Proposed Estate Law Tax Changes: What You Need To Know, Part I
(Note: This article was contributed by our Law Clerk, Lindsay Keough. )
Right now, the United States House of Representatives is considering proposed legislation that, if enacted, will have significant impacts on estate planning for each and every US citizen. Although the proposal is still in the early stages of the legislative process and may be subject to some tweaks along the way, the proposal as currently written could very well be signed into law, with some changes taking effect before the new year.
Part I of this two-part series will explain three of the important changes to federal estate law tax that are included in the proposal. Stay tuned for Part II to learn what these changes mean for those who have not yet created an estate plan and the steps that should be taken now to avoid any negative impacts that the proposed legislation might bring before it’s too late.
#1 Reduced federal gift and estate tax exemptions
The federal government imposes two types of taxes on gifted assets made during a person’s lifetime or at death that fall outside of certain exemption limits. Taxes on gifts made during a person’s lifetime are referred to as “gift taxes,” and taxes on gifts made at death are referred to as “estate taxes.” Both are subject to the same exemption rate.
Currently, the exemptions for individuals and married couples are $11.7M and $23.4M, respectively. This means that if an individual or married couple gifts assets of an amount lower than or equal to their respective exemption limit, the transfer would be free of the federal gift or estate tax.
This may no longer be the case, however, if the proposed legislation is signed into law. The proposal would cut the exemption amount in half, meaning that individuals could protect just $6M, and married couples could protect just $12M from the federal gift and estate tax.
#2 Increased income tax rates
Another proposed change being considered by the House is an increase in the income tax rates on individuals, trusts, and estates. The proposal seeks to increase the highest or “marginal” income tax rate from 37% to 39.6% for individuals, trusts, and estates. This means that unmarried individuals with taxable income over $400,000, and married individuals filing joint tax returns with taxable income over $450,000 will be subject to the increased rate.
The proposed legislation, if passed, would also subject trusts and estates with a modified adjusted gross income (“MAGI”) over $100,000, and individuals with a MAGI over $5M to a 3% surcharge tax.
These changes would take effect at the end of December 2021.
#3 Estate tax imposed on grantor trusts
With a grantor trust, the person creating the trust is considered the owner for income tax purposes. The owner, rather than the trust, pays the tax imposed on the income generated by the trust. This means that the trust’s income is taxed at the individual rate, rather than a higher tax bracket.
Another benefit of grantor trusts is that they are shielded from federal estate tax because they are considered outside of the owner’s estate when they die. However, the proposed legislation would eliminate this benefit. Specifically, any grantor trust that is created after the legislation is enacted would be included in one’s estate when they die. Although grantor trusts created before the date of enactment would not be subject to the new law, any contribution to the existing trust that is made after the date of enactment will be included in the person’s estate.
To recap, three important changes to federal estate law tax included in the proposal are: (1) reduced federal gift and estate tax exemptions, (2) increased income tax rates, and (3) estate tax imposed on grantor trusts. Remember, even though these proposed changes have not yet been enacted, the time to act is now. Stay tuned for Part II to learn what these changes mean for those who have not yet created an estate plan and what you can do to take advantage of important benefits before they are gone for good.