On November 16, 2017, the House of Representative passed the Tax Cuts and Jobs Act on a party-line vote (227-205), with several GOP representatives from California, New Jersey, and New York voting against the bill in part because it would reduce the deduction for state and local taxes. Later that same day, the Senate Finance Committee voted to approve the Chairman’s Mark as modified by the Chairman’s Modification to the Chairman’s Mark of the “Tax Cuts and Jobs Act” (“Modified Mark”) on a party-line vote (14-12). As discussed in our previous article, the Chairman’s Mark was significantly different from the House’s Tax Cuts and Jobs Act, and the Modified Mark includes additional proposals that further distinguish the Senate’s proposals from the House’s Tax Cuts and Jobs Act.
Transfer Tax Provisions in the Modified Mark
The Modified Mark provides that all tax reforms for individuals, including estate, gift and generation-skipping transfer (GST) tax reforms, will expire after December 31, 2025, bringing back the current tax rules. Thus, the proposal contained in the Chairman’s Mark to double the basic exclusion amount from $5 million to $10 million expires and reverts back to $5 million for transfers made and deaths occurring in 2026 and thereafter. The disappearing transfer tax exemption raises difficult tax issues. For example, if a taxpayer uses transfer tax exemption that later vanishes, will there be some form of recapture tax when the taxpayer makes additional gifts or dies? We considered this issue when the transfer tax exemption amount was scheduled set to fall back to $1 million in 2013, but the results are less than clear.
Even though the Modified Mark sunsets all individual income tax reforms, it does not sunset the proposal to use the chained consumer price index instead of the standard consumer price index to adjust transfer exemptions and exclusions (as well as other tax benefit items) for inflation, which would result in slower growth of those items. As a result, this will cause some taxpayers to pay higher taxes down the road as the standard CPI outpaces the chained CPI.
Changes to Electing Small Business Trusts
The Modified Mark expands the definition of qualified beneficiaries of an electing small business trust (“ESBT”). An ESBT, along with certain other trusts (e.g., grantor trust and qualified subchapter s trust) is an eligible shareholder of a subchapter S corporation (an “S Corporation”). Under current law, a non-resident alien may not be an S Corporation shareholder or a potential current beneficiary of an ESBT. The Modified Mark would allow a non-resident alien to be a beneficiary of an ESBT. Because an ESBT (and not the non-resident alien) pays Federal income tax on its S corporation income, the interests of the government are not prejudiced by this proposal.
In addition, the Modified Mark provides that an ESBT’s charitable deduction would be determined under the rules applicable to individual taxpayers, as opposed to the trust rules. Thus, the percentage limitations and carryforward provisions applicable to charitable contributions made by an individual taxpayer would also apply to an ESBT.
Income Tax Brackets
Under the Modified Mark, the income tax brackets for estates and trusts would be as follows:
|Income Threshold||Tax Rate|
|Not over $2,550||10% of the taxable income|
|Over $2,550 but not over $9,150||24% of the excess over $2,550|
|Over $9,150 but not over $12,500||35% of the excess over $9,150|
|Over $12,500||38.5% of the excess over $12,500|
The Modified Mark has several other proposals applicable to the estate planning community. It would increase the amount of contributions that may be made by the designated beneficiary of an ABLE account, which are tax-favored savings programs for disabled individuals, to the lesser of (i) the amount of the Federal poverty line for a one-person household or (ii) the individual’s compensation for the taxable year. The designated beneficiary would also be allowed a “savers credit” for contributions made to the ABLE account. Lastly, a designated beneficiary would be allowed to rollover a qualified tuition program (e.g., 529 Plan) to his or her ABLE account or one for a member of his or her family.
Retirement and Charitable Provisions
The Modified Mark proposes certain changes to charitable and retirement provisions, including (i) repeal of the exception to the contemporaneous written acknowledgement requirement for gifts of $250 or more to a charity when the charity files a tax return that includes the information that would otherwise be included in the contemporaneous written acknowledgement, (ii) adding an exception to the excess business holding rules applicable to private foundations for philanthropic business holdings if (a) certain ownership requirements are met, (b) all profits of the business are distributed to charity, and (c) independent operations requirements are met, and (iii) eliminating the rule allowing re-characterization of contributions made to a traditional IRA or Roth IRA as being made to the other type of IRA (e.g., elimination of the “back door” Roth IRA).
The Modified Mark supports reinstatement of appropriate IRS funding levels by stating that “the sense of the Senate [is] that politically motivated budget cuts are counterproductive to deficit reduction, diminish the IRS’s ability to adequately serve taxpayers and protect taxpayer information, and reduce the IRS’s ability to enforce the law.” The IRS has faced budget cuts since 2010 and its yearly budget is estimated to be around $900 million less than it would be if funding levels in 2010 were maintained and adjusted for inflation.
The Modified Mark includes several provisions intended to gain the support of certain members of the Senate, including special treatment for (i) Alaska Native Corporations and settlement trusts; (ii) producers of beer, wine and distilled spirits; (iii) victims in the Mississipi River Delta flood disaster area; (iv) owners of private aircrafts; and (v) citrus grove owners (would be allowed to expense certain costs of replanting citrus trees lost by casualty). This type of deal making is common, but highlights the very slim 52-48 Republican majority in the Senate.
Avoiding the Byrd Rule
The Senate Republicans are going to great lengths to avoid the Byrd Rule. Reconciliation bills like the Tax Cuts and Jobs Act may be passed by a simple majority vote; however, if the bill contains “extraneous provisions,” a point of order can be raised that would increase the required number of votes to 60 for the extraneous provision. An extraneous provision includes one that causes an addition to the deficit after the close of the 10 year budget window.
In order to permanently reduce the corporate tax rate from 35% to 20%, the Modified Mark provides for the expiration of the individual tax reforms in 2026. Therefore, without further Congressional action, the beneficial individual income tax reforms will be lost, including (i) the increase in the standard deduction and the reduction individual marginal income tax rates, (ii) the doubling of the transfer tax exemption amount, (iii) the reduced tax rate for certain small pass-through businesses, (iv) the increased child tax credit, and (v) the repeal of the alternative minimum tax. In addition, the Modified Mark includes the repeal of the individual mandate of the Affordable Care Act, which helps reduce the cost of the bill because fewer people will be covered by health insurance subsidized by the government.
One may wonder why the individual tax reforms that benefit individual taxpayers expire in the future, while the reduction in corporate tax rates do not. The reality is that the GOP must avoid the Byrd Rule to pass these tax reforms, and, politically, GOP members are banking on the prospect that it will be easier to negotiate the extension of individual tax reforms prior to their expiration than the cut in corporate tax rates.
The full Senate is expected to take up the Chairman’s Mark of the Tax Cuts and Jobs Act after the Thanksgiving holiday. However, at least one Senate Finance Committee member has suggested that Senate Republicans will hold a closed-door conference with their House counterparts on the tax bill during the week of November 20. As the tax legislation works its way through the reconciliation process, we will keep you informed of its progress and possible effect on the estate, gift and GST taxes and other estate planning provisions.
About the Authors:
Matthew J. Ahearn is Board Certified in both Wills, Trusts & Estates and Tax Law by The Florida Bar Board of Legal Specialization. He has extensive experience in the areas of estate and business succession planning, asset protection planning, charitable planning and planning to minimize or avoid wealth transfer taxes. Mr. Ahearn handles all aspects of probate and trust administrations, including estate and gift tax audits before the Internal Revenue Service. He represents both beneficiaries and fiduciaries in contested matters. He may be reached at firstname.lastname@example.org.
Kyle C. Griffin practices in the areas of estate planning, probate and trust administration and taxation law. In addition, he assists clients with state and local tax issues, including sales and use taxes, corporate tax and property taxes. He may be reached at email@example.com.