In light of the global pandemic and its impact on the US economy, President Biden’s administration has proposed legislation with the goal of starting to build back the economy. The legislation, dubbed the “Build Back Better Plan,” seeks to employ a bottom-up strategy focusing on improving the living standards of the middle-class population.
The strategy involves providing funding for Coronavirus relief, infrastructure, social services, welfare, and reducing the impact of climate change. The Biden administration proposed a plan to fund the Build Back Better strategy by changing estate laws.
While the proposed plan is still in negotiation, here’s what the residents of North Carolina can expect from the new estate laws if they are implemented.
What Are the Proposed Estate Law Changes?
The Biden administration’s proposed estate laws affect two areas of estate law:
- Estate and gift tax
- Grantor trusts
- Non-business asset valuation
Reduction of the Estate and Gift Tax Exclusion Limits
The current North Carolina estate tax laws have no estate or gift tax provisions. The only applicable taxes on estates and gift transfers are federal taxes.
According to Title 26 of the IRS tax codes, any property transferred from one individual to another for nothing in return or for a lesser value than the gifted item is subject to taxation. However, every US citizen is entitled to a lifetime gift tax exclusion of up to $11.7 million for individuals and $23.4 million for married couples.
The proposed changes are set to reduce the estate and gift tax exclusion from the current $11.7 million down to $6.2 million. If the proposal is adopted, the changes will take effect on January 1, 2022.
Changes to Non-Business Valuation Rules
Under current law, you can transfer non-business assets such as real estate or marketable securities to a family member as a gift through a family limited partnership/liability company.
A direct transfer would trigger transfer taxes, income tax, and capital gains tax on the asset’s value. However, asset transfer as a gift is subject to valuation discounts, allowing you to transfer, sell or gift the property with minimum tax liability.
The proposed changes will terminate the use of valuation discounts when determining the value of non-business assets. While there’s no clear definition of what non-business assets, the expectation is that it will include assets such as:
- Marketable securities
- Leased assets
- Cash
- Property, etc.
Changes to Rules Governing Grantor Trusts
Over the years, many wealthy individuals have used grantor trusts in estate planning to avoid paying heavy taxes on high-value assets. While inheritance tax is 0% up to the exclusion limit, it is subject to capital gains tax if an estate or gift accrues interest.
Under current law, the grantor and the trust are two separate legal entities, meaning any asset transfer between the grantor and the trust would ideally be subject to taxation. However, the grantor trust allows the grantor to transfer assets out of their estate while retaining ownership of the trust without incurring transfer taxes.
The grantor’s only tax liability is income tax on the trust’s assets. Assets transferred through a trust don’t count as gift tax and therefore do not reduce the grantor’s lifetime gift tax exclusion.
The proposed estate law changes would render grantor trusts an ineffective estate planning technique in the following ways:
- The new legislation would require the value of the assets in the grantor’s trust declared as of the grantor’s death.
- Upon the grantor’s death, all asset transfers to beneficiaries except the grantor’s spouse will be considered a gift from the grantor and subject to gift tax laws.
- All transactions and asset transfers between the grantor and the trust will be subject to income tax.
- If the grantor decides to deactivate the trust, the assets in the trust will be treated as additional gifts to the beneficiaries, taxable up to the gift tax exclusion limit.
Should the proposed changes to grantor trusts be enacted, the new laws would only apply to trusts created during or after the date of implementation.
How Will the Proposed Changes Affect Grantor Trust Planning Strategies?
Grantor trusts will be the most affected area by the proposed changes to estate law. Individuals holding grantor trusts should be on the lookout for new changes and understand how they will impact their estate plans.
Irrevocable Life Insurance Trusts
Grantors with life insurance policies can set up an irrevocable life insurance trust (ILIT) to receive the death benefit while excluding it from the grantor’s estate. In this case, the trust’s beneficiaries would receive the death benefits without paying estate taxes.
The proposed laws dictate that upon the grantor’s death, the value of the death benefit should be included in the grantor’s estate, subjecting the beneficiaries to estate taxes. The only exempted insurance trusts from the new laws will be grandfathered insurance trusts―those purchased before the Affordable Care Act was enacted.
Grantor Retained Annuity Trusts
One of the most effective estate planning techniques for high-appreciating assets is using Grantor Retained Annuity Trusts (GRATs). The trust is set up to transfer assets from the grantor’s estate to the trust and freeze the value of the trust by paying an annuity to the grantor.
The setup prevents the value of the trust from appreciating, thereby avoiding capital gains tax. Upon the grantor’s death, the beneficiaries claim the trust’s benefits with no tax liability.
Under the new proposed laws, the transfer of the assets to the beneficiaries will be considered a gift from the grantor and therefore subject to gift tax if they exceed the federal exclusion limit.
Spousal Lifetime Access Trusts
Grantors set up Spousal Lifetime Access Trusts (SLATs) to benefit their spouse upon the grant’s death. SLATs exclude assets from the grantor’s estate, making it possible to transfer to the spouse without any tax liability.
However, under the new law, SLATs will be rendered useless since the assets have to be declared as part of the grantor’s estate, which is subject to gift tax laws.
Qualified Personal Residence Trusts
The proposed laws will also render Qualified Personal Residence Trust (QPRT) useless by requiring the assets in the trust to be declared as part of the grantor’s estate. The purpose of a QPRT is to exclude the grantor’s home from their estate so they can transfer it to the beneficiary without incurring a gift tax.
Start Planning For The Future Today
If you’re wondering how your estate plan will be affected by these and other proposed law changes, now is the time to start the discussion. Contact David Anderson today to schedule a consultation and start planning for how these changes may affect your family and estate planning today!