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Estate Tax Planning Alert

Estate Tax Planning Alert: Federal Tax Proposals May Require Immediate
Planning Action Before Year-End

Pending federal tax proposals include some significant estate tax measures
The House Ways and Means Committee has been working on the tax items that may be included in the pending “Build Back Better” reconciliation bill. We summarized many of these tax proposals in our recent blog article: Federal Tax Update: Reconciliation Bill Proposals from the House Ways and Means Committee.

This article will specifically address some of the proposed estate tax measures that could require immediate estate planning action prior to December 31, 2021.

Reduction in the amount of the Unified Credit
As a result of the 2017 tax act, under current law, the amount of wealth that be transferred without any gift, estate or generation skipping transfer tax is $11.7 million. The 2017 tax act generally doubled the Basic Exclusion amount, adjusted for inflation, from 2018-2025. The House proposal accelerates the 2026 reduction to 2022 and would reduce the amount to a $5 million inflation adjusted amount that may be around $6.2 million in 2022.

Action item: Consider gifts now to efficiently use the current exemption amount
Taxpayers should act immediately to endeavor to use exemption before it declines by half. So, for some wealthy taxpayers that have not yet used their exemption, planning might entail on an urgent basis (not just before end of year) using as much exemption as is appropriate. “Appropriate” requires considering of your budget and cash flow needs, sources of income and other cash inflows. Another consideration of making large gifts is whether to place the gift into trust for the benefit of a specified beneficiary(ies).

Restrictive Valuation Rules for Nonbusiness Assets
Under current law, a marketable securities portfolio may be transferred into a family limited partnership (“FLP”) or a family limited liability company (“LLC”) followed by a gift or sale of non-controlling fractional interests to various trusts. When that is done, the value of the non-controlling entity interest might be reduced by 15-35% or more depending on the facts, type of assets, and opinion of the qualified appraiser. That discount has been a common component of estate tax minimization planning. The IRS has long sought to restrict the use of discounts, especially on non-business assets, and Congress appears to be on board. There clearly was concern that valuation discounts in the context of cash and marketable securities, while supported by valuation theory, may not be an appropriate component of the estate tax system.

The House proposal provides that there will not be any valuation discount permitted for transfer of non-business assets. Nonbusiness assets include passive assets held to produce income such as cash, marketable securities, triple net leased real estate and other assets not used in the active conduct of a business. Several of these terms raise definitional issues as to what is included, or not. At what point does real estate become characterized as a passive investment asset versus an active business?

To minimize planning machinations these new rules on valuation discount restrictions include look-through rules that requires treating an entity as owning pro-rata the underlying asset of an entity in which it owns a 10% or greater interest.

This proposal will eliminate the use of FLPs and LLCS for discounting marketable securities and perhaps other assets as well.

Action item: Consider gifts now of assets that are subject to the discount planning that will be eliminated or restricted by this proposal. Immediate planning may be necessary to perform the business or asset valuations necessary to determine the appropriate valuation discounts to apply to assets to be gifted.

Limitations on Grantor Trusts
Grantor trusts have long been valuable estate planning tools, and this planning tool may be eliminated or substantially limited under the proposed legislation. If the proposed legislation is enacted as currently drafted, it would significantly limit the use and effectiveness of many grantor trusts, including certain life insurance trusts (ILITs), grantor retained annuity trusts (GRATs), intentionally defective grantor trusts (IDGTs), and spousal lifetime access trusts (SLATs).
If your estate plan currently includes any of these grantor trusts, or if you have been contemplating making gifts to a grantor trust to use remaining exemptions or if you are considering a sale to a grantor trust, we urge you to contact one of our estate tax advisers now. Because the changes affecting grantor trusts may be effective as soon as the legislation is enacted (potentially prior to the end of 2021) and may impact pre-effective date grantor trusts, the window of opportunity to act with respect to grantor trusts may be rapidly closing.

Potential urgent action items include:
1. Prefunding life insurance trusts with enough cash to pay premiums for several years even if this means using a portion of a person’s exemption amount
2. Executing all documents related to a sale to a grantor trust before the enactment of the draft act so that the transaction can be grandfathered into the current non-recognition rules.

Recap of potentially immediate planning action
1. Utilization of current higher Unified Exemption amounts – Individuals with significant estates that may be affected by the reduction in the Unified Exemption amount should consider appropriate gifts now before the potential decrease in the exemption amount in 2022.
If the assets to be gifted are business interests, or other assets that may require formal valuations to determine the amount of the gifts arrange for the performance of those formal valuations as soon as possible.

2. Taking advantage of current valuation discounting component of estate planning – Individuals planning to gift asset that may benefit from current discount planning opportunities should take the necessary action to make those gifts as soon as possible.
If utilizing existing valuation discounts will require a formal valuation of the asset to be gifted arrange for the performance of those formal valuations as soon as possible.

3. Grantor trust planning – If grantor trusts are part of a current estate plan OR if use of a grantor trust is currently being contemplated, contact one of our estate planning advisers to discuss potential immediate action including prefunding life insurance trusts with enough cash to pay premiums for several years even if this means using a portion of a person’s exemption amount and executing all documents related to a sale to a grantor trust before the enactment of the draft act so that the transaction can be grandfathered into the current non-recognition rules.

Next steps
If you would like to discuss these potential action items further please contact us at info@herbein.com.

Planning Team

  • Stacy Weller, Tax Partner at saweller@herbein.com
  • Alan Wecht, Tax Partner at acwecht@herbein.com regarding estate tax planning considerations
  • Randy Raifsnider, Partner and Business Valuation Specialist at rcraifsnider@herbein.com regarding business valuation considerations.

Article prepared by Stacy A. Weller