2021 proposed gift and estate tax laws affecting private business owners and planning strategies to utilize now

By J. Aaron Byrd, Esq., Frost Brown Todd LLC

The landscape for business succession planning, retirement planning, and estate planning is ever changing. To plan effectively, private business owners should be aware of the latest proposed changes to income tax, estate tax, gift tax, and generation-skipping tax laws.

Under current law, each person can pass assets of $11,700,000, during their lifetime or at death (the “unified credit amount”), less any exemption amount used during their lifetime. Assets above $11,700,000 are taxed at 40%. Under current law, the unified credit amount will increase annually until December 31, 2025, when it will decrease to approximately $7,000,000, per person.

The 99.5 Percent Act also:

• Reduces lifetime gift exemption to $1,000,000;
• Reduces annual exclusion gift exemption to $10,000 per-donee and a total of $20,000 per-donor;
• Includes valuation discount limitations when determining the fair market value of minority interests of nonoperating businesses;
• Implements a minimum 10-year term for any Grantor Retained Annuity Trusts (GRAT);
• Eliminates the zeroed-out GRAT strategy of wealth transfer;
• Limits generation-skipping or dynasty trusts to term of 50 years; and
• The effective date is December 31, 2021.

The limitation on fair market discounts for business transfers and elimination of the zeroed-out GRAT strategy could significantly limit transfer tax strategies and opportunities, especially for business owners.

Senators Chris Van Hollen (D-MD), Cory Booker (D-NJ), Bernie Sanders (D-VT), Sheldon Whitehouse (D-RI), and Elizabeth Warren (D-MA) introduced the Sensible Taxation and Equity Promotion (STEP) Act in March 2021. 

The STEP Act would significantly alter the current “step-up in basis” rules for inherited assets.  Generally, under current law, when someone dies the income tax basis of their assets are “stepped-up” to the fair market value of the assets as of the decedent’s date of death and no income tax on these capital gains is assessed as a result of death. Only when those assets are later sold will income tax associated with a capital gain be assessed. This capital gain is only assessed on the difference between that date of death “stepped-up” basis value and the actual sale price of the asset.

The STEP Act limits that “step-up” in basis to only allow $1MM of the growth in assets to receive a step-up in basis. The remainder of the inherited assets will be subject to an immediate payment of capital gains tax at death, even if the assets are not actually sold. An additional $500,000 of “step-up” in basis will be permitted for primary residences. The STEP Act also requires realization of capital gains every 21-years for assets that continued to be held in trust.

While these proposals are subject to modification and negotiation in the Congressional lawmaking process, now is the time to consider the following strategies to prepare for potential changes:

• Create a Spousal Lifetime Access Trust (SLAT) designed to receive gifts from one spouse to benefit the other spouse. The beneficiary spouse can serve as trustee of the SLAT, have full access to the SLAT during their lifetime, and keep SLAT assets protected from creditors. For estate tax purposes, the SLAT should not be included in the estate of the donor spouse or the beneficiary spouse if properly structured.
• Create a GRAT to take advantage of the still permitted zeroed-out GRAT strategy and short-term GRAT strategy while GRAT “hurdle rates” are historically low. The July GRAT hurdle rate is only 1.2%.  Under a short-term GRAT, the donor will receive an annual annuity of the assets contributed to the GRAT with a 1.2% growth factor. When the GRAT terminates, any assets remaining in the  GRAT above that 1.2% hurdle rate, will pass to the GRAT beneficiaries free of gift and estate tax. 
• Consider initiating an Installment Sale of closely held business assets to SLAT or another irrevocable trust to move the growth of your closely held business assets off the estate tax balance sheet.
• Intra-Family Loans also allow for asset transfer without gift taxes and currently the rates are historically low. For July 2021, rate range from 0.12% to 2.07% depending on the term of the loan. This strategy works especially well for parents who wish to help finance home purchases or business purchases for children. 
• Return to more “traditional” estate planning with Life Insurance owned by an Irrevocable Life Insurance Trust (ILIT). Opportunities exist for policies to be held on one individual’s life or on a couple’s life as a Second to Die life insurance policy inside an irrevocable life insurance trust or a SLAT so that the death benefit from those policies are received free of estate tax.

This article is intended only as a general high-level summary of proposed changes in federal gift and estate taxes and does not create a lawyer-client relationship. It is important for business-owners, investors, and others to consult with their legal and tax counsel to analyze how these proposed changes may affect them and the best ways to prepare. For questions, please contact J. Aaron Byrd, 513.651.6823 or abyrd@fbtlaw.com.

Frost Brown Todd LLC is a Goering Center Sponsor, and the Goering Center is sharing this content as part of its monthly newsletter, which features member and sponsor articles.