Tax Plan will Take a Bigger Bite Out of 2022 Estates

R. Christopher Rosenthal, CPA/ABV/CFF, ASA, AEP | Brian Broxterman, CFA, ASA | Zachary Reichenbach, CFA, CPA/ABV/CFF

The House Ways & Means Committee released its tax proposals on September 13, 2021 (the “Tax Plan”). There are several provisions in the plan that will affect individuals and businesses.  As valuation experts, we commonly work with estate planners to provide credible valuation and consulting advice.  From an estate planning perspective, here are estate and gift tax provisions that will impact taxpayers and planners.

One: Big Cuts in Lifetime Exemptions 

The Tax Plan cuts lifetime exemption in half. This reduces the inflation-adjusted $10 million lifetime exemption, $11.7 million in 2021, to approximately $6 million in 2022. Estates surpassing that threshold, after charitable donations and other deductions, are subject to the tax, which has a top rate of 40%.

This change brings the lifetime exemption back to 2017 levels which produced nearly 3 times as many taxable returns and $4 billion in additional tax liabilities compared to 2020 figures, based on estimates from the Tax Policy Center.[1]  Overall, the tax policy center estimates that letting the higher exemption expire at the end of 2025 would increase the number of taxable returns to 9,000.

Two: Grantor Trusts Included in the Taxable Estate

In addition to changes to the lifetime exemption, the Tax Plan also removes common planning techniques.

“One of the biggest tools in the estate planners’ tool kit is the grantor trust. This change effectively eliminates it as a planning tool” said Tara Popernik, director of research at AllianceBernstein Holding LP’s private wealth unit.

Planners have historically used grantor trusts to hold assets outside of the estate.  This type of trust allows assets to appreciate income tax-free for the beneficiaries and are typically not included in the grantor’s estate for federal tax purposes.  However, based on the recent provisions from the Bill, these grantor trusts are included in the decedent’s taxable estate.

According to the Bill, the use of a grantor trust would be changed in three ways:[2]

1. First, a grantor trust would be in the owner’s taxable estate, with a credit adjustment to account for use of any gift tax exemptions.
2. Second, a gift tax would be triggered on any distribution from a grantor trust to a beneficiary with the exceptions that the beneficiary is the grantor’s spouse or if the distribution discharges an obligation of the grantor.
3. Third, asset sales to the grantor trust by the owner would incur federal income tax in the same manner as if the owner sold assets to a third party.

Three: Eliminating Valuation Discounts for Certain Assets

Another feature of the Tax Plan that will impact planners is a look-through rule that seeks to eliminate valuation discounts on entities that hold 10% or more of their assets in the form of passive investments in other entities.  The Bill defines passive assets as assets that are held for the production of income and not used in the active conduct of a trade or business.  In addition, the Bill contains a list of passive assets which include cash or cash equivalents, stock in a corporation or any other equity, profits or capital interest in a partnership, evidence of indebtedness, options, forwards or futures contracts, annuities, real property, personal property and collectibles.

Interests in family investment companies were previously transferred at their fair market values. Due to common lack of control and lack of marketability characteristics, interests in these investment companies were frequently appraised at a 15-35% discount from their fair market values. The Bill seeks to eliminate these discounts.

Four: Income Tax Rate Increases

The proposed changes to income tax rates affect individual tax rates.  Under the Bill, the top marginal individual tax rate increases from 37% to 39.6% and widens the top bracket group.  In addition, the Bill also proposes a 3% surcharge tax to trust or estate with income exceeding $100,000, to married taxpayers filing separately with income exceeding $2,500,000 and to any other taxpayer, such as married taxpayers filing jointly and head of households exceeding $5,000,000.[2]

Action: Plan Now for Favorable 2021 Treatment

Some families have taken a wait-and-see approach to tax planning in 2021. Others may have recently learned that they will now be treated as a taxable estate. In either case, time is quickly running out. Attorneys, appraisers, and others in the planning community have experienced a rush of activity in 2021. If these changes impact your family’s planning, now is the time to act.

The professionals at Vallit Advisors have worked with families and their legal and other advisors for decades assisting with complex business valuation assignments for estate planning purposes. Our analysis and reports are designed to withstand IRS scrutiny. Please call us today if we can assist with your valuation needs before the end of 2021. 

[1] https://www.taxpolicycenter.org/briefing-book/how-many-people-pay-estate-tax

[2] Information from National Law Review: https://www.natlawreview.com/article/estate-tax-watch-2021-house-ways-and-means-committee-proposal-lowers-estate-tax.