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Tax Law Changes Could Mean More Americans Will Pay Estate Taxes

We have written about the impending tax law changes several times over the past few months. While we might sound like a broken record, the message is worth repeating. Changes are coming and now is the time to prepare!

One highly anticipated change is the reduction of the estate tax exemption to about $6 million per person, which is projected to raise $52.3 billion for the federal government over the next five years. Though most Americans will not be affected if the estate tax exemption is reduced, there are still many individuals, including those who live in the Washington Metropolitan area, who will be.

The Estate Tax Exemption

Both President Biden and Senator Bernie Sanders have sought to decrease the lifetime federal estate tax exemption from $11.7 million ($23.4 million for married couples) to $3.5 million. Senator Sanders also wants to reduce the gift tax exemption to $1 million. However, the House Ways and Means Committee’s proposal would reduce the exemption for federal estate, gift, and generation-skipping transfer (GST) taxes to $5 million, adjusted for inflation, which would mean $6 million in 2022.

Although the $11.7 million exemption amount was due to sunset in 2026, there is now an added urgency for taxpayers who this will affect. Under the proposals floating in Congress, the new exemption would take effect on January 1, 2022, leaving just a couple of months for individuals to act to preserve their exemption by giving away assets before the end of this year.

Irrevocable Grantor Trusts and Grantor Retained Annuity Trusts GRATs

Irrevocable Grantor Trusts have been used in estate planning because they allow a gift to beneficiaries to grow income tax-free since the grantor (the person who created the trust and made the gift) pays the income taxes on earnings of the trusts. Under some proposals in Congress, the assets/proceeds from certain grantor trusts, such as the Intentionally Defective Grantor Trusts (IDGTs) or Irrevocable Life Insurance Trust (ILIT), would be taxed as part of the grantor’s estate when he or she dies, even though the assets were given away, possibly many years before death.

Proposals would grandfather in existing Irrevocable Grantor Trusts - so long as no additional assets were added to the trust after the law was enacted.
Also, current proposals would change the rules around Grantor Retained Annuity Trusts (GRATs). GRATs were enacted into the law to combat perceived abuses in trust structures. Proposals want to change the rules so GRATs have longer terms and must provide for a taxable gift when created and a guaranteed percentage of assets when the GRAT term ends.

What Should You Consider Doing?

This is a tough question. No one knows when exactly Congress will change these tax laws (or other tax laws that may affect you). However, if Congress does act this year, the changes are likely to take effect on January 1, 2022. Estate planning is a process and takes time to accomplish. And, even if Congress does not act this year, the estate tax exemption will be reduced and cut in half on December 31, 2025. So, acting sooner means that more growth and appreciation could escape future estate taxation.

If your estate is large enough to be affected, or could grow to be large enough to be affected, discuss your options with your estate planning attorney or financial advisor and decide what steps should be taken before year-end. These options could include making a large gift this year, creating and funding an Irrevocable Grantor Trust this year, and possibly creating and funding a GRAT this year. Remember, estate planning is a process that should evolve and change as your family situation changes, your assets change, and the laws change!

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