Take-Away: The President’s (or Treasury’s) 2023 Budget proposal contains a provision that would require trusts to annually file financial statements and possibly disclose the trust beneficiaries.

Background: Recall that a year ago some Senators, including Bernie Sanders, proposed the Sensible Taxation and Equity (STEP) Act. The STEP Act included provisions that required annual reporting by many trusts with the IRS. While the STEP Act was never adopted in 2021, some of its proposal have resurfaced in the 2023 Budget proposal, the so-called Green Book.

STEP Act Proposal: This 2021 proposed legislation would have required trusts with more than $1.0 million in assets or trusts with $20,000 in income to report a balance sheet, income statement, trustees, beneficiaries and a “full and complete accounting of all trust activities and operations for the year.”

2023 Budget Proposal: Treasury’s 2023 budget proposal has several provisions that apply to estate planning and trusts, including the adoption of the STEP Act’s annual trust reporting obligations.

  • Annual Trust Reporting: Under a section called “Improve Tax Administration for Trusts and Decedent’s Estates” the proposed 2023 budget would require the reporting of estimated value of trust assets. But unlike the STEP Act, this proposed legislation would require all trusts with an estimated value over $300,000 at the end of a taxable year, or a trust with $10,000 income, to report information about its settlor, trustees and “general information with regard to the nature and estimated total value of the trust’s assets as the Secretary might require.”

In other words, this proposal with regard to annual trust reporting would cover more trusts than the STEP Act in light of the lower dollar or income thresholds. In addition, the scope of the information to be collected is not entirely clear given the proposed delegation to Treasury to write regulations on what needs to be reported- probably the STEP Act requirements reappear in the form of Treasury Regulations.

The Green Book claims that the government needs information on domestic trusts because “so much wealth currently is held in domestic trusts, the lack of data hampers efforts to design tax policies intended to increase the equity and progressivity of the tax system.” [Recall that irrevocable trusts that accumulate income are already at the highest marginal income tax bracket when income exceeds $10,400!]

Three Other Budget Proposals: The 2023 Green Book contains three other proposals that affect estate planning in one form or another.

  1. Expanded Definition of Executor: The Tax Code provides that if there is no fiduciary appointed and acting in the U.S., then any person in actual or constructive possession of property that is included in the decedent’s gross estate will be treated as the executor for estate tax purposes, [IRC 2203.] Thus, since this definition only applies to federal estate taxes, no party is empowered to represent the estate with regard to income taxes, gift taxes and other filing obligations without a court appointed fiduciary. In addition, it is possible for multiple individuals to fall within the statutory definition of executor by virtue of possessing only modest amounts of the decedent’s property. The 2023 Green Book proposes that: (i) the definition of executor apply for all tax matters, not just federal estate taxes; and (ii) the Department of Treasury is given the authority to establish a priority order when multiple individuals meet the statutory definition of executor.
  2. Estate Tax Lien Extended: The Tax Code provides a special estate tax lien to secure the payment of unpaid estate and gift taxes. [IRC 6324.] Unless that tax liability is paid, the lien remains in effect for 10 years. The perceived problem is that often there is a deferral of federal estate taxes in excess of 10 years, such as when a decedent’s estate consists of a closely held business and the election is made to pay federal estate taxes associated with the business in annual installments over 14 years. [IRC 6166.] If the IRC 6166 election is made, then the lien expires prior to full payment of the deferred estate tax. The budget proposal is to have the IRC 6324 lien continue during any deferral or installment payment period while taxes remain unpaid.
  3. Expand the Cap on Valuation Decreases for Special Use Property:  For estate tax purposes, the fair market value of property is generally determined at the property’s highest and best use. However, there is an optional valuation election that can be made when qualified real property or personal property can have its value reduced to reflect its actual use. [IRC 2032A.] As a practical matter, this valuation election is normally limited to property that is used in farming or a trade or business where the property comprises a substantial part of the taxable estate (35+%). This reduction in value is currently capped at $1.23 million for a decedent who dies in 2022. The budget proposal would increase this cap to $11.7 million effective for those decedents who die on or after the election date.

Conclusion: No one knows if any of these proposals will become law as part of the 2023 budget reconciliation process. The thought of annual reporting requirements to the IRS imposed on a trustee is a concern, when you consider that one of the perceived attributes of a trust is preserving confidentiality of a family’s wealth. In addition, requiring the trustee to annually file an additional statement with the IRS, beyond the annual income tax returns, will simply increase the cost to administer irrevocable trusts- a cost that will be passed along to the trust beneficiaries. In anticipation that some annual reporting requirements might be imposed on trustees of a pot trust, where the value of assets or reported income will probably exceed the imposed dollar reporting thresholds, the trustee might be empowered in the pot trust’s boilerplate provisions to sever the trust into separate ‘stand-alone’ trusts, one for each pot trust beneficiary, to stay below the thresholds.