The proposed legislation is pushing a high tide toward shore. This could sweep away many gift and estate planning strategies, impacting grantor trusts first.
An advanced tax strategy under current law is to structure trusts as “intentionally defective grantor trusts.” This structure requires (or said positively, allows) the individual who establishes the trust (the grantor) to pay all of the income tax on the trust’s earnings. The trust is therefore relieved from paying the income tax, while the grantor can further reduce his or her taxable estate (through the income tax payments). Most importantly, the trust property is not included in the grantor’s estate at death. The compounding effect of this tax-free growth in trust can create an impressive shifting of wealth down to the next generation and beyond, and all outside the reach of the Federal estate tax system.
If it passes into law, the new legislation will effectively eliminate future grantor trust planning, on the date of enactment. Early forecasts suggest this could occur in the coming month or two (before year-end), though the winds of change are always gusty and unpredictable. This may leave only a brief window to establish these trusts for those interested. A broad range of trusts are classified as grantor trusts, including Intentionally Defective Grantor Trusts (IDGTs), Spousal Lifetime Access Trusts (SLATs) and Irrevocable Life Insurance Trusts (ILITs). “Contributions” to any such grantor trust after the law is enacted will result in numerous negative tax consequences. The biggest impact is that a portion of the trust property would be included back into the grantor’s estate at death.
Although pre-existing trusts will be grandfathered, any additional contributions to pre-existing trusts must be made before the date the new law is enacted in order to maintain the grandfathered status. For those who have an existing SLAT or IDGT and have not fully used their lifetime gift and estate tax exemption, consider making additional contributions to these trusts at this time (see separate article below on going-forward strategies for ILITs).
What is a contribution? The proposed law is not clear, and it is possible that a contribution may include much more than gifting property to a trust. For example, a contribution may include substituting (or swapping) property between the grantor and the trust. This is currently a technique to exchange low basis property in the trust with the grantor’s high basis property of equal value, without considering it a sale or exchange.
Is an installment sale a contribution? Historically, installment sales to grantor trusts have offered a way to “freeze” value by shifting the future appreciation of the grantor’s property to the target trust. Such a technique is often used when the grantor has already exhausted his or her gift/estate tax exemptions. It is true that intra-family transactions have long been subject to IRS scrutiny, especially since the sale of property from the grantor to a grantor trust has not been a realization event that triggers income taxes. This would change under the proposed law. For those considering an installment sale transaction, this should be fully completed before the law is enacted.
The waters are choppy out there. Make sure you move your beach umbrella and sandcastle before the high tide rolls in.