Another frightening inheritance tax change and new action items for many affluent taxpayers


I thank my partner Brandon Ketron, CPA, JD, LLM for his help with this position.

The inheritance tax revisions released by the House Ways and Means Committee on September 13 got our full attention for very good reason, given that the effective date of material changes would be the date. at which President Biden signs the bill, assuming it passes the House of Representatives and the Senate.

Many taxpayers and their advisers have rushed to establish or fully fund special irrevocable trusts that can both avoid federal estate tax and buy or exchange assets with the grantor without income tax charges.

These “faulty grantor trusts” may pay for the appreciation of the assets by giving out low interest long term promissory notes, while the grantor / contributor pays income tax attributable to the income of the trust.

Not all of these features will be possible with respect to trusts that are formed or to the extent that they are funded after the date of promulgation, but the law would grant vested rights to trusts, to the extent that they are funded, until after the date of enactment. at the date of promulgation.

We therefore assume that these grandfathered trusts would be able to swap assets tax-free after the promulgation date, or buy more assets for low-rate promissory notes. ‘interest – – – but it turned out to be too good to be true, at least according to House Report 117-130 released on September 28.

This report indicates that the wording of the proposed new law was intended to provide that sales or exchanges that take place after the enactment date will be taxable, as if the sale were to a separate taxpayer. The report recognized that the current wording of the proposed bill does not provide for this, but that it should be amended to reflect the intention of the committee.

As a result of this, the individuals and families who created and maintain trusts that do not qualify for income tax, including most “dynasty trusts” and retained annuity trusts. by grantors should review the assets they own in and outside of these trusts, and consider whether to swap assets, sell assets or otherwise reconfigure agreements or change trusts themselves before this new law does ‘enters into force.

This issue is discussed in a YouTube video posted last Saturday which can be viewed HERE.

For example, I may have established a trust that owns $ 2,000,000 of appreciated shares that I would like to redeem from the trust before my death, so that the shares can get a new income tax base at that time. the fair market value on my death. So I give the trust $ 2,000,000 in cash or other high base assets, and the trust transfers the shares to me.

Under current law, this can be accomplished without income tax; however, if the new law is amended to provide for the above, after the date of enactment of the new law, it will be treated as if I had sold the stock for $ 2,000,000 at the time of the sale.

As a second example, I can own 49% of an LLC that owns $ 2,000,000 of appreciated stock.

I could sell the 49% interest in the LLC to the same trust for $ 980,000 (49% of $ 2,000,000), and since I will not be eligible for a rebate under the new law, I may receive a promissory note payable only for up to my life expectancy, at the currently applicable federal rate, which is only 1.74% per annum.

This sale will be taxable as long as my tax base in 49% of the LLC is less than $ 980,000, but luckily it looks like the sale would be eligible to be reported using the installment method and taxed as it goes. that payments are received on the note.

If my tax base is greater than $ 980,000, my loss will not be considered to have occurred as grantor trusts will be considered a related party for the purposes of section 267 of the IRC which prohibits losses on sales or trade between related taxpayers. Different rules apply to subsequent sales depending on whether the subsequent sale is for a gain or a loss. If the subsequent sale is for a gain, then the trust will take a base in an amount equal to my higher base because it is authorized to offset any gain against the previously denied loss.

For example, if Bob sells property that he bought for $ 100,000 to a ceding trust for $ 70,000, Bob will not be allowed to recognize the loss of $ 30,000. If the trust later sells the property for $ 110,000, the trust can offset the gain against the previously denied loss of $ 30,000 and only pay tax on a gain of $ 10,000, as if its base in the property at the time of the sale was $ 100,000.

However, assuming the same facts as above, if the trust later sells the property for $ 50,000 ($ 20,000 less than the trust paid for it), it will not be able to realize a loss of $ 20,000, which acts as if the basis of the trust in the property was what the trust paid Bob for it.

This new revelation from the Ways and Means Committee has many tax advisers in the position of having to explain to clients who have established defective assignor trusts in the past the possibility of a short window of opportunity to trade or sell assets that may come to an end. in a few weeks, or even a few days.

While we can be sure that any changes to the tax law will be somewhat different from what has been proposed, the effective dates of these changes should be as early as the date of adoption of the elements described below. above.

Further changes are expected to come into effect for transactions taking place on or after September 13, 2021, including a 25% capital gains rate, and sales of shares in the Company Section 1202, also known as name of Qualified Small Business Stock (“QSBS”), subject to income tax up to 50% of the gain thereon, instead of being completely tax-sheltered such as enforced under the law as currently drafted.

Many taxpayers have established Grantor Retained Annuity Trusts (“Libres”), which receive a donation of assets from a grantor and then make a flow of payments back. What remains under the FREE after the payment stream can pass tax free to the descendants of the transferor or others.

Many FREEs do not have sufficient cash flow to make the required payments and, therefore, satisfy the payments by transferring valued assets such as shares that can be owned and traded or private companies or LLC interests.

Such transfers could trigger income tax after the enactment date, if the tax base of the assets transferred back to the grantor will be less than their fair market value.

FREE’s licensors may therefore consider swapping FREE’s assets now for cash before the new law comes into effect.

It’s hard to predict what the new tax laws might do in the estate and gift tax arena, but individuals and families who have valued assets and faulty assignment trusts or FREEs should consider opting out. decide whether to swap assets or buy or sell them in exchange for notes. , after consulting their tax advisers, who can already be fully booked, at least until October 15, as they prepare extensive tax returns and advise their clients on PPP loans, ERC credits and other situations unique resulting from COVID 19.

The above and more will be discussed by me with Brandon Ketron on Saturday at 11am EDT. For free entry to the webinar or replay, you can email [email protected]

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