For the 99.5% Act

In late March, the “For the 99.5% Act” (the “Act”) was introduced to Congress. The Act contains several additions, removals, and amendments to the Internal Revenue Code that would significantly alter estate and business planning practices. The changes, if enacted, that would be most relevant to comprehensive planning for the private client are summarized below.

Reduction in Estate and Gift Tax Exemptions

The current exemption amount from federal estate tax is set at $11.7 million per taxpayer. If enacted, this amount would dramatically be reduced down to $3.5 million. This same $11.7 million is the exemption limit from federal gift tax. If the proposed legislation is enacted, the gift tax exemption would be divorced from the estate tax exemption, as the proposed cap is set to be reduced to $1 million. The Act provides that this reduction would become effective December 31, 2021.

Structural Change and Overall Increase in Estate Tax Rate

Under the current federal estate tax structure, a flat 40% is imposed on the gross amount of a decedent’s estate in excess of the estate tax exemption. The proposed change would implement the following progressive tax system:

  • 45% for estates valued between $3.5 – $10 million;
  • 50% for estates valued between $10 million – $50 million;
  • 55% for estates valued between $50 million – $1 billion; and
  • 65% for estates valued at $1 billion or greater.

The proposed legislation provides that this reduction would become effective December 31, 2021.

Amendment to the Generation-Skipping Trust (“GST”)

Several jurisdictions allow trusts to hold terms of 100 or more years. The proposed legislation, however, would implement a mandatory imposition of tax every 50 years for trusts with these lengthy, extended terms. Consequently, GSTs would become less tax effective in the future. The Act provides that this change would become effective upon enactment.

Major Adjustments to Grantor Retained Annuity Trusts (“GRATs”)

Under the current federal tax code, GRATs can be utilized by individuals by transferring appreciating assets to their next of kin via this special “freeze” trust without the appreciation being subject to taxation. The Act, however, includes a required 10-year term minimum on GRATs. Additionally, the proposition includes a prohibition of the estate planning tactic of “zeroing out” transfers. If enacted, GRATs will likely become a far less used estate planning tool. This adjustment would become effective law upon enactment.

Reduction in Annual Gift Exclusion

Every taxpayer is currently afforded an “annual exclusion” of up to $15,000 in tax-free gifts before dipping into the applicable gift tax exemption amount. Nonetheless, if enacted, this annual exclusion will be decreased to $10,000 per donee. Additionally, the Act would impose a $20,000 limit on the use of an annual exclusion per donor. This reduction would become effective upon enactment.

Removal or Significant Decrease in Valuation Discounts

Because interests in closely held business entities are generally illiquid and lack marketability, federal tax law currently allows a valuation discount whenever there is a transfer involving a minority interest or family member. The proposed change will eliminate or significantly decrease this discount and would become effective upon enactment of the Act.

Grantor Trusts to be Included in Decedent’s Taxable Estate

Currently, grantor trusts can be structured so that the income of the trust is taxable to the grantor, while the assets of the trust are excluded from the grantor’s estate for estate tax purposes. Nonetheless, the legislation proposes to include the entire value of the grantor trust to the decedent’s estate. This means gifts and/or distributions from a grantor trust would become taxable. Similarly, insurance proceeds received by irrevocable life insurance trusts would now be included in the grantor’s estate as well. This new rule would only apply to:

  • trusts created on or after the date of the enactment of the Act;
  • any portion of a trust established before the date of the enactment of the Act which is attributable to a contribution made on or after the date of the enactment of the Act; and
  • any portion of a trust established before the date of the enactment of the Act that is treated as owned by a person other than the grantor, if such person engages in a sale, exchange or comparable transaction with the trust that is disregarded on or after the date of the enactment of the Act.

Although these proposed changes would significantly alter estate and business planning, there is still time to create a comprehensive plan that would not be subject to a number of the proposed changes if enacted. DUGGAN BERTSCH would be pleased to discuss any questions you might have regarding estate and business planning.

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