President’s Tax Plan Would Kill Or Suppress Numerous Common Estate Tax Planning Techniques

On March 28th, the Biden Administration issued a 250-page General Explanation of the administration’s fiscal year 2023 revenue proposals. Click this link the view the “Green Book” PDF. Well-advised taxpayers are already considering actions to take before these new proposals would become effective.

Besides increasing the corporate income tax rate to 28% and long-term capital gains and qualified dividend rates for taxpayers with taxable income of more than 1 million dollars to 37%, the proposal would also cause taxation on death for capital gains assets owned by a decadent. The proposals would also impose capital gains tax on the gift of an appreciated asset to descendants to the extent exceeding the applicable thresholds described below while also disallowing valuation discounts for fractional interests unless the transfer is of an interest in an active trade or business, in which case valuation discounts would still apply to the extent assets are actively used in the conduct of such active trade or business.

Fortunately the proposals do provide a $5,000,000 (as adjusted for inflation) exclusion from the imposition of capital gains taxes on transfers during lifetime or at death, and transfers to charity or a spouse would not be subject to these rules. The proposals provide an effective date of January 1, 2023, unlike prior proposals which had retroactive effect, so there is still time to act for those considering lifetime transfers.

The proposals also take surgical cuts out of some of the most popular estate tax planning vehicles and techniques, including Grantor Retained Income Trusts (“GRATS”) which are often used to provide for appreciating assets to be removed from an affluent person’s estates. The proposed language requires that any remainder interest in a GRAT must have a minimum value, at the time such interest is created, of the greater of (1) 25% of the value of the GRAT assets or (2) $500,000 (provided that the total value of GRAT assets is greater than $500,000). Further the proposal would (a) prohibit the Grantor from acquiring via exchange an asset held in the GRAT without recognizing gain or loss, (b) would require that GRATs have a minimum term of 10 years and a maximum term of the life expectancy of the annuitant, plus ten years, and ( c) would provide that payment of income tax on assets held by the GRAT is considered a gift.

The proposals would not prevent the use of irrevocable trusts that are disregarded for income tax purposes but outside of a Grantor’s estate for estate and gift tax purposes, but would treat sales of assets between a Grantor and such a trust as being taxable if the assets sold are appreciated.

Also, grantors would also be subject to gift tax on the payment of income tax attributable to what is known as a “Defective Grantor Trust”. This may apply for trusts already established, and may cause many families to swap assets with existing trusts before this law would come into effect in 2023.

There is no mention of reducing the $12,060,000 per taxpayer estate and gift tax exemption, which is going up with inflation and is scheduled to go up with inflation but will go down to half of the otherwise applicable level on January 1, 2026 unless there is a law passed by the Senate, House of Representatives and a President before then.

Bernie Sanders has proposed that the exemption come down to $3,500,000 and not increase with inflation thereafter, but this is not mentioned in the new plan.

The proposal also takes aim at the concept of “basis shifting” amongst related parties through the use of partnerships. The proposal specifically states that it “would prohibit any partner in the distributing partnership that is related to the distributee-partner from benefitting from the partnership’s basis step-up until the distributee partner disposes of the distributed property in a fully taxable transaction.”

Another new addition to the proposals requires consistent treatment in the valuation of promissory notes. For example, a common estate planning technique involves selling assets to a defective grantor trust for a long term note with interest at the applicable federal rate, and so long as the face value of the note is equal to the value of the assets sold there is no gift considered to have been made. Many planners take the position that the long term note issued at the Applicable Federal Rate can be valued at a discount if subsequently transferred or held at death due to the fact that the interest rate (the Applicable Federal Rate) is below market value and the risk involved with collecting on a long term note. The proposals would eliminate this dichotomy by requiring the note to be valued as if it was a demand note with no discount for a “below market” interest rate.

The proposals also would require new informational reporting on the total value of assets held in domestic trusts, similar to current reporting required for assets held in offshore trusts, if the value of the trust’s assets exceeds $300,000, or if the trust’s income for the tax year exceeds $10,000.

The Generation Skipping Tax rules, which allow wealth to transfer under trusts from children to grandchildren to great-grandchildren without incurring estate tax at each level, would also be beefed up under the proposals by limiting the duration of the exemption allocated to trusts to last as long as the life of any trust beneficiary who either is no younger than the transferor’s youngest grandchild or is a member of a younger generation but who was alive at the creation of the trust regardless of the term of the trust. Recent trends in state law has eliminated or greatly extended the Rule Against Perpetuities to allow trusts to continue for multiple generations. For example, Florida recently passed legislation that would allow a trust to continue for up to 1,000 years, this new proposal would assess GST taxes much sooner than expected.

The proposal also provides for an increase in the top marginal tax bracket from 37% to 39.6% to apply to married taxpayers with Adjusted Gross Income in excess of $450,000 ($400,000 if a single filer) beginning January 1, 2023.

Taxpayers having a family net worth of over $100 million may face a “constructive sale tax” that would treat them as having sold their capital gains assets subject to a 20% capital gains tax, which would be payable over a period of nine years. For example, a family having a net worth of $100 million that consists of $50 million in assets that are worth what they cost and $50 million of assets that cost $20 million would have a capital gains tax imposed on $30 million, and would thus owe approximately $6 million in taxes.

In addition to the above income tax changes, the proposals would notably:

  1. Allow deferral of only $500,000 per taxpayer each year for 1031 like-kind exchanges of real property.
  2. Require ordinary income taxes to be paid to the extent of prior straight line deprecation deductions on the sale of depreciable real property (Section 1250 property), rather than applying ordinary income taxes only to the extent of accelerated depreciation deductions taken.
  3. Treat carried interest, which includes most forms of hedge fund manager income, as ordinary income.
  4. Eliminate tax incentives provided to fossil fuel producers.

While it remains to be seen whether any or even a few of the above proposals may see the light of day as a law, taxpayers should keep in mind that what they do now can influence taxes to be paid later, both under the present law and possible future law.

My partner Brandon Ketron and I are presenting a complimentary 30-minute webinar on these new taxes Wednesday, March 30, 2022 at 11:00 AM EDT. Please email for a free recording.

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