On September 15, 2021, the House Ways and Means Committee released its Build Back Better Act (“BBBA” or “Act”) that, if enacted into law, will severely limit current tax planning techniques even ahead of the scheduled January 1, 2026, reduction in the $10 million dollar basic exemption amount for the gift tax, estate tax and generation-skipping transfer tax. Significant proposals were also made this year in the form of the “For the 99.5% Act and “The STEP Act”. Some of the proposals contained in these earlier proposals are not included in the BBBA. These included repeal of the step-up in basis rule and treatment of death as a taxable event and generation-skipping taxes every 30 years.
However, the BBBA eliminates discount planning for nonbusiness (i.e., financial) assets and grantor trust planning. This Memo focuses on the impact and timing of these rules and the planning required ahead of its passage into law.
Estate Tax Exemption–Reduction in Exclusion. The BBBA temporary increase from 2020 which was scheduled to revert back to its pre-2020 amount in 2026, would, instead, be rolled back as of January 1, 2022. This reduces the current $11,700,000 per person exemption to an inflation adjusted exemption of $6,020,000. The effective date is gifts and persons dying after December 31, 2021.
Grantor Trust Rules. The grantor trust rules have been a cornerstone of estate planning for decades. The Act would radically the benefits of traditional estate planning using the income tax benefits of creating irrevocable trusts that are disregarded for income tax purposes…so-called “defective grantor trusts”. Virtually all irrevocable trusts in existence are structured to achieve desired grantor trust status to neutralize any income tax consequences of transactions between the grantor/trust creator of a trust and the trust, itself. This change would be implemented by applying the estate tax to any grantor trust (that is a trust over which the grantor is deemed the “owner” for income tax purposes). A completed gift would only occur during the grantor’s lifetime if a distribution were made to other than the grantor’s spouse.
As presently drafted, spousal lifetime access trusts (SLATS); grantor retained annuity trusts (GRATS) and qualified personal residence trusts (QPRTS) and certain charitable lead annuity trusts (CLATS) would no longer be available after the effective date of the BBBA (not January 1, 2022, like the reduction in the estate tax exemption. These provisions of the BBBA have an effective date of the date of enactment and would include pre BBBA trusts for which a contribution is made after the date of enactment. Similarly, life insurance trusts for which premiums are being made may no longer escape estate taxation if trust income is used to pay principal. A related provision disregards the grantor trust rules when there is a sale of property between the trust and the grantor (and a person other than the grantor who is deemed to be the tax owner). This provision is also effective as of the date of enactment. What is not clear is if the sale occurs with respect to a trust created BEFORE the date of enactment. This, alone, my spawn the creation of trusts this year to exploit this potential loophole. This is something that may be addressed before the BBBA is passed into law.
Valuation Discounts. A cornerstone of current planning is to create limited liability companies funded with closely held business assets or financial assets (stocks, bonds, options, traded on a nationally recognized exchange). The grantor and his or her spouse, own all the voting and non-voting interests. Shortly after creation, funding and issuance of initial membership interests, non-voting, non-manager membership interests are gifted and/or sold to a defective grantor trust. This results in the tax-free transfer of the discount and enables the assets to grow income tax free in the irrevocable trust with no obligation to pay any income tax on the earnings of the trust, all of which is taxable to and paid for by the grantor and which payment of taxes is NOT a gift back to the beneficiaries of the trust.
What Was Excluded. The BBBA does not treat death as income taxable event. The BBBA does not eliminate step-up in basis at death. Gift, estate and generation-skipping tax rates remain capped at 40%.
What Should Be Done Now? Serious consideration should be given to creating SLATs, sales to grantor trusts using valuation discounts and using gift and GST exemptions before they are lost. Time is off the essence, as these techniques require lead time to properly age transfers to Family LLC’s which will then be gifted and/or sold to irrevocable grantor trusts. Any trust that can benefit from decanting should be completed ahead of the effective date of the grantor trust provisions.
