After a summer of relative quiet regarding anticipated tax changes, on September 13, 2021, the House Ways and Means Committee introduced their proposals for tax legislation to help pay for the Build Back Better Act. These provisions are still in their preliminary form and there is likely to be much negotiation in the House of Representatives and Senate before anything can be finalized. However, in talking with clients, it is important to help them understand the potentially complex implications of the proposals so any necessary planning can be done before any legislation is effective. Some proposals that may impact individual taxpayers are described below. 

Grantor Trusts
One of the most notable transfer tax proposals is a change to the grantor trust rules. 

What is a grantor trust? Many of the strategies that clients have in place, or are considering implementing this year, rely on the grantor trust rules. Proposed changes to those rules are far-reaching, and it is important for clients to understand the possible impact on their planning. A grantor trust is a type of trust where the grantor is treated as the “owner” of the trust assets for income tax purposes and, as a result, the grantor is responsible for paying taxes on the trust’s income. Under current law, when a trust is properly structured as an irrevocable grantor trust, it is treated differently for transfer tax purposes than it is for income tax purposes. From a transfer tax perspective, the assets transferred to the trust and their appreciation can be removed from the grantor’s taxable estate. From an income tax perspective, the assets of the trust can grow without the burden of income taxes because the income tax liability flows back to the grantor. In other words, the grantor has given away the assets for estate tax purposes but is still the owner for income tax purposes.

The proposal. The proposed legislation provides that an irrevocable grantor trust would no longer be outside of the transfer tax system at the grantor’s death. Instead, the assets held in the grantor trust would be included in the grantor’s taxable estate. Further, trust distributions or termination of the grantor trust status during the grantor’s life may result in a gift that may be subject to gift tax. While the legislation provides for an adjustment for amounts previously treated as taxable gifts to avoid double tax, the transfer tax benefit of funding an irrevocable grantor trust is significantly curtailed. The proposed legislation also provides that a sale to a grantor trust would no longer be disregarded for income tax purposes.

Effective date. Under the current proposal, this change in treatment of grantor trusts would be effective as of the date of enactment of the legislation. The proposal specifically provides that the new rules would apply to (1) trusts created on or after the date of enactment, or (2) a portion of any previously created trust to which an addition is made after the date of enactment. This means that grantor trusts that are in place and funded before the date of enactment would be exempt (or “grandfathered”) from the new rules and will remain grandfathered as long as no additional assets are contributed to them. 

Potential impact. If these grantor trust rules are enacted as proposed, then many planning strategies may be greatly impacted and even effectively eliminated. Some of the planning techniques that will likely be curtailed include:
• Spousal lifetime access trusts (SLATs)
• Grantor retained annuity trusts (GRATs)
• Irrevocable life insurance trusts (ILITs)
• Sales to grantor trusts
• Qualified personal residence trusts (QPRTs)

The impact on these strategies—and others that may utilize grantor trusts—could be different depending on the strategy and whether it is in existence before the date of enactment.

Actions to consider. In light of this proposed legislation, there are some steps clients may want to consider to avoid the impact of these potential changes to grantor trusts:
• Complete as soon as possible any planned gifts to an irrevocable grantor trust—whether a new trust or one already in existence.  It is important to consider the time it will take to:
• Create and execute the trust document
• Open any new accounts
• Transfer assets
• Discuss with advisors the impact of the proposal on any existing irrevocable grantor trusts or those created after the date of enactment
• Fund premiums early for insurance policies held in an ILIT, especially those with premiums due over the next few months
• Complete any pending sales to irrevocable grantor trusts as soon as possible


Other Transfer Tax Proposals
Some of the other proposed changes to the transfer tax include:
• Returning the estate, gift and generation-skipping transfer tax exemptions to $5 million, adjusted for inflation, as of January 1, 2022, rather than January 1, 2026
• Eliminating valuation discounts for nonbusiness assets held in an entity, effective on date of enactment

Personal Income Tax Proposals
The proposed legislation also includes many changes to the personal income tax, including:
• Returning the top individual income tax bracket to 39.6% for those with income of more than $400,000 (single) or $450,000 (married filing jointly), effective for tax years after December 31, 2021
• Increasing the tax rate on long-term capital gains to 25% for those with income of more than $400,000 (single) or $450,000 (married filing jointly), effective September 13, 2021
• Imposing a 3% surtax for those with income of more than $5 million (married filing jointly) and trusts with income of more than $100,000, effective for tax years after December 31, 2021
• Increasing minimum required distributions and imposing new contribution limits for retirement accounts that exceed $10 million for those with income of more than $400,000 (single) or $450,000 (married filing jointly), effective for tax years after December 31, 2021

These are just a few of the current legislative proposals and, at this point, it is impossible to know whether, how much, or in what form any of the proposals will be enacted. It is important for clients to talk with their qualified tax and legal advisors about the impact of these provisions on their overall planning. 

Theresa Marx is a senior wealth strategist for CIBC Private Wealth Management in Chicago and provides estate and financial planning services to high-net-worth clients.