When the Tax Cuts and Jobs Act of 2017 increased the estate and gift tax exemption amount from $5.49 million to $10.98 million, it significantly reduced the number of wealthy Americans that had to worry about such taxes. However, the exemption and other trust and estate tax rules may change in 2022 under the Build Back Better Act (though now unlikely to be passed) or other legislation. While this is a risk, we recommend clients avoid making drastic changes to their tax and investment strategies at this time. However, they should consult their team of advisors regarding their individual circumstances.
Proposed Changes to the Unified Credit
The unified tax credit (or gift and estate tax exemption) is the total amount you (and your estate after you pass) can give away tax-free over your lifetime. As noted above, this was doubled in 2017 and further indexed for inflation so it continues to increase every year. It is $12.06 million per person for 2022.
The original BBBA proposed reducing the exemption to $5 million per person, indexed for inflation starting in 2022. However, this provision is no longer part of the bill still being debated. The higher amount is set to expire in 2025, so high-wealth individuals should discuss planning for this with their advisors. We will also discuss this topic in a future post.
Proposed Trusts and Estate Income Tax Changes
Currently, the BBBA provides for a surtax on high-income trusts and estates. An additional tax of 5% would apply to a trust or estate with income over $200,000, plus another 3% if it is over $500,000. This surcharge, if passed, would have significant implications for grantor and non-grantor trusts.
In a grantor trust, the grantor is still alive and is responsible for paying taxes on the income. The trust is essentially ignored and the income is taxed at the grantor’s individual income tax rate. However, proposed surcharges on individual income could mean higher tax rates for grantors as well.
With a non-grantor trust, the grantor is deceased or, if living, does not possess any so-called grantor trust powers. The trust is therefore treated as a separate entity for tax purposes. It pays taxes on all income but receives a deduction for income distributed to beneficiaries. Because of the relatively low amount of income needed for the surtax to be imposed on trusts, it is important to consider potential tax strategies to reduce taxes should the legislation be passed.
For instance, the trust may be able to make charitable contributions to minimize taxes. If the language of the trust does not allow it to donate directly, it may be possible to invest trust assets in an entity that has the power to make charitable contributions, thus passing along the charitable deduction to the trust. However, to implement this strategy, the trust documents must be carefully drafted and/or reviewed and IRS rules must be followed.
As a general rule, we discourage clients from changing their tax and investment strategies based on proposals in Congress. The likelihood of legal changes is just one of many factors to be weighed in planning. However, some strategies may be beneficial in your present situation as well as potentially lower your taxes if legislation is passed.
Discuss your planning needs with your team of advisors. We provide our clients with a full review of their finances, needs, and goals and advise them regarding the best strategies for their circumstances. Contact us today for an evaluation.