As Congress vacillates over its spending Bill, it gives us a lot of time to speculate on what we would do if certain proposals come to light. Please keep in mind that everything is up in the air at the moment, so we are not recommending any action. We just need to explore options so we are ready for a potential late in the year Tax Bill.
Under the House Ways & Means Committee mark up, the Democrats proposed language that would make assets in a grantor trust includable in the grantor’s estate, eliminating the ability to set up “intentionally defective trusts”. This will eliminate a grantors’ ability to pay income taxes on behalf of the trust without triggering taxable gifts. The legislation would also make it so that transactions with an existing grantor trust, such as sale of a business or other assets, would not be ignored for tax purposes and would become taxable.
This change would significantly diminish, if not eliminate, the use of these type of arrangements which have been a cornerstone of estate planning
If that comes to pass, what would the estate planning landscape look like?
The current proposals have grandfather provisions for existing grantor trusts and transactions, but once that is exhausted, we believe we will see a shift towards non-grantor trusts. Non-grantor trusts are treated as separate taxpayers which can create some tax advantages.
Depending on the final law passed, there a variety of advantages that could be gained from a non-grantor trust. For instance, we may be able to shift income to low-income taxed states. Unlike grantor trusts, which share the grantor’s residency, non-grantor trusts are treated as separate taxpayers and can often be located in a different, low-tax state.
Another tax planning opportunity with non-grantor trusts involves qualified small business stock (QSBS), which House Democrats want to scale back. Taxpayers now can generally claim up to a 100 percent tax exclusion equal to the greater of $10 million or 10 times the tax basis upon the disposition of QSBS. The House proposal, would limit the exclusion to 50 percent of gain for any trust or estate, or for individuals with an adjusted gross income above $400,000.
Even under the proposed regime, the exclusion limitation would apply on a per-issuer basis, and because non-grantor trusts are treated as separate taxpayers for purposes of this limitation, the exclusion might be multiplied for gifted stock.
Another potential opportunity offered by non-grantor trusts is the ability of the taxpayer to control the timing of gain recognition, either to accelerate gains in anticipation of a tax rate increase or to defer income taxes. If a client sells an asset to a non-grantor trust and elects the installment sale method, the client may have better control over the timing of the gain that is recognized compared with the sale of that same asset to a third party in which there is no installment method available.
It is still too early to know which direction the final legislation will take, but it is important to have a rough game plan for how we would respond to the significant changes being discussed in Congress.
We will continue to monitor the development of this legislation and develop taxpayer friendly strategies to help mitigate the impact of these changes.
