Investors who have certain trusts, or are considering creating a trust, should be aware of the dramatic tax changes that are part of a tax proposal winding its way through Congress, warned Warren Racusin, partner in the trust and estates practice at Lowenstein Sandler, a national law firm based in Roseland, N,J,
Grantor trusts frequently are created to control the amount of income and estate tax that the owner or heir has to pay. The proposed changes in the Build Back Better Act would reverse some of those tax advantages, eliminating the core reason for creating the trust, Racusin said in a recent interview. In some instances, any trust income over $12,750 could be taxed at the highest tax rate of 37%, he said.
The bill also proposes cutting the per-spouse gift and estate tax exemption, which is currently set at $11.7 million, in half, effective January 1, 2022.
Because the bill has not been finalized, there is no way of knowing what will be in it if it is signed into law by President Biden, but investors need to be thinking about their options now, said Racusin, who advises individuals and their families on changing tax laws to help them protect assets through estate and tax planning. The bill is currently in the House Ways and Means Committee.
“There will be no one-size-fits-all solution to the tax options once the bill is enacted, but individuals and their advisors need to be doing a risk-benefit analysis now,” he said. “It’s sort of like trying to build a house without a plan, but the options have to be considered.”
The changes will affect grantor trusts, which are trusts in which the individual who creates the trust is the owner of the assets for income and estate tax purposes. Grantor trusts, which can be revocable or irrevocable, include life insurance trusts, spousal lifetime access trusts, grantor retained annuity trusts, and grantor charitable lead annuity trusts.
One of the changes could harm individuals who have created irrevocable life insurance trusts and who continue to fund premium payments or make contributions on trust-owned policies through annual gifts, Racusin said. A trust is created with an insurance policy to remove it from estate taxes, he explain, but the proposed bill could change the tax treatment.
A change proposed in the bill would increase the income tax levied on the contributions. Therefore, individuals who own these types of trusts will want to consider making contributions before the bill becomes a law.
In addition, if a person is considering creating a new grantor trust, he or she should complete that planning before the proposal becomes law if they can, he added.
Advisors also will want to help their clients determine if their trusts are considered separate tax payers for IRS purposes or if the trust is considered part of the creator’s income, Racusin said. In addition, if assets are sold to a trust, the advisor will need to consider whether the assets are subject to capital gains taxes.
“The proposed changes do not just affect the wealthy,” Racusin said. “They can harm those who do not consider themselves wealthy, as well.”