Last month, the House Ways & Means Committee (the "Committee") approved draft legislation (the “Legislation”) as part of Congress' ongoing $3.5 trillion budget reconciliation process. The Legislation includes significant tax proposals that, if passed, will dramatically change the tax and estate planning landscape for high-income and high-net worth individuals.

On September 26, 2021, the House Budget Committee released House Report No. 117-130 (the “Report”). The purpose of this 501-page Report is to explain the intent of the tax provisions contained in the 881-page Legislation.

Below is an overview of the tax proposals that are particularly relevant for estate planning purposes:

1. Reduction in Gift, Estate, and Generation-Skipping Transfer ("GST") Tax Exclusion:  The bill proposes to accelerate the reduction of the basic exclusion amount for gift, estate, and GST taxes from $11.7 million to $5 million (subject to inflationary adjustments), which was scheduled to occur in 2026. These reductions would be effective for gifts made, or individuals dying, after December 31, 2021.
2. Elimination of Grantor Trust Benefits: The bill also proposes to eliminate the estate planning benefits of grantor trusts, i.e., trusts that are deemed to be owned by the creator of the trust or another person (each referred to as a "grantor") for federal income tax purposes. The following rules would apply to trusts created on or after the date of enactment and to existing trusts to the extent transfers are made to such trusts on or after the date of enactment.
   • Estate Tax Inclusion. Assets owned by a grantor trust would be included in the grantor's estate and subject to estate tax upon the grantor's death. 
   • Distributions as Gifts. Distributions from a grantor trust during the grantor's lifetime would generally be treated as taxable gifts. 
   • Taxation Upon Termination of Grantor Trust Status. If the trust's grantor trust status is terminated (i.e., the trust becomes a separate taxpayer from the deemed owner), the grantor would be deemed to have made a taxable gift of the trust assets.  
   • Gain Recognized Upon Transfers to Grantor Trust. Transfers between a grantor trust and its grantor would be subject to income tax regardless of when the grantor trust was created.
   Most tax advisors previously inferred that the grantor trust provisions of the Legislation would apply only to (i) grantor trusts created after the date of enactment and (ii) gifts made after the date of enactment to pre-enactment grantor trusts.  However, the Report clarifies that the Legislation would apply to all post-enactment transfers between a grantor and grantor trust, including grantor trusts created prior to the date of enactment.  Therefore, a sale or swap of assets after the Legislation’s effective date between a pre-enactment grantor trust and its grantor would be an income tax realization event.  Likewise, a GRAT annuity payment made in kind with appreciated assets to the grantor after the Legislation’s effective date would be an income tax realization event.  With respect to these grantor trust provisions, the Report includes footnote 933, which states, “A technical correction may be necessary to reflect this intent.”
3. No Valuation Discount for Nonbusiness Assets: Under the proposed legislation, the opportunity to claim valuation discounts when a taxpayer transfers certain business interests that own "nonbusiness assets" would be eliminated. These nonbusiness assets, such as cash, stocks, bonds, and real property (with exceptions for certain active real estate trades and businesses), would be valued as if the transferor transferred such assets directly to the transferee at full fair market value. This proposal would apply to all transfers made after the date of enactment.
4. Tax Increases for High-Income Taxpayers. The proposals include a number of tax hikes for high-income taxpayers, which would take effect January 1, 2022.
   • The top marginal rate income tax rate would increase from 37% to 39.6% for individuals, trusts, and estates.
   • The top income tax rate for long-term capital gains would increase from 20% to 25%.
   • Trusts and estates with income over $100,000 would be subject to a 3% surcharge tax based upon their modified adjusted gross income ("AGI"). This 3% surcharge tax would also apply to individual taxpayers, whether single or married, with modified AGI in excess of $5 million. For married individuals filing separately, the 3% surcharge tax would apply to modified AGI in excess of $2.5 million.
5. Limitations on the Qualified Small Business Stock Exclusion: Currently, taxpayers may exclude a specific percentage of capital gain from income when selling qualified small business stock ("QSBS"). The bill provides that taxpayers with AGI of $400,000 or more and all trusts and estates would only be allowed to exclude 50% of the eligible gain. This provision would generally be effective for sales occurring after September 13, 2021.

Several of the tax proposals outlined above would be effective upon the date of enactment. However, it is important to note that the provisions above are only legislative proposals. The pending Legislation with any revisions must be approved by additional House Committees, the full House of Representatives and the Senate before it will become law. 

While it is impossible to accurately predict when, or what version of, the bill may ultimately become law, taxpayers should promptly seek guidance from their attorneys and other trusted advisors in determining how to proceed in this uncertain environment.

Contact the Wealth Preservation Practice Group.

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