Proposed Legislation Would Lead to Major Tax and Estate Planning Changes – Speedy Action May Be Required Before Window Closes

September 24, 2021

Congress has drafted proposed legislation that would lead to major income and estate tax changes for individuals and corporations.  While the legislation in its present form may not be enacted and is subject to revision as it winds itself through the legislative process, taxpayers should consider taking immediate action to prepare for the proposed changes in case they are enacted.  It is likely that the changes will take effect as of the date of enactment of the proposed legislation or as of January 1, 2022.  It is also possible that some of the legislation would be retroactive to the date it was introduced (September 13, 2021).   Set forth below is a summary of some of the more significant proposed changes.

Tax Rate Increases

The proposed legislation would increase the highest marginal individual income tax rate from 37% to 39.6% for taxpayers with taxable income over $450,000 who file jointly, and for single filers with taxable income over $400,000.   Trusts and estates would also be subject to the 39.6% rate on any taxable income over $12,500.

The proposed legislation would also increase the capital gain tax rate to 25% for taxpayers with taxable income over $5,000,000 (married joint) and $2,500,000 (single or married filing separate).  In addition, a 3% net investment income tax would also apply to such taxpayers. 

The proposed legislation also imposes a 3.8% tax on ordinary trade and business income for individuals with taxable income above $400,000 for single filers and $500,000 for individuals who are married and file jointly, as well as trusts and estates, which would be subject to this tax on taxable income over $13,450

The proposed legislation also includes a 3% surcharge on modified adjusted gross income in excess of $5,000,000 for married filers or $2,500,000 for single filers and $100,000 for trusts and estates. 

Section 1202 Stock

Section 1202 currently permits taxpayers to exclude all or part of their capital gain income from certain stock investments that are held for at least 5 years.  The proposed legislation would limit this benefit for individuals with income in excess of $400,000 to 50% of the capital gain. 

Estate and Gift Planning

Reduction of Estate and Gift Tax Exemption

Under current law the estate and gift tax exemption is $11.7 million per person.  The proposed legislation would reduce the exemption to the pre-2018 level of $5 million per person, indexed for inflation (from 2010), which would be approximately $6,020,000. 

Changes to Valuation Rules

Current law provides for valuation discounts in connection with the transfer of assets including non-controlling interests in entities such as partnerships and limited liability companies.  The proposed legislation would eliminate discounts on the valuation of entity interests owned at death or transferred by gift  if the entity only holds nonbusiness assets such as cash, stock, debt, annuities, and real property (other than certain real property used in a real property trade or business, which includes development, management, leasing, or construction businesses).

Changes to Grantor Trust Planning

Under current law grantor trusts can be structured so that the trust assets are excluded from the grantor’s taxable estate, while the grantor remains personally liable for income taxes on income earned by the grantor trust.  The draft act provides that grantor trusts created on or after the date of enactment will be included in the grantor’s taxable estate. While existing grantor trusts would be grandfathered under the current rules, gifts made to a pre-existing grantor trust after the effective date of the proposed legislation would be includible in the grantor’s estate.

These proposals applicable to grantor trusts, could severely diminish the current benefits of grantor retained annuity trusts (GRATs), qualified personal residence trusts (QPRTs), spousal lifetime access trusts (SLATs), and insurance trusts as tax efficient estate planning techniques to remove property (and appreciation thereon) from a grantor’s estate.  For an explanation of some of these techniques please see link.

In addition, the proposed legislation would also deem a sale of appreciated property to a grantor trust by the grantor as a sale between unrelated parties and subject such sale to income tax based on the inherent gain.  This proposal would restrict the ability to remove future appreciation from a grantor’s estate through income tax-free sales by a grantor to a grantor trust.

Although many clients have taken advantage of some of the foregoing estate planning strategies, there are many who have sat on the sidelines.  Given the short window before these changes might become effective, clients who desire to take advantage of the opportunities under the current law should avoid any further delay by contacting one of the attorneys listed below in our Private Client Service Group.