital gains will disappear at your death.

Proposals Would Eliminate the Cost Basis Step-Up for Inherited Assets with over $1 Million in Gains

Source: Fact Sheet. The American Families Plan; Sensible Taxation and Equity Promotion (STEP) Act.

Estate Tax Proposals
Increase the Federal Estate Tax
Who may be affected?
  • Taxpayers with assets over $3.5 million
Tax proposals
Under current rules for 2021, you can transfer up to $11.7 million during your lifetime or at death without paying gift or estate tax. You can also transfer up to that same amount to grandchildren or lower generations, outright or in trust, without incurring generation-skipping transfer (GST) tax.

The $11.7 million amount is a record high amount, and it’s already scheduled to be cut in half in 2026 (after adjustments for inflation). The new tax proposals would cut the exemption even further and sooner.

Beginning in 2022, the exemption would come down to $3.5 million for transfers at death and only $1 million for gifts you make during your lifetime. The GST exemption would also come down to $3.5 million.

At the same, the proposals would increase the tax rates for gifts, estates and generation-skipping transfers made above the exemption amount to as high as 65% from the current flat rate of 40%.

Actions to consider
These potential changes put a spotlight on gifting now to use your exemption amount before you lose it. Depending on your circumstances, gifting may or may not make sense. Some taxpayers may go as far as making gifts above the exemption to pay tax at current rates. For others, a close look at your circumstances may reveal that gifting does not make sense even if the law changes.

Running the numbers under the potential new rules may also highlight liquidity concerns following your death that you may not have considered with the current high exemption amounts.

Proposals Would Lower Transfer Tax Exemption Amounts and Increase Estate Tax Rates

Source: For the 99.5% Act.

Limit the Estate Tax Planning Opportunities for Wealth Transfer (4 Proposed Changes)

Who may be affected?

  • Taxpayers with assets over $3.5 million ($7 million for married couples)
  • Families with existing irrevocable trusts

1) Grantor retained annuity trusts
Grantor retained annuity trusts (GRATs) have been a very effective strategy to transfer wealth to beneficiaries tax free. Once you transfer assets to the trust, any appreciation of the trust above the IRS hurdle rate (in the range of 0.4% to 2% in recent years) can transfer to your heirs tax-free. GRATs have been particularly effective if you have already used your gift and estate tax exemption, since GRATs typically are structured so you do not make a taxable gift.

The new tax proposals significantly limit the benefits of GRATs. In most cases, GRATs would be required to last at least 10 years and you would be required to make a taxable gift of 25% of the amount you contribute to the GRAT when setting up the trust.

Actions to consider
For families that have used GRATs in the past, you may want to complete any new GRATs before the law changes. You may also want to consider alternative GRAT strategies to take advantage of current rules over a longer period.

Proposals Would Limit the Tax Effectiveness of Grantor Retained Annuity Trusts

Source: For the 99.5% Act.

2) Grantor trusts
Another powerful strategy in estate planning has been the use of grantor trusts. These trusts allow you to make a gift and remove those assets from your estate for estate tax purposes. But the gifted assets are still treated as if you own them for income tax purposes. This can simplify your tax reporting. It also can supercharge your gifting as your gift can grow free of income tax. In addition, grantor trusts often are used to buy assets out of your estate in an installment sale that can effectively “freeze” the value of your estate.

This proposal would undo these tax advantages. Under the proposed rule, grantor trusts would be included in your estate for estate tax purposes. In other words, you could no longer have a trust that you’re treated as owning for income taxes yet out of your estate for estate taxes. This would cut off installment sales to grantor trusts. It also would impact irrevocable life insurance trusts and other common forms of trusts.

Actions to consider
Families with large estates should consider creating grantor trusts now. Installment sales still can be completed under current law. Existing trusts would be grandfathered, but transactions with those trusts would be limited. Families with existing grantor trusts should take a close look at the terms of those trusts to make sure the trusts can fulfill their purposes under the new rules.

Proposals Would Limit the Tax Effectiveness of Grantor Trusts

Source: For the 99.5% Act.

3) Valuation discounts
Currently, the value of gifts of interests in family-owned entities, such as limited partnerships and limited liability companies, can be discounted for tax purposes. These discounts are based on the lack of marketability and lack of control of minority interests and can range from 5% to over 40% of the pro rata value of the entity. For example, a 25% interest in a family entity worth $20 million could be valued at $3 million with a 40% discount rather than the pro rata value of $5 million or 25% of the value of the entity as a whole.

The potential new rules would take away these discounts for any non-business holdings of an entity. While active businesses could still be discounted, cash, marketable securities and certain other assets would be valued at their direct value despite being held within a separate entity.

Actions to consider
For families owning entities with non-business holdings, now may be the time to complete gifts of interests in the entities. Depending on your circumstances, real estate assets still may qualify for discounts. As a result, close attention to your specific circumstances is necessary to understand your current opportunities and what may go away in the future.

Proposals Would Put a Limit on Valuation Discounts for Tax Purposes

Source: For the 99.5% Act.

4) Annual tax-free gifts
In 2021, you can give $15,000 to an unlimited number of people each year with no gift tax consequences. If you have three children and seven grandchildren, $15,000 gifts to each of them could move $150,000 out of your estate each year with no need to file a gift tax return and no use of your gift and estate tax exemption. If you are married, you could gift twice these amounts.

The potential changes would put two new limits on these transfers. First, the $15,000 limit per donee would come down to $10,000. Second, there will be a $20,000 maximum for the total gifts you make to anyone in trusts or involving family entities, restricted property or illiquid assets.

Actions to consider
If you regularly make these annual exclusion gifts to many people, or you make them to even a few people in trusts, you will likely need to revisit your gifting plans. You may want to accelerate gifts to the current year. For trusts holding life insurance policies, you may want to make taxable gifts now to prefund premium payments you know will be need in the future

Proposals Would Cap Annual Tax-Free Exclusion Gifts

Source: For the 99.5% Act.

Generation Skipping Transfer Tax Proposal
Set a Time Limit on the Generation Skipping Transfer Tax Exemption
Who may be affected?
  • Families with GST Tax Exempt Trusts
Tax proposal
In recent years, the laws of several states have been changed to allow trusts to exist for many generations, and in some cases, for perpetuity. These so-called Dynasty Trusts are generally created to be exempt for generation-skipping transfer (GST) tax purposes. This allows these trusts to avoid estate or GST tax for as long as funds continue to be held in the trust.

With the new proposals, the benefit of these trust would be seriously curtailed. New GST exempt trusts would be required to terminate after 50 years. Existing GST exempt trusts would effectively lose their exemption within the same period. Actions to Consider The new rules likely would not put an end to Dynasty Trusts, but the dynasty would not last as long. Existing trusts will need attention to understand the tax burdens going forward. New trusts will require special drafting to comply with the new provisions as well as future changes that could occur before the trusts terminate.

Proposals Would Terminate GST Tax Exempt Trusts after 50 Years

Source: For the 99.5% Act.

 

Contact Us for a Personalized Wealth Planning Consultation

Please contact your Fiduciary Trust advisor to discuss how these potential tax law changes may impact you. If you are not a client, please contact us for a complimentary consultation with a Fiduciary Trust Wealth Planner. We can help you determine what actions to take to prepare for these possible tax law changes.




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IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor.

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