The House Ways and Means Committee recently released its plan to pay for President Biden's proposed Build Back Better Act. While the plan is still in negotiations and changes to the legislation are likely, many of the proposed changes to the Internal Revenue Code would directly impact gift and estate tax planning.
The proposal, if successful, could have wide-ranging impacts on owners of family businesses and their goals of transferring those businesses to beneficiaries either during life or upon an owner's death.
One major change proposed by the legislation would be to reduce the federal gift and estate tax exemption from the current $10 million exemption (indexed for inflation to $11.7 million for 2021) to $5 million (indexed for inflation to roughly $6.2 million) as of January 1, 2022.
Under current law, the existing $10 million exemption would revert back to the $5 million exemption amount on January 1, 2026. This acceleration in the reduction of exemption will affect the portion of family businesses that can be transferred free of gift and estate tax.
The House Ways and Means proposal would also make major changes to dramatically curtail the ability to use grantor trusts as an effective estate planning technique. Grantor trusts have long been used by family business owners to efficiently and effectively transfer family business interests to beneficiaries.
The affected types of trusts include Spousal Lifetime Access Trusts (SLATs), Irrevocable Life Insurance Trusts (ILITs), Grantor Retained Annuity Trusts (GRATs), and Qualified Personal Residence Trusts (QPRTs) that are structured as grantor trusts. If a family business owner has created any one or more of these types of trusts, there may be action to be taken now to avoid future negative effects of the proposed law change.
Valuation of Nonbusiness Assets
The valuation of nonbusiness assets is also the subject of the proposed law. If adopted, the legislation would eliminate the use of valuation discounts when valuing nonbusiness assets held in an entity. It is expected that "nonbusiness assets" would likely include assets not used in the active conduct of business and may specifically include passive investment in real estate held in an entity.
While transfers of business assets by family business owners will fall outside of this defined limitation, if a family entity holds both business assets and nonbusiness assets, the proposed law change would prohibit application of any valuation discount to the nonbusiness assets held in the family entity. This could have notable impacts on the gift and estate tax valuations of entity interests being transferred by a donor to his or her beneficiaries.
Additionally, to the extent of family businesses holding passive investments in real estate and other nonbusiness assets, the disallowance of discounts on nonbusiness assets may have significant impact on how the entity determines the fair market value of the business under the relevant buy-sell provisions of the entity's governing documents.
For more in-depth information on the proposed tax law change affecting estate planning, please see our recent advisory.