Estate Planning Tax Law Changes – Be Prepared!

None of us can predict what will happen in D.C., but we can take steps now to prepare for changes coming in the near future.

As we write this commentary, Congress and the White House are negotiating over proposed legislation which, if enacted in its current form, would significantly change tax laws that impact estate planning.

The latest proposals, incorporated into the budget reconciliation bill commonly known as the “Build Back Better Act.”  Most of the relevant proposals in the reconciliation bill would be effective as of the date of enactment, or as of January 1, 2022, whichever is later.

Understandably, estate planners are anxious about advising their clients to take action now in order to preserve certain advantages that could be curtailed by any new legislation. However, given the potential magnitude of the proposed changes and the uncertainty as to which of them will pass, it can be a challenge to know exactly what we should advise our clients to do.

The bottom line is that we don’t know what the final legislation will look like, or when specific new rules will be effective. All we can do is consider what has been proposed and how to advise clients in the event those proposals do become law.

The best advice for clients now is to be prepared – have documents ready to sign (perhaps more than one version, each designed to address a different legislative result) and have assets ready to transfer because time is – and will continue to be – of the essence.

Estate and Gift Tax Exemption Reduction – Using the Excess Exemption Before It’s Lost.

The unified estate and gift tax exemption is currently $11.7 million and is already scheduled to drop in 2026 to around $6 million. Pending legislation would accelerate this reduction, likely effective on January 1, 2022.

Most commentators feel this is the most likely change that will impact estate planning, and that it won’t be retroactive (but there are no guarantees). What we do know is that taking full advantage of the higher exemption before it’s gone requires using the full amount – $11.7 million – rather than making a smaller gift of say $6 million.

This is because a taxpayer’s use of the exemption is cumulative, so using the increased exemption before it is lost requires exhausting the amount of the potentially reduced exemption and making gifts in excess of that amount.

Making Gifts in Trust – Contending with the Grantor Trust Proposals.

For clients who wish to fully use the current high exemption by making gifts, it is usually best to give property away in trust – perhaps to children, a spouse and children, or other beneficiaries – to take advantage of the benefits provided by trusts, including creditor protection, asset management, and the reduction in transfer tax for future generations. In addition, gifts in trust allow for the use of certain safety nets to address the possibility of retroactive changes, as well as the concerns of clients who may be nervous about completely losing the benefit of transferred property.

Authorizing a qualified disclaimer of a gift in trust by the trustee or a particular beneficiary may provide a mechanism for unwinding a gift in the event retroactive changes make the gift undesirable.

One wrinkle the proposed legislation has thrown into trust planning is the potential for changes to the treatment of irrevocable grantor trusts. These proposed changes in irrevocable grantor trust treatment seem to be causing the most concern among estate planners, because they represent a radical shift.

Not only would irrevocable grantor trusts automatically be included in the grantor’s estate at death, but any action to terminate irrevocable grantor trust status before death would trigger an immediate taxable gift, as would distributions from a irrevocable grantor trust to beneficiaries.

As proposed, trusts in existence before the effective date – likely when signed by the President – will be “grandfathered” and not subject to the new rules. This means that irrevocable grantor trusts already in existence should not be included in the grantor’s estate, if no new contributions are made to the trust after the effective date. Therefore, non-grantor trusts will become much more common once again as they were before the early 1990’s.

If you are drafting a trust to use the increased exemption, it can be difficult to know whether to create an intentionally “defective” grantor trust, or whether it is a better strategy to draft a non-grantor trust.

We are now looking at ways to allow for flexibility, such as drafting the trust as a grantor trust and including a mechanism that can fully eliminate grantor trust status before the effective date of the law. Another option might be to draft a non-grantor trust with a mechanism to turn on grantor trust status if this portion of the proposed law is not enacted.

It also might be prudent to have two trusts ready to sign – one grantor and one non-grantor – so that you can decide after it becomes clear what changes in the law will take effect (i.e., once passed by Congress but before signed by the President) and take quick action before the law becomes effective.

The Impact of Grantor Trust Changes on ILITs.

The grantor trust changes will impact irrevocable life insurance trusts – or “ILITs” – which typically receive contributions annually to pay policy premiums. Those annual contributions will trigger the grantor trust inclusion even in an existing grandfathered ILIT, so pre-funding ILITs with enough funds to pay future premiums is recommended, to the extent the client can afford it. Split dollar life insurance arrangements may also be a viable option for certain clients.

Don’t Ignore Other Proposed Changes.

Although much of the focus in the estate planning world has been on the possible changes noted above, the proposals under consideration include a wide array of provisions that could impact estate planning clients in other ways.

For example, the Net Investment Income Tax (NIIT) would be expanded in a way that could seriously impact S Corporation shareholders who currently are not subject to FICA tax. Meaning, S-corporation profits, for the first time in history, would be subject to social security tax, which is 15.3% on the first $142,800 of S-corporation net income, plus 2.9% on income above that level, plus a surtax of another 0.9% on income tax exceeds $250,000 of S-corporation profits for joint filers ($200,000 for single filers).

Additionally, proposed valuation limits could curtail often-used planning techniques involving the transfer of family-owned entities considering valuation discounts.

In addition, the proposed grantor trust changes could have other sweeping effects. For example, they would have a chilling effect on grantor retained annuity trusts (GRATs) and sales to grantor trusts because satisfying annuity or note payments owed back to the grantor in kind would trigger taxable gain.

Additionally, the end of a GRAT term would appear to trigger a taxable gift to the remaindermen (the ultimate beneficiaries) under the grantor trust proposals discussed above. Without clarifying language in the statute (or forthcoming regulations), this would impact existing GRATs as well, which seems at odds with the other grandfathering available for grantor trusts created prior to the effective date.

The Takeaway – Be Prepared but Don’t Panic.

With the crystal ball cloudy on what provisions will be enacted and when, it’s wise to keep track of the legislative process and keep informed and ready to pull the trigger on trust planning in progress. There likely will not be more than a day or two between the time the news breaks that legislation has been passed and the time the President signs it, so the time to prepare is now.

Times of change require attentiveness and diligence, but don’t despair – none of us have, or can be expected to have, all the answers in the face of legislative uncertainty. The best thing we can do is to be prepared, and to open a frank dialogue about the potential changes and the possible benefits and risks involved in planning before those changes take effect. With the right drafting tools and good communication, we can help our clients navigate an uncertain and unnerving situation with calm and ease, by planning ahead and being ready to act when the time is right.

Adapted by John Balian, Esq, from a 10/5/2021 article written by

The ILS Legal Team of Interactive Legal

About John Balian

John Balian has been designated a Certified Specialist in Taxation Law by the Board of Legal Specialization of the State Bar of California.  John’s areas of practice includes tax planning for sales of businesses and real estate, income and estate/gift tax audit representation, IRS Appeals, Tax Court representation, tax planning for judgments and settlements, estate and wealth transfer planning, and inheritance dispute consultation and mediation.

Don’t Miss Out on New State Income Tax Deduction for your Federal Tax Returns!

To Qualify, Single Member LLCs and sole-proprietorship would have to become S-corporations or Partnerships for Tax Filing Purposes.

  • Since the Tax Cut and Jobs Act was passed, there’s been a $10,000 cap on the state and local/property tax deduction on individual federal income tax returns.
  • However, California now offers workarounds, allowing some pass-through business owners to sidestep the limit on state income and property tax write-offs.

A growing number of states, including California, are offering pass-through businesses (S-corporations, LLC that file a partnership tax return, and partnerships) a workaround for the $10,000 federal deduction limit for state income and property taxes, known as SALT (state and local taxes).  

Note, however, single-owner LLCs and sole proprietorships do not qualify for this tax break.

A controversial part of Republicans’ 2017 tax overhaul (“The ax Cut and Jobs Act),  the SALT write-off cap was and remains very costly for filers who itemize deductions and can’t claim more than $10,000 for property and state income taxes. 

The limit has been a burden to those in high-tax states, such as California.

The IRS has issued official guidance on these new state laws as in November 2020, offering the green light to certain businesses.

More than a dozen states have passed legislation to approve the workaround, including Alabama, Arkansas, Arizona, California, Colorado, Connecticut, Georgia, Idaho, Louisiana, Maryland, Minnesota, New Jersey, New York, Oklahoma, Rhode Island, South Carolina and Wisconsin, according to the American Institute of CPAs. There is pending legislation in Illinois, Massachusetts, Michigan, North Carolina, Oregon and Pennsylvania.

However, it may not be the right move in all cases, financial experts say. 

How the tax on pass-through businesses works

Many companies are pass-through businesses with profits flowing to owners’ individual tax returns.

The new law allows the state income tax that would normally be paid by the owner, to be paid by the business entity.  If paid by the business entity, its federal taxable income passed-through to the owner will be lower by the amount of the state tax so paid, effectively giving the business owner a reduction in federal taxable income for the state income tax paid by the business, which is otherwise not available as a tax deduction for high-income individual taxpayers.

California Senate Bill 150 allows these qualifying businesses to pay an extra 9.3% tax on each owner’s share of the company’s net income.  Owners who participate may then claim a credit on their California tax return equal to the 9.3% tax, so that they only pay tax once company pass-through income.

By: John Balian, J.D. MS Tax, Of Counsel to Schneiders & Associates, L.L.P.

Adapted from CNBC Article published July 22, 2021


The Latest IRS Mindset – Enforcement (but with a lighter touch since the pandemic)

The IRS Commissioner, Charles “Chuck” Rettig, a former Los Angeles-based tax lawyer of 38-years, diligently made his rounds last year at virtually every major tax conference around the country. 

The message –  

            “I’m an enforcement guy, I’m a taxpayer service guy. I hope to touch every aspect of the tax service.”

he said to an audience of over a thousand accountants at the 2019 American Institute of CPAs’ Engage conference. 

He went on to say:

            “The IRS has the ability to help this country, and this country has the ability to help the world, and as tax pros, you have the ability to help the IRS.”

He called on tax practitioners to help taxpayers and the IRS resolve issues quickly and transparently, by saying:

            “It’s the responsibility of everyone here to get there first — if your clients have issues, clean it up fast. I believe tax practitioners need to do the right thing. If you discover problems in preparing for an IRS exam [audit], let us know.”

On the tax enforcement front, he said: 

            “Taxpayers who are trying to do it right will have my support. Those who wake up with an idea of a creative way not to pay tax,  I’m paying attention to that. We will have a much greater presence on enforcement than before. We will be in every neighborhood that we can be, we’ll be touching people, but a fair touch.”

According to the IRS’ own website, the mission of the IRS remains:

             “Provide America’s taxpayers top quality service by helping them understand and meet     their tax responsibilities and by applying the tax law with integrity and fairness to     all.”  

            This mission statement describes the IRS’ role and the public’s expectation about how the IRS     should perform that role.

  • In the United States, the Congress passes tax laws and requires taxpayers to comply.
  • The taxpayer’s role is to understand and meet his or her tax obligations.
  • The IRS’ role is to help the large majority of compliant taxpayers with the tax law, while ensuring that the minority who are unwilling to comply pay their fair share.

So while IRS staff began 2020 with expectations of increased enforcement activity to encourage taxpayer compliance, when the pandemic hit around mid-March 2020, and Congress passed the CARES Act, the IRS quickly had to switch its efforts toward taxpayer assistance with stimulus payments and the implementation of payroll tax credit procedures. 

On top of that, approximately 56,000 of its 80,000 employees were instructed to work from home.  Much of this work-at-home workforce was slated to return to work in mid-July, but lock-downs around the country postponed their return to work. To date, it appears as though they will continue to work from home through the end of 2020, according to informal discussions with IRS staff.

Of course, without the ability to knock on doors to collect taxes, and visit taxpayers at their places of business to better conduct audits, IRS staff efforts toward enforcement of civil tax laws have been somewhat hampered.  However, conversions with IRS staff lead me to believe that they have been quite busy enforcing the nation’s tax laws, though with a bit of a handicap from home.

IRS Criminal Investigation, on the other hand, seems to be unphased by the work-at-home directive as many of its prosecutions and investigations have marched forward, especially in relation to COVID-19 EIDL and PPP loan fraud.  The Justice Department made such loan fraud cases a super priority and a number of cases have move forward with criminal charges and prosecutions with speed rarely witnessed in federal criminal cases.

Lastly, looking at the sheer quantity of new tax regulations being issued on a daily basis, it is clear that at least IRS attorneys and technical specialists remain extremely productive despite their requirement to work from home.  Much of the Jobs Act and CARES Act tax legislation required interpretation and guidance. The IRS has been quicker than ever to issue guidance to taxpayers and tax professionals on how to apply these tax new laws.

By: John Balian, Of Counsel