The Treasury’s Green Book and its Impact on Estate Planning

In late May of 2021, the Treasury Department issued the “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals,” (the “Proposal”) also known as the “Green Book.” The tax proposals presented in the Green Book address changes to a myriad of areas and industries, as we discussed in our Beyond the Bottom Line on June 16, 2021. The implications for estate, gift and fiduciary taxation pose a dramatic impact on how advisors and clients approach planning, and are the focus of this Beyond the Bottom Line article.

The most notable proposed change in the Green Book is a recognition of gain on transfers of appreciated property into, or distributed in kind from, trusts and partnerships. Under the Proposal, these transfers, whether because of a death or gift, would be subject to income tax as capital gains on the date of transfer, with some notable exceptions and exclusions, as follows:

• Transfers to revocable, wholly-owned Grantor trusts would not be considered a recognition event.
• Transfers of tangible personal property and qualified small business stock (QSBS) would be excluded from gain recognition.
• Taxpayers will receive a $1 million dollar per person general exclusion on gains generated from transfers. Any unused portion of the exclusion that remains at the taxpayer’s death would be eligible for portability to their surviving spouse.
• Taxpayers would continue to be eligible for a $250,000 exclusion on gains generated from the sale of their personal residence, in addition to the general exclusion, as is currently allowed under IRC Section 121.
• Losses on transfers at death are available to offset gains generated from transfers.

In addition to the exclusions, transfers to a surviving spouse at death and to charities would be exempt from capital gains on transfers. The Proposal does not specifically exempt lifetime transfers (gifts) to a spouse from gain recognition.

Following a transfer, whether from a death or gift, the recipient’s basis would be adjusted to the fair market value of the assets on the date of transfer. However, if a gift is made during the taxpayer’s lifetime and the gains are excluded from taxation because of the general exclusion, then the recipient would inherit the transferor’s original basis. As for transfers at death shielded from taxation by the general exclusion, it is uncertain whether the assets would inherit the transferor’s original basis or receive a step up in basis.

In some instances, taxpayers would be able to defer tax payments generated from gains on transfers. For gains generated from the transfer on non-liquid assets (interest in a family partnership, for example), taxpayers will be eligible for a 15-year payment plan. Currently, this deferral is only available for estate taxes generated from closely held businesses. Tax on gains generated from transfers of liquid assets (publicly traded stock, for example) would be due with the return.

For compliance purposes, it is unclear how these transfers will be reported. One possibility is that gains from transfers at death would be reported with the decedent’s estate tax return and gains generated from lifetime transfers would be reported with the taxpayer’s gift tax return. However, another possibility is that an entirely separate capital gains tax return could be required. Regardless of how the transactions are reported, the Proposal presents more complex reporting requirements for taxpayers and advisors nationwide.

How will this effect current estate planning strategies?

Intentionally Defective Grantor Trusts

Intentionally defective grantor trusts (IDGT) are a very powerful tool in an estate planner’s arsenal. In an IDGT, the Grantor irrevocably transfers assets to a trust while retaining responsibility for the income taxes generated from the assets. By doing so, the Grantor is able to remove the assets from the Gross Estate and the assets can appreciate without being subject to estate tax. Additionally, by remaining responsible for the income taxes generated by the assets, the Grantor is essentially able to make “tax-free” gifts to the beneficiaries.

Under the Proposal, these transfers would be subject to gift and transfer taxes. The assets are still removed from the Grantor’s estate, but at a much higher cost. Thus, the allure of using an IDGT in an estate plan is heavily diminished.

Charitable Split-Interest Trusts

A charitable split-interest trust is a trust that is created for the benefit of a charity, as well as for named beneficiaries, often family members of the grantor. Split-interest trusts can be structured to provide current income/principal benefits and remainder benefits to either party. Thus, split-interest trusts are generally either a charitable remainder trust or a charitable lead trust.

Charitable remainder trusts operate by distributing a set amount of income or principal to the named beneficiaries for their lifetime. Upon the beneficiary’s death, the remaining assets held in the trust are contributed to a specified charity. Charitable lead trusts essentially operate in the same manner, except that the roles are reversed. The charity will receive a set amount of income or principal for a pre-determined amount of time. The beneficiary will receive the remaining assets after that time expires.

Therefore, under the Proposal, contributions to a split-interest trust would be partially subject to capital gain taxes upon the transfer for the beneficiary’s prorated share of the assets contributed. The prorated portion of the contribution that is to benefit the designated charity would be exempt from transfer taxes. Thus, the intent and appeal of creating a split-interest trust is reduced.

Dynasty Trusts

A dynasty trust is a trust that is created to pass wealth to successive generations over an extended, or indefinite, period of time without incurring gift, estate, or generation-skipping transfer (GST) taxes. While the Proposal does not attack the GST status of these trusts, it does propose a deemed sale recognition event. The Proposal calls for income recognition on assets held in these trusts for more than 90 years that have not been subject to a recognition event during this time. The effective date for these recognition events would begin on January 1, 1940. Therefore, this will not have an effect on dynasty trusts until January 1, 2030.

While this will not have much of an effect on trusts that regularly buy and sell assets, it could have a significant impact on trusts that hold closely held businesses and real estate. With the additional tax liability, this proposal could prevent a family’s wealth from being passed down wholly intact, especially if the assets held are illiquid in nature.

What was not included in the Green Book’s proposals?

While there are a multitude of alarming proposals included in the Green Book, there were also several notable items that were not mentioned.

For instance, there is no mention of reducing the lifetime estate tax exemption, which was temporarily increased to a historically high level with the passage of the Tax Cuts and Jobs Act (TCJA) in 2017. However, this temporary increase is set to expire in 2026 and will revert to pre-2018 levels (roughly $5.5 million) at this time. Also, there is no mention of increasing the estate tax rate, which is currently 40%.

Since the temporary increase in the estate tax exemption from the TCJA, clients and advisors have worried about a potential “claw back” of a taxpayer’s used portion of the increased exemption. For example, if a taxpayer were to make gifts during the temporary period up to the lifetime estate tax exemption’s limit, could these previously exempted gifts be pulled into the taxable portion of their estate? Fortunately, there is no mention of this sort of provision.

Finally, there is no mention of retroactive transfer taxes on year-to-date 2021 gifts that would be subject to gain recognition under the new proposal.

In conclusion, the proposed changes in the Green Book could have a massive and wide-spread effect on your estate plan. We will continue to monitor developments on these proposals and provide updates as they occur. If you wish to discuss how these proposals might affect your estate plan or tax situation, please contact your BMSS tax professional.