Tax Proposals of the House Ways and Means Committee: Reconciliation Bill to Target Trusts, Estates, and the Wealthy

On Sunday, September 12, 2021, the House Ways & Means Committee (the "Committee") released draft legislation as part of Congress' ongoing $3.5 trillion budget reconciliation process. The legislation, as approved by the Committee on Wednesday, September 15, includes significant tax proposals that, if passed, will dramatically change the tax and estate planning landscape for high-income and high-net worth individuals.

Below is an overview of the tax proposals that are particularly relevant for estate planning purposes:

1. Reduction in Gift, Estate, and Generation-Skipping Transfer ("GST") Tax Exclusion:  The bill proposes to accelerate the reduction of the basic exclusion amount for gift, estate, and GST taxes from $11.7 million to $5 million (subject to inflationary adjustments), which was scheduled to occur in 2026. These reductions would be effective for gifts made, or individuals dying, after December 31, 2021.
2. Elimination of Grantor Trust Benefits: The bill also proposes to eliminate the estate planning benefits of grantor trusts, i.e., trusts that are deemed to be owned by the creator of the trust or another person (each referred to as a "grantor") for federal income tax purposes. The following rules would apply to trusts created on or after the date of enactment and to existing trusts to the extent contributions are made to such trusts on or after the date of enactment.
   • Estate Tax Inclusion. Assets owned by a grantor trust would be included in the grantor's estate and subject to estate tax upon the grantor's death.
   • Distributions as Gifts. Distributions from a grantor trust during the grantor's lifetime would generally be treated as taxable gifts.
   • Taxation Upon Termination of Grantor Trust Status. If the trust's grantor trust status is terminated (i.e., the trust becomes a separate taxpayer from the deemed owner), the grantor would be deemed to have made a taxable gift of the trust assets.
   • Gain Recognized Upon Sale to Grantor Trust. With respect to trusts created and funded after the date of enactment, sales between a grantor trust and its grantor would be subject to income tax.
3. No Valuation Discount for Nonbusiness Assets: Under the proposed legislation, the opportunity to claim valuation discounts when a taxpayer transfers certain business interests that own "nonbusiness assets" would be eliminated. These nonbusiness assets, such as cash, stocks, bonds, and real property (with exceptions for certain active real estate trades and businesses), would be valued as if the transferor transferred such assets directly to the transferee at full fair market value. This proposal would apply to all transfers made after the date of enactment.
4. Tax Increases for High-Income Taxpayers. The proposals include a number of tax hikes for high-income taxpayers, which would take effect January 1, 2022:
   • The top marginal rate income tax rate would increase from 37% to 39.6% for individuals, trusts, and estates.
   • The top income tax rate for long-term capital gains would increase from 20% to 25%.The top income tax rate for long-term capital gains would increase from 20% to 25%.
   • Trusts and estates with income over $100,000 would be subject to a 3% surcharge tax based upon their modified adjusted gross income ("AGI"). This 3% surcharge tax would also apply to individual taxpayers, whether single or married, with modified AGI in excess of $5 million. For married individuals filing separately, the 3% surcharge tax would apply to modified AGI in excess of $2.5 million.
5. Limitations on the Qualified Small Business Stock Exclusion: Currently, taxpayers may exclude a specific percentage of capital gain from income when selling qualified small business stock ("QSBS"). The bill provides that taxpayers with AGI of $400,000 or more and all trusts and estates would only be allowed to exclude 50% of the eligible gain. This provision would generally be effective for sales occurring after September 13, 2021.

Several of the tax proposals outlined above would be effective upon the date of enactment. While it is impossible to accurately predict when, or what version of, the bill may ultimately become law, taxpayers should promptly seek guidance from their attorneys and other trusted advisors in determining how to proceed in this uncertain environment.

Contact the Wealth Preservation Practice Group.

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