What May Happen and What You Can Do Now
The House Ways and Means Committee has now released its plan for tax changes, some of which may become law and take effect on January 1, 2022, or even sooner.
Released earlier this week, this proposed legislation contains several changes to tax laws, including increased individual and corporate income tax rates, increased capital gains tax rates, reduced gift and estate tax exemption amounts, and changes to grantor trust taxation rules – all of which are designed to help pay for the $3.5 trillion spending package. It is important to note that proposed legislation will likely go through revisions before it is passed by the House and brought to the Senate.
Individual + Corporate Income Tax Rates
The top individual rate will go from 37% to 39.6% on taxable income above $400,000 for individuals and $450,000 for married couples. There would be an additional 3% surtax on individuals with adjusted gross income over $5 million. A 3.8% net investment income tax would also apply to investment income derived in the ordinary course of business for taxpayers with taxable income greater than $400,000 for individuals and $500,000 for married couples.
Currently, the corporate rate is a flat 21%. The proposed corporate income tax rates will be graduated, with the top rate being 26.5%. For corporations with income less than $400,000, the rate would be 18%. Personal service corporations would be subject to a flat 26.5% tax rate.
Capital Gains Tax Rates
The top capital gains tax rate will increase from 20% to 25%.
Gift + Estate Tax Exemption
This proposed legislation would lower the current $11.7 million gift and estate tax exemption to the pre-2017 amount of $5 million (adjusted for inflation). This would be effective as of January 1, 2022.
Grantor Trust Taxation Rules
One of the most commonly used estate planning tools is the grantor trust. Irrevocable grantor trusts are typically designed to remove assets from the taxable estate of the trustmaker, or “settlor”, while continuing to tax the income to the settlor during the settlor’s life. The proposed legislation would do away with many of the benefits of irrevocable grantor trusts.
Specifically, the ability to sell appreciated assets to a grantor trust in exchange for a low interest rate promissory note without any capital gain recognition will be lost under the new law, as the gain on such sales will be taxed to the settlor (but a loss on such sales will not be deductible).
Further, for estate and gift tax purposes, the assets remaining in trust at the settlor’s death would be included in the settlor’s taxable estate. If a distribution is made from the trust to someone other than the settlor, the settlor’s spouse, or in discharge of a debt of the settlor, such distribution would be deemed a taxable gift from the settlor to the recipient of the distribution. The entire amount transferred from the settlor to the trust would be deemed a gift if the trust ceases to be a grantor trust during the settlor’s life.
As mentioned, these are still only proposed changes at this time, and there will likely be revisions before any legislation is passed. This means that you still have time to take action now, before any new laws take effect.
Because we don’t know exactly what will happen, or when, we urge you to take steps now to protect you and your family:
- Review your existing estate planning documents (i.e., Revocable Living Trusts, Wills, Durable Powers of Attorney) and funding.
- Make changes to provisions in your documents, and adjust asset titling and beneficiary designations, to provide for flexibility for future planning.
- Consider making gifts and restructuring loan agreements to take advantage of the current high gift and estate tax exemptions before they disappear.
- Create Spousal Lifetime Access Trusts (SLATs) to transfer closely-held business interests, marketable investments, or real estate out of your taxable estate and out of the reach of creditors, while providing for access to trust property by your spouse or other family members.
- Create and fund Irrevocable Life Insurance Trusts (ILITs) to remove life insurance from your taxable estate while still providing liquidity to your family after your death.
- Create and fund a Grantor Retained Annuity Trust (GRATs) to make a gift of real estate or other property to a trust at a very low gift tax value, and pay an annuity (income stream) to the trustmaker for a set number of years.
While it is not certain what the final legislation will look like, we can be sure there will be changes, and the changes could result in increased taxes for many of our clients and colleagues. Note that some of the changes may take effect immediately upon passage, and others may take effect on or after January 1, 2022. Certain types of trusts and planning strategies may be grandfathered, so it is best to plan now.