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The Biden administration has issued its annual list of legislative and revenue priorities, entitled the “General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals Analysis and Discussions” (the Green Book). The Green Book contains extensive tax proposals that could significantly impede estate-planning opportunities currently available to our clients if enacted.
Many clients will ask whether they can just ignore the Green Book proposals. After all, the proposals may be doomed in a divided Congress. However, the Green Book’s restrictive estate tax proposals would be very costly for certain clients and inhibit important planning if adopted, and there are some reasons for concern.
First, one or more of the Green Book proposals could be used as a bargaining chip to resolve the ongoing debt ceiling or other fiscal negotiations. Deals happen all the time in Washington. After all, it was a pothole bill that brought us basis consistency reporting rules as a supposed revenue raiser.1
Second, high profile senators have been encouraging the Treasury to act where it can to close perceived loopholes.2 Perhaps in a sign that the Treasury is eager to oblige the request, the Internal Revenue Service recently issued Revenue Ruling 2023-2, stating its opposition to increasing the basis of assets in a grantor trust not included in the decedent’s estate.3 If the President can’t consolidate legislative support for his Green Book priorities, perhaps the IRS and Treasury could take administrative action to limit perceived trust and other tax abuses. For example, given that the Treasury still has administrative authority to issue regulations that “prevent the undervaluation” of interests in closely held entities, might the Treasury revisit the Internal Revenue Code Section 2704 anti-discount regulations?4
Reluctance to Heed Warnings
Clients have been reluctant to heed warnings about possible legislation. Over the past decade, trust and estate tax rules have felt like a moving target with significant proposals and possible tax changes. In 2012, 2020 and 2021, practitioners and their clients were frenetic to plan preemptively to avoid the effects of possible tax changes, none of which were enacted. So, rather than provide another overview of the Green Book proposals, it may be helpful to identify specific categories or types of clients who might consider preemptive planning before further changes are made via regulatory action, case law or legislation. Practitioners might consider targeted communications to these specific clients about the risks they face rather than a broad warning similar to those given in 2012, 2020 and 2021.
Clients to Target
Here are some categories of clients who might consider proactive planning steps:
Clients who haven’t yet created grantor, dynastic generation-skipping transfer (GST) tax-exempt trusts. The Green Book proposals that would alter the tax benefits of using a grantor trust appear to be intended to affect trusts created after enactment. For example, the payment of income taxes on any grantor trust created on or after the date of enactment will constitute a gift. Further, the Green Book proposes gain recognition on transactions between a grantor and a grantor trust after the date of enactment. That could eliminate the transfer of highly appreciated assets to trusts. While there’s no way to predict what may be enacted, creating trusts now that may be grandfathered under current law may prove advantageous. Those trusts might even be created as home state trusts with modest current funding pending further developments.
Clients interested in asset protection. Almost all clients can benefit from asset protection planning, either for themselves or for their families. These clients should endeavor to complete planning before possible estate tax changes because any tax law changes would likely increase the costs of implementing asset protection planning. Regardless of tax changes, it may be preferable for these clients to complete planning before a claim might arise that would require that planning be deferred.
Clients who depend on gifts to pay insurance premiums. One of the Green Book proposals would limit annual gifts to trusts to $50,000. This could create challenges for clients who depend on large ongoing annual gifts to pay insurance premiums on policies owned by irrevocable life insurance trusts (ILITs). Those clients might want to consider using their remaining exemption to fund gifts to ILITs. Alternatively, clients may wish to use grantor retained annuity trusts (GRATs) to shift assets into an ILIT by naming a non-GST tax-exempt ILIT as the receptacle at the backend of a ladder of GRATs.
Clients who intend to use GRATs. The Green Book proposals would weaken GRATs as a planning tool. Any client considering this planning strategy may wish to proceed before possible limiting legislation is enacted. This strategy might be particularly useful for wealthy clients who have fully exhausted exemption and who prefer the security of the GRAT valuation adjustment mechanism.5
Clients who benefit from high lifetime exemption amount. The Biden administration has been clear that it would reduce the lifetime exemption from gift and estate tax from $12.92 million in 2023 (indexed for inflation) to a lower amount, if it could garner the votes to pass the necessary legislation.6 Even assuming that there aren’t enough votes in Congress to reduce the exemption now, the current exemptions were put into place by the Tax Cuts and Jobs Act, which sunsets at the end of
December 2025. Clients who could benefit from using more of their bonus or temporary exemption before 2026 might consider pursuing planning sooner rather than later on the chance that regulatory or legislative changes may occur.
Hard-to-Value Assets
Ultra-high-net-worth clients with hard-to-value assets such as real estate and closely held businesses might consider planning now in case any one or more of various Green Book proposals affecting this type of planning are enacted. Some of the many concerning Green Book proposals include:
Eliminating valuation adjustment mechanisms.7 Formula clauses would generally no longer be permitted to adjust the value of gifts. This proposal would be effective for gifts made after Dec. 31, 2023. This proposal would likely pose significant planning challenges for business owners because it’s difficult to know the exact value of a closely held business interest as of the moment when the transfer occurs. Formula gifting enabled transfers from one generation to the next by reducing the risk of triggering a gift tax. Further, this may be an area that practitioners should watch closely. The IRS stated that it doesn’t agree with the Tax Court’s decision to allow formula clauses in Wandry.8 It noted that it will “not follow the [Wandry] decision in disposing of cases involving other taxpayers,” and it appears from the Green Book that the Biden administration agrees.
Restricting valuation discounts on non-publicly traded property transferred to or for the benefit of a family member to the pro rata value of the aggregate gross value of all interests held by the transferor and family members. Passive assets would be segregated and valued as separate from the business or other asset. This rule would apply to intrafamily transfers in which the family collectively held a 25% or greater interest. How would valuation discount restrictions impact closely held business owners? Perhaps the Green Book proposals are foreshadowing a return of the IRC Section 2704 anti-discount regulations that might be implemented without Congressional action. Hopefully, any newer version of the Section 2704 regulations will heed the concerns expressed by many in the professional community that the carve-outs for “operating” businesses were incomplete and would hamper business succession planning.
Succession Planning
Succession planning for closely held business owners might be severely impacted. Closely held business owners might therefore consider the merits of planning before any changes might occur, while we know what the rules are.
Current planning for these clients might include gifts and sales transactions to grantor trusts using defined value formulas and the use of GRATs for hard-to-value assets for those clients who have used their exemption amounts and might want transfer methods other than sale transactions. Overall, it might be prudent to consummate large transfers before the end of 2023 “just in case.”
Bipartisan Support
Some changes may receive bipartisan support. The Corporate Transparency Act (CTA) was enacted into law with bipartisan support. Perhaps the Green Book proposals on new reporting of trust assets, GST tax inclusion ratio and data on trustees might find a political foothold sufficient to be enacted. Those provisions would significantly impact the reporting by trustees of sensitive information to the IRS. Some might view the new Green Book trust proposals as an extension of the same concepts set forth already in the CTA but applied to trusts instead of entities.
The proposal to increase the estate tax exclusion for farm, ranch and certain business property from $1.3 million to $13 million is the type of benefit that might play well politically (for example, saving the family farm).
These and other changes might well be enacted with the consent of the Republican controlled House.
Déjà Vu?
We’ve seen significantly adverse estate tax proposals before. But will the result be déjà vu “all over again,” or might this round of proposals make more actual impact than prior ones? General warning letters to clients might sound like another tale of “Chicken Little.” Perhaps targeted communications to clients who have more at risk if changes are enacted, or other motivations to act now (asset protection, succession planning), may achieve better results.
Endnotes
1. See Section 2004 of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, P.L. 114-41.
2. On March 20, 2023, Senators Elizabeth Warren, Bernard Sanders, Chris Van Hollen and Sheldon Whitehouse wrote a letter to Janet Yellen, Secretary of the Department of the Treasury, www.warren.senate.gov/imo/media/doc/2023.03.20%20Letter%20to%20Treasury%20re%20Trusts.pdf.
3. Internal Revenue Bulletin 2023-16 (April 17, 2023).
4. 26 CFR Part 25 [REG-163113-02] RIN 1545-BB71, http://federalregister.gov/a/2016-18370.
5. Leaving aside the question as to whether grantor retained annuity trust valuation adjustment mechanisms might be compromised by Chief Counsel Advice 202152018 (Dec. 30, 2021).
6. The President’s Build Back Better plan would have reduced the current exemption to $5 million, indexed for inflation, starting in January 2022.
7. Some commentators have speculated whether these proposals would apply to a Christensen-type spill-over mechanism in which the trust and charity have to negotiate the adjustments and the Internal Revenue Service isn’t arguably involved.
8. See generally,Wandry, T.C. Memo. 2012-88 and Internal Revenue Bulletin 2012-46, in which the Internal Revenue Service described its non-acquiescence.