Take-Away: Presidential candidate Bernie Sanders has proposed a massive overhaul of the transfer tax system. If Mr. Sanders becomes President, and the color of Congress changes to blue in 2020, there could be a dramatic reduction in the gift and estate tax exemptions along with the effective elimination of many conventional estate planning techniques.

Summary of the Proposed 99.8% Act Provisions:

  • Estate Tax Exemption: The current federal estate and gift tax exemption of $11.4 million per taxpayer would be reduced to $3.5 million per taxpayer.
  • Gift Tax Exemption: Lifetime gifts by a taxpayer would have a flat $1.0 million gift exemption, down from $11.4 million per taxpayer.
  • Crummey Gifts: Annual exclusion crummey gifts, i.e. lapsing annual exclusion withdrawal rights, would be completely eliminated
  • Clawback: Clawback would be validated. This means that the value of gifts made today using today’s $11.4 gift tax exemption would be brought back into the taxpayer’s federal estate tax base when estate taxes are calculated.
  • Estate Tax Rate: The federal estate tax rate would increase from 40% to 77% when a taxpayer’s taxable estate is valued at over $1 billion.
  • Grantor Trusts: Grantor trusts would have the value of their assets included in the settlor’s taxable estate, reduced only by taxable gifts that were made to that trust. Terminating the grantor trust status of the trust during the settlor’s lifetime would result in a lifetime gift by the settlor of the value of the trust’s assets, less the value of the taxable gifts that were made to the trust by the settlor.
  • GST: Generation skipping transfer trusts, for which the transferor’s GST exemption was applied, would be limited to a period not to exceed 50 years. Unclear is if an existing GST exempt trust would be grandfathered from this 50-year limit.
  • Valuation Discounts: The use of valuation discounts would be greatly restricted. Valuation discounts would not even be permitted in a family planning context, which would be effective on the enactment of the proposed Act.
  • GRATs: Grantor retained annuity trusts would be greatly restricted. While a GRAT would still be permitted, it would have a minimum duration of 10 years, dramatically increasing the risk that the GRAT will not ‘work’ to shift wealth gift tax free. In addition, there would be a minimum required gift amount when the GRAT was formed, i.e. a gift tax would be assessed on funding the GRAT, thus removing the ability to have a zeroed-out GRAT. Probably rolling GRATs would effectively be eliminated with these changes as well.
  • Effective Date: The effective date for these legislative changes would be December 31, 2019.

Quick Observations:

  • Dejas-Vue All Over Again? Some of these proposed changes may sound familiar. That is because they were a recurring part of President Obama’s annual Greenbook tax law proposals, e.g. a minimum 10 year GRAT with mandatory gift; a $3.5 million estate tax exemption amount. Some are entirely new.
  • Clawback Cloud? Validating clawback would place a cloud on any lifetime gift planning that attempts to shift wealth to younger generations if the value of the gift increases the donor’s taxable estate.
  • GRATs Gone? With a mandated gift element, i.e. no more zeroed-out GRATs and a minimum 10-year duration, the use of GRATs may disappear.
  • Doomed Dynasty Trusts? Dynastic trusts that use the taxpayer’s large GST exemption might still work, but avoiding transfer taxation with a dynasty trust would only be for a couple of generations, not in perpetuity.
  • Stop Sales to Grantor Trusts? The popular planning strategy of selling appreciated assets to a grantor trust would slow down, or stop, with the proposed tax treatment of grantor trusts.
  • New Life for ILITs?: While ILITs might come into vogue again with the reduction of the estate tax exemption to $3.5 million, the conventional funding of an ILIT using a crummey withdrawal right would make the ILIT more expensive to set up since it would consume part of the settlor’s lifetime $1.0 million exemption.
  • FLPs and FLLCs Finished?: If valuation discounts will no longer be available in intra-family transactions, the conventional use of family limited partnerships and limited liability companies to shift wealth at a discount to younger family members or trusts for their benefit may be greatly curtailed.
  • DAPTs Deterred?: If the gift tax exemption falls to $1.0 million, and clawback is validated for federal estate taxation purposes, then some individuals who consider funding a domestic asset protection trust (DAPT) may be less inclined to fund such a trust, or they will have to structure the trust in such a way as to rely on an incomplete gift to the DAPT, which might make the trust assets more vulnerable to creditor claims.
  • The Return of the Credit Shelter Trust?: While portability is apparently untouched in Mr. Sander’s proposal, there may be renewed interest in making a credit shelter trust a component part of a married couple’s estate plan.
  • Non-Reciprocal SLATs Accelerated?: Creating and funding non-reciprocal spousal lifetime access trusts (SLATs) might get more attention by a married couple in light of the December 31, 2019 proposed effective date for the proposed tax law changes, created now to avoid the mandatory clawback

Conclusion: No, I do not think that many of these proposals will become law anytime soon. But they do act as a reminder that nothing, when it comes to tax laws, is certain, and for those individual who have decided upon a wait-and-see approach to engage in estate planning should be encouraged to no longer sit-on-the-fence and to start their planning process now.