By: Wayne Zell
Technical provisions in the President Biden’s “Green Book” explanation of his tax proposals released on May 28th could adversely affect many advanced estate planning techniques used to minimize or legally avoid gift, estate and generation skipping transfer taxes (collectively, “Wealth Transfer Taxes”). These proposals use the income tax system, rather than the Wealth Transfer Tax system, to disrupt planning techniques.
One significant target is dynasty trusts. Wealthy families can use dynasty trusts (i.e., trusts that may last in perpetuity) to escape Wealth Transfer Taxes for multiple generations of descendants. The President’s proposal would force trusts to pay capital gains tax on appreciated assets every 90 years, but taxes could be imposed as early as December 31, 2030. While this is not technically a Wealth Transfer Tax, it imposes income tax on transactions that previously would have avoided such treatment.
Another, even more controversial proposal is a tax on capital gains at death. Currently, taxpayers are allowed to adjust or step-up the tax basis of assets in their estate to fair market value at death without paying capital gains tax on the adjustment. The proposal would capture income tax (again, not a Wealth Transfer Tax in the traditional sense) on unrealized capital gains at death.
President Biden’s proposed plan would also charge a capital gains tax when assets are transferred into, or distributed from, certain kinds of trusts. This proposal specifically targets tools like the intentionally defective grantor trust (“IDGT”), a common, complicated, technique that can allow the wealthy to move money out of their taxable estates to benefit heirs. Under today’s rules (if properly structured), you can transfer assets into an IDGT without incurring income tax on the transfer, and shift wealth to future generations without incurring Wealth Transfer Taxes. The proposal would impose income tax on transfers into and out of such trusts (again, not a Wealth Transfer Tax, per se).
The Green Book does not contain any other changes to the Wealth Transfer Tax system, which currently imposes tax on wealth transfers at up to 40%. But the changes that have been proposed create a new, radically different way of taxing transactions that has not been seen before, which clearly will disrupt planning for wealth clients going forward.
No one knows how the proposals will work in practice if they are in fact enacted. The final language in any tax bill will be up to Congress, and, assuming legislation is eventually enacted, some details might not be even settled until the IRS issues regulations. More importantly, I would expect Republicans and moderate Democrats to oppose these proposals, given their controversial nature.
While we wait for details of President Biden’s tax package to solidify, there’s little we can do except speculate on how the provisions might affect wealthier clients. I can say that the proposals clearly have impacted the rush to engage in current advanced Wealth Transfer Tax planning.