Last month we sent a Client Alert about the “Build Back Better Act” (the “Proposed Act”) which contains tax law changes that would negatively impact numerous estate planning initiatives. The Proposed Act includes a couple of proposals that would eliminate many of the benefits of irrevocable grantor trusts (i.e., an irrevocable trust where the grantor is treated as owning the assets of the trust for income tax purposes but not for estate tax purposes).
One proposal would subject distributions from the grantor trust (other than distributions to the grantor or the grantor’s spouse) during the grantor’s life to gift tax and subject the assets in a grantor trust to estate tax at the grantor’s death. The proposal would apply to grantor trusts created after the proposed legislation becomes law (the “Enactment Date”) and a portion of existing grantor trusts attributable to contributions after the Enactment Date.
The proposal could have a significant negative impact upon irrevocable life insurance trusts (“ILITs”). An ILIT is an irrevocable trust that owns a life insurance policy on the grantor’s life or a second-to-die policy on the lives of the grantor and the grantor’s spouse. Under current law, if the ILIT is properly created and administered, then the proceeds of the life insurance policy owned by the ILIT are not subject to estate tax at the death of the grantor or grantor’s spouse. Typically, the grantor makes annual gifts to the ILIT to provide funds to pay premiums on the life insurance policy.
Many existing ILITs are grantor trusts. We anticipate that gifts to an ILIT after the Enactment Date would be contributions that would “taint” a portion of the ILIT, causing a portion of the life insurance proceeds to be subject to estate tax at the grantor’s death, thereby reducing the intended benefit of the ILIT.
We recommend that clients consider transferring enough funds to an ILIT before the Enactment Date to allow the payment of premiums for multiple years, rather than only contributing an amount to cover premiums for the next year. This would allow time to develop other methods to fund the payment of future premiums after guidance is issued concerning how the Proposed Act will be interpreted and enforced.
Another section of the Proposed Act would reduce the gift/estate tax exemption and generation-skipping transfer (GST) tax exemption from $11.7 million this year to approximately $6 million next year. Consideration should be given to making large gifts, not only to ILITs, but to other types of trusts, this year before the exemptions are reduced by half.
We will continue to monitor the progress of the Proposed Act. Although we cannot be certain whether any of the provisions disclosed in the Proposed Act will become law, we believe it is necessary to highlight that certain provisions discussed in this Alert would be effective as of the Enactment Date. We understand that the Proposed Act may be passed by the House in the near future. As such, if you wish to take advantage of the current tax laws before the proposed changes take effect, then it is imperative that you contact your attorney at Dean Mead immediately.
Ft. Pierce, Stuart & Vero Beach