The new House proposal introduces several changes in various sectors, especially regarding gifting and tax exclusions. These changes place restrictions on certain wealth transfer strategies, by reducing the lifetime gift and estate tax exclusions from the current $12 million for each person to a rough estimate of about $6 million by 2022.
Small businesses with a significant portion of their net worth held in business interests need to be aware of the proposed tax policies and review their current estate plans now in order to protect their assets. Anyone who wishes to leave a legacy to their loved ones, charities or other legacies should fulfill all the changes to their estates now, before tax policy changes restrict your estate.
Various aspects of wealth transfer strategies will be affected by the new proposed tax laws; here’s what you can expect.
Gifting
According to Forbes, the generation-skipping transfer (GST) still sits at $11.7 million per person. It allows you to offer an annual gift of up to $15,000 to individuals and $30,000 for married couples. The gift has no limit on the number of people to include.
The new proposed laws will significantly impact how these strategies work. It is expected to go into place after Dec. 31, 2021, and includes changes such as lowering GST exceptions from $11.7 million to $3.5 million, reduction of gift tax exemption from $11.7 million to $1 million per person and decreases of annual gift exclusions to $10,000 per recipient while limiting the donor to $20,000 for total yearly exclusion gifts. The donor is therefore limited to making gifts without using their lifetime exemption.
Tax rates also changed and increased by 45% for $3.5 million–$10 million, 50% for $10 million–$50 million, 55% for $50 million–$1 billion, and 65% for $1 billion and greater.
Intra-Family Loans
It is possible to make an intra-family loan at lower rates than using commercial lenders. The loan will not trigger any additional gift tax. If the borrower invests in loan assets, the wealth shifts and will earn higher returns over the required interest rates.
With an intra-family loan, the business establishes both a creditor relationship and the payment of interest. Always consult your wealth team before making such a move. These loans are attractive but can be challenging.
Changes to the GST
The GST tax is initiated when you transfer wealth to generations two or more removed from you, adding the gift or estate tax. You can also structure a trust to enable the exemption applicable to pass wealth to multiple generations without incurring GST tax charges.
The new act proposes to lower the GST exemption to cap the duration of trusts exempt from the GST by 50 years. Therefore, GST tax is accessible only at the end of that period at the same rates as estate tax.
Irrevocable Grantor Trusts
These trusts remove all assets from a small business's taxable estate, but they do not possess any structure allowing the individual to own trust assets used for income tax purposes. When the grantor pays the income tax, the trust property remains intact and helps to reduce the grantor's taxable estate.
From the act, the grantor needs to have trusts included in the taxable estate upon their death. Any distributions to beneficiaries are all subject to the gift tax. The same proposal is also applicable to insurance trusts.
Grantor Retained Annuity Trusts (GRATs)
GRATs are irrevocable trusts that allow you to make a gift of property. A small business can carry out the process outside the taxable estate using trust and transfer of appreciation on assets. Therefore, it is possible to make a transfer without or with a bit of gift value.
The new act requires a minimum GRAT term of 10 years and a gift tax assessment of $500,000. It also applies to 25% of the fair market on property value used to find the trust. It eliminates all the beneficial aspects of using GRATS.
Inherited Assets
Certain assets step up in cost basis upon death. Its basis becomes the value at death. It often results in the elimination of taxable gains on inherited assets.
The new proposed tax plan requires that any $90 gets taxed when the total gain on unsold assets exceeds $1 million. It will exclude all smaller estates that may apply for charitable gifts.
What Now?
Transferring wealth is proving to be complicated and complex with the House’s new proposed act. The constantly changing tax laws place significant restrictions on wealth transfer strategies, impacting small businesses. It is imperative for small-business owners to be aware of the proposed changes, and to act quickly and strategically. Don’t wait until the proposal is set in stone before you take a look at your plan. It is best to work with a trusted advisor to update your estate plans accordingly and protect your business’s assets, your estate, your family and your long-term goals from future implications.
Josh Sailar is an investment advisor and partner at Blue Zone Wealth Advisors, an independent registered investment advisor in Los Angeles. He specializes in constructing and managing customized advanced plans for business owners, executives and high-net-worth individuals. He holds the designations of Certified Financial Planner (CFP®) and Certified Plan Fiduciary Advisor (CPFA), the FINRA Series 7, 63, 65 licenses, as well as the tax preparer license.
