Many estate planning attorneys are following the news about the Build Back Better Act (the Act) and how it could affect their clients. This news story is a moving target, as Congress is likely to make changes to the legislation, and there is no guarantee that it will even pass.
The Act’s tax increases are mostly targeted toward the mythical 1 percent of Americans who make upwards of $400,000 per year. While many clients would not be affected, it is important to be prepared to advise those who would. In addition, some clients are worried about whether the stepped-up basis at death would be eliminated, so estate planning attorneys should advise clients as to whether their concerns are justified.
Read on to learn how much your estate planning practice and strategies would be affected by the passage of the Build Back Better Act.
What Is the Build Back Better Act?
The Act is a $3.5 trillion effort to pay for President Biden’s policies, which include education, family, infrastructure, and climate-change mitigation programs. Some of the tax-law changes would fund these initiatives by raising about $1 trillion over the next decade.
Your clients could be affected by changes to the gift and estate tax exemption, grantor trusts, and the valuation of assets.
Gift and Estate Tax Exemption
Back in 2017, President Trump signed the Tax Cuts and Jobs Act, which doubled the gift and estate tax exemption, as well as the generation-skipping transfer (GST) tax exemption, to $10 million each. Adjusted for inflation, that number is currently $11.7 million each.
While the higher number is set to expire in 2026, the Act would accelerate the expiration date to January 1, 2022. The exemptions would drop to just over $6 million each. If you have a client who would be affected by this, now is the time to make plans to take advantage of the higher exemption amount before the end of the year.
If your client’s net worth is well below $6 million, they do not need to rush to make their gifts before the end of the year. Of course, married clients would have $12 million in combined exemption amounts in play.
Irrevocable grantor trusts have typically been an effective way to transfer wealth without incurring capital gains taxes. This works when assets appreciate at a higher rate than the promissory note that the grantor signed when transferring the assets to the grantor trust.
The Act would eliminate this advantage and recognize gains on appreciated assets that are sold to a grantor trust. However, the grantor would not receive credit for a loss.
One thing that would not change: the interest on loans between a grantor and a grantor trust would not be subject to income tax.
Sometimes, a grantor will swap assets with a grantor trust, exchanging those with a high basis for those with a low basis. In the past, these swaps would be free of capital gains tax, but that would no longer be the case if the Act passes.
In addition, the Act would create a new section that would further change the rules relating to grantor trusts. These changes include the following:
- The assets of a grantor trust would become part of the owner’s gross estate when the owner dies
- Distributions from a grantor trust would become a taxable gift, unless the gift is to the grantor, the grantor’s spouse, or to pay a debt
- If a trust is no longer a grantor trust while the grantor is still alive, its assets would be taxable
The Act would also reduce the effectiveness of three other kinds of trusts.
Grantor Retained Annuity Trust
Grantor retained annuity trusts (GRATs) are common tools for estate planning attorneys. The trustee transfers assets to the trust in exchange for equivalent payments over the next few years, and the appreciation in excess of the payments stays in the GRAT.
Under the Act, the appreciation of the GRAT assets would be includable in the grantor’s taxable estate; so, it would be better to make a regular gift instead of using a GRAT.
Spousal Lifetime Access Trust
A spousal lifetime access trust (SLAT) is set up for the benefit of a trustee’s spouse and heirs. However, since including a spouse as a beneficiary qualifies the SLAT as a grantor trust, it is likely to become subject to estate tax if the Build Back Better Act passes.
An insurance trust makes the premium payments for an insurance policy using annual gifts to the trust, which causes the death benefit to be free from estate tax. Again, since insurance trusts usually qualify as grantor trusts, the death benefit would be subject to estate tax if the Act becomes law. Existing insurance trusts would be grandfathered with the exception of premium payments that are made after the Act takes effect.
Another change that would result from the Build Back Better Act regards asset transfers involving family entities that are funded by marketable securities.
The Act would call for a split analysis of assets when a portion of one of these entities changes hands. Nonbusiness assets would be treated separately as a direct transfer, while the rest of the transfer would be valued using the “willing buyer/willing seller” analysis. This would eliminate any discount of the value of the nonbusiness assets.
Another change would involve the valuation of business or farming property. The property value of business or farming property can be reduced from its fair market value to its value as it pertains to the business. Currently, the highest amount that this property value can be reduced to is $750,000. If the Build Back Better Act passes, that number would increase to $11.7 million, adjusted for inflation.
Despite clients’ fears about the elimination of the stepped-up basis at death, the current version of the Build Back Better Act does not do away with it. An asset’s basis will be reset at the time that its owner dies, rather than causing the heirs to pay tax on the asset’s appreciation.
Qualified Business Income Deduction
The Tax Cuts and Jobs Act allowed individual business owners, as well as some trusts and estates, to deduct up to 20 percent of the following:
- Qualified business income
- Qualified publicly traded partnership income
- Qualified real estate investment trust dividends
Under the Build Back Better Act, those deductions would be capped at $10,000 for trusts and estates.
How Many Estate Planning Clients Would Be Affected?
Like the proposed income tax increase, these changes are targeted toward wealthy Americans. If your clients are not looking to transfer more than $6 million to the next generation, the Build Back Better Act is unlikely to affect them.
As CNBC noted, the Biden administration is targeting the so-called 1 percent, which includes households with an annual income of $400,000 and up, with its efforts to generate tax revenue by increasing the income tax rate to 39.6 percent from 37 percent.
Keep in mind that the Build Back Better Act may not pass, at least not in its current form. Some members of Congress would like to dial back the overall price tag from $3.5 trillion to $1.5 trillion, so the current proposal, which came out of the House Ways and Means Committee, could see drastic changes. Even if the Build Back Better Act gets through the House, the evenly divided Senate may throw some roadblocks in its way.
What Actions Should Estate Planners Take?
The first thing estate planning attorneys should do is to keep their clients calm. The news cycle can be alarming, but you can quiet their fears by explaining who would be affected by these changes and who would not.
Assure them that the rules regarding the stepped-up basis and dynasty trusts are not scheduled to change at this time.
Identify clients who would be affected and work with them to take advantage of the current, higher estate and gift tax exemption.
Keep your eye on the news about the Build Back Better Act’s progression through Congress. Know which provisions would go into effect at the end of the year (transfer tax exemptions and farm and business evaluation) and which would start as soon as the Act becomes law (everything else).
By following these guidelines, estate planning attorneys can help clients navigate the roiling political waters that can affect their gifts to benefactors and future generations.
Earn 1.5 CLE credit and learn about the Build Back Better Act, including immediate action steps to address the decrease in the exemption amount, increase in the capital gain rate, demise of IDGTs and GRATs, the mega-IRA rules, and more by watching our on-demand webinar with Robert S. Keebler, CPA, MST, AEP (Distinguished).