On September 13, 2021, the House Ways and Means Committee released a tax proposal to fund the Build Back Better Act. Although the Act has not been signed into law, the potential consequences to current estate and financial planning techniques require review for high-net-worth families. Below is a summary of the primary proposals and their respective anticipated effective dates.
Decrease in Estate and Gift Tax Exemption
The estate and gift tax exclusion represents the maximum amount that may be transferred to heirs before incurring estate or gift taxes. This exclusion was initially set at $5 million per taxpayer in 2011, increasing annually with inflation. In 2018, the Tax Cuts and Jobs Act doubled the exclusion to $10 million with a sunset provision back to the original inflation adjusted $5 million amount on January 1, 2026. Therefore, without any legislative changes, the current $11.7 million exemption would increase with inflation until 2026, at which time, the exemption would revert to approximately $6 million. However, the Build Back Better Act accelerates the sunset provision to January 1, 2022. Therefore, if this proposal becomes law, taxpayers will have until the end of the year to maximize the additional$5.7 million of available exemptions. It should be noted that only gifts exceeding $6 million will be impacted by this change as illustrated below.
Assume you have a $30 million estate and have not yet utilized any of your exemption. If you gift $6 million in 2021 and pass away in 2022, you will have used the entirety of the reduced exemption. The estate will pay 40% estate taxes on the $24 million net amount, resulting in estate taxes of $9.6 million. If instead you were to maximize the full $11.7 million exemption in 2021 and pass in 2022, the estate will pay taxes on the remaining $18.3 million, resulting in taxes of $7.32 million. Maximizing gifting in 2021 yields $2.28 million in estate tax savings.
Elimination of Valuation Discounts
Under current legislation, gifts of interests in nonbusiness assets are eligible for valuation discounts reflecting lack of marketability and lack of control. The idea being that a third-party buyer would not likely pay 15% of the total value of an asset for a 15% interest if the majority owner has complete control. Likewise, purchasing an interest in a private entity often requires additional costs such as attorneys’ fees, diligence costs, and importantly, time, compared to purchasing a share of a publicly traded company, free of trading costs, instantaneously. Accordingly, gifts of interests in a private entity can be reduced in value for gift tax purposes to reflect these limitations. However, the proposal explicitly disallows the use of valuation discounts for such transfers as of the enactment date of the Build Back Better Act.
Limitations of Grantor Trusts
Grantor trusts are structured such that the grantor is treated as the owner of the assets for income tax purposes but not for transfer tax purposes. Through this process, the grantor continuously removes assets from the estate through the payment of taxes and allows the trust to grow free from the burden of taxes. However, under the Build Back Better Act, any grantor trust established after the bill’s enactment date will be included in the grantor’s taxable estate, thereby removing their utility for gifting purposes. Irrevocable grantor trusts funded prior to the enactment date will be grandfathered under the current rules, except to the extent that any additional contributions are made after the enactment date.
It is uncertain whether any of the proposals in the Build Back Better Act will become law. However, given that some of the provisions may be effective as of the enactment date, we recommend that you consider whether you wish to gift and/or establish trusts for your heirs in a timely manner. If you have any questions regarding how your estate plan may impact your financial plan, please contact our office to discuss.