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Client Alert: Congressional Bills Suggest Significant Changes to Wealth Transfer Tax Regime: What You Need to Know

The March 25th introduction of the “For the 99.5% Act” (the “Act”) by Senators Sanders and Whitehouse has caused great angst for estate planning practitioners and their clients, alike. Although a reduction in the large unified federal estate, gift and generation-skipping transfer tax exemptions has long been anticipated, the sweeping proposed Tax Code revisions suggest an upcoming sea change in the planning landscape. Although the specific provisions of the legislation, if and when enacted, are currently unknown, high and moderate net worth individuals are urged to consider implementing currently available gifting strategies soon, with a goal of transferring wealth out of their taxable estates while the large federal exemption amounts are in place.

For context, the Tax Cuts and Jobs Act (“TCJA”), effective January 1, 2018, temporarily set the federal estate, generation-skipping transfer (“GST”) and gift tax exemption amounts to a $10M base, adjusted annually for inflation ($11.7M for 2021) for each living individual and decedent, with amounts transferred to heirs above this amount subject to a tax rate of 40%.  For a married couple, this amount increases to $23.4M for 2021.  Under current law, the TCJA is set to sunset (or revert to prior law) after December 31, 2025, when we have anticipated a reduction in the inflation-adjusted exemption by approximately half.

The Act threatens to sooner and further reduce these exemptions in the broader context of a complete overhaul of the federal transfer tax regime. Although the Act is unlikely to pass in its current form, its introduction (and that of similar bills recently announced by other Democratic Senators) presents a strong push by a number of Congressional Democrats to close what have long been viewed as major loopholes in our inheritance tax system favoring the wealthiest 0.5% of Americans. A synopsis of the most consequential of the Act’s proposed changes follows.

Effective for decedents dying after, and gifts made after, December 31, 2021:

  • Reduction of the federal estate tax exemption amount for U.S. citizens and domiciliaries to $3.5M ($7M per married couple), not indexed for inflation, substantially increasing the number of federally taxable estates.
  • Reduction of the federal gift tax exemption amount for U.S. citizens and domiciliaries to $1M, not indexed for inflation. (This represents a decoupling of the gift tax exemption from the basic federal estate tax exclusion.)
  • Imposition of a progressive estate tax rate, with estates valued at over $3.5M but less than $10M taxed at a 45% rate; over $10M but less than $50M taxed at a 50% rate; over $50M but less than $1B taxed at a 55% rate; and estates over $1B taxed at the top 65% rate.

Effective for transfers made after the Act’s enactment date (possibly as soon as October 2021):

  • No step-up in basis at the grantor’s death for assets in a grantor trust that are not includible in the grantor’s estate for estate tax purposes. (Importantly, note that the “Sensible Taxation and Equity Promotion (STEP) Act,” recently introduced by Senator Van Hollen, would entirely eliminate the basis step-up at death on unrealized gains and impose a capital gains tax at death, with a $1M exclusion and few exceptions. This tax payment would be a deduction on the estate tax return and not a credit; therefore, double taxation would not be eliminated. If enacted in its current form, this legislation would be retroactive to January 1, 2021.)
  • Grantor Retained Annuity Trusts (“GRATs”) will have a mandatory minimum 10-year term and a minimum gift equal to the greater of 25% of the trust’s fair market value or $500,000. The increased mortality risk and gift tax cost (particularly in the context of a $1M gift tax exemption) imposed by these restrictions would effectively negate the GRAT as a viable wealth transfer strategy.
  • Valuation discounts for lack of marketability and lack of control will be disallowed for transfers of assets of family limited partnerships and other entities if family members (i) maintain control, or (ii) own the majority interest, unless the assets are used in the active conduct of a trade or business, as defined for income tax purposes.

Additional Notable Proposed Changes:

  • Post-enactment distributions to trust beneficiaries of funds attributable to post-enactment contributions, made to both pre- and post-enactment grantor trusts, will be subject to federal gift tax during the grantor’s lifetime.
  • In any calendar year post-enactment, the exclusion for gifts to a trust will be capped at two times the applicable annual exclusion, which is indexed for inflation.  In the case of the current $15,000 annual exclusion, this would limit a donor’s annual gifts to a trust (for life insurance premium payments or otherwise) to $30,000, regardless of how many beneficiaries are granted a withdrawal right.
  • Generation-skipping transfer trusts (“GST trusts”) created post-enactment will be considered “qualifying” trusts for a period of 50 years only; thereafter, distributions from the trusts will be subject to the GST tax, imposed at the highest applicable estate tax rate (65% under the Act). GST trusts created pre-enactment will be deemed qualifying trusts for a period of 50 years from the date of enactment.

Some Initial Planning Implications:

  • Grantor Trusts: Grantor trust status is an income tax characterization that causes all of the trust’s income to be taxable to the donor. This has often been the preferred income tax treatment of irrevocable trusts, as the donor’s income tax payments are not taxable gifts and reduce the donor’s taxable estate, while allowing the trust’s assets to grow income tax free outside of the donor’s taxable estate. In a striking blow to current grantor trust law, the Act would include in the donor’s taxable estate (i) assets in a grantor trust established post-enactment, and (ii) post-enactment contributions to a grandfathered grantor trust, less the value of any taxable gift made by the donor. This means that in order to avoid estate tax inclusion of the transferred assets, clients will need to consider implementing non-grantor trusts. For grandfathered trusts, great care will be required to ensure that no contributions are intentionally or inadvertently made to the trusts post-enactment, in order to keep the assets out of the donor’s estate. “Toggling off” grantor trust treatment of existing trusts before the new law is enacted may be a viable strategy. If so, this may be a favorable option given the costs associated with estate inclusion.
  • Irrevocable Life Insurance Trusts (“ILITs”): ILITs have long been a cornerstone of estate planning and not only for the very wealthy. The Act calls the viability of this technique into question, as in addition to the grantor trust concerns discussed above, these trusts are generally designed to qualify gifts to the ILIT for insurance premium payments, for the donor’s annual exclusion amount. With the proposed annual exclusion cap on gifts to trusts, clients will be wise to prefund their ILITs currently with many years’ premium payments to minimize gifts to the trusts post-enactment and remove the risk of estate inclusion for a portion of the ILIT’s death benefit. Options for continued viability of ILITs will likely include non-grantor trust status (which limits planning flexibility for the ILIT’s insurance policies) and split-dollar loan agreements with respect to those policies. Clients might also consider establishing GRATs pre-enactment that terminate into ILITs, such that any remainder is available to fund future premium payments.
  • GST Trusts: The Act would put an end to so-called “dynasty” trusts, restricting the compounding of wealth by subjecting distributions from a GST trust to the GST tax at year 50. Accordingly, shielding assets from creditors on a multigenerational basis may no longer be an option. Various planning strategies may be considered in this context, including mandating distribution of the trust assets at year 49, or funding the trust with liquid assets for payment of younger generations’ educational and medical expenses, which are exempt from the GST tax.

If enacted, the proposed changes to the transfer tax regime will be highly consequential.  Although the Act has yet to become law, Congressional momentum to address America’s wealth inequality underscores the need for clients to confer with their estate planning professionals soon to identify present opportunities to implement effective wealth transfer strategies.

To find out more about how the information contained in this Client Alert may relate to the implementation of your personal estate plan, please call your attorney in our Trusts & Estates Group at Ruberto, Israel & Weiner as soon as possible, as the new law, in its final form, could be enacted well before the end of 2021.

This summary is presented for informational and educational purposes only, does not constitute legal advice, and cannot be used for the purpose of avoiding tax penalties. Use of this summary does not create an attorney-client relationship and is not a substitute for legal counsel.

This article was co-authored by Deborah Pechet Quinan and Deborah Qualia Howe. Deborah Pechet Quinan is the Chair of RIW’s Trusts & Estates Practice Group. Deborah can be reached at dpq@riw.com or 617-742-4200.

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This summary is presented for informational and educational purposes only, does not constitute legal advice, nor create an attorney-client relationship. For a full understanding of the issues, please contact counsel of your choice.

POSTED IN: News, Trusts & Estates

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