Take-Away: Last week Bernie’s Sander’s (Vermont) proposed a Bill, “For the 99.5 Percent Act.” This week (March 29) we have Senator Chris Van Hollen’s (Maryland) proposed Bill “Sensible Taxation and Equity Promotion Act of 2021.” Senator Van Hollen’s Bill would have an effective date of January 1, 2021.

Summary: Senator Van Hollen’s Bill would make transfers by lifetime gift, or on death, a deemed sale, or recognition event, thus triggering the immediate taxation of unrealized or built-in capital gains. This fairly technical Bill is 32 pages long, so only a short summary of some of its key provisions follow. Considerable detail is omitted. (I confess I had to take a nap after I read through the proposed legislation.)

Retroactive Effective Date: Unlike Senator Sander’s Bill, which would either provide for an effective date for some of its provisions on January 1, 2022, or an effective date only after the Bill becomes law, Senator Van Hollen’s Bill would have a retroactive effective date of any transfers (lifetime or at death) that occur after December 31 2020.  In short, gifts of appreciated assets this year in anticipation of major tax legislation would trigger capital gains recognition by the donor.

Deemed Sale: A deemed sale would result at the time of a lifetime gift or the transfer of wealth at the owner’s death. Property that is transferred by gift, or in trust, or upon the death of the transferor “shall be treated as sold for its fair market value to the transferee.”  I did not see any reference to not using valuation discounts to determine fair market value, but the Bill does refer to apply the rules under IRC 2701 to avoid depressed valuation ‘game-playing’ in intra-family transfers.

Taxation of Future Irrevocable Trusts: Much like the Canadian rule on the taxation of trust- owned assets, an irrevocable trust that holds built-in gains property would be taxed every 21 years. An exception would apply to this every 21-year deemed sale for taxable gifts made to the irrevocable trust which were treated, and taxed, as a deemed sale.

Taxation of Existing Irrevocable Trusts All trusts that are nongrantor trust property “shall be treated as sold for fair market value on the last day of the taxable year ending 21 years after the latest of December 31, 2005, or the date the trust was established, or the last date on which such property was treated as being sold.” While there may be some grandfathered older trusts, if I am interpreting this provision correctly the Bill also seems to create a trust’s realization of built-in gain in trust assets, via a deemed sale, starting in 2026.

Grantor Trusts Taxed: A deemed sale would occur when a grantor trust ceases to be classified and taxed as a grantor trust. Similarly, a deemed sale occurs when a distribution is made from the grantor trust to someone who is not the grantor of the trust. In either situation, the transfer “shall be treated as a transfer on the death of the grantor.”

Exceptions: There appear to be several exceptions to the deemed sale provisions:

  • Taxable Gifts: It appears that if there is a taxable lifetime gift, i.e. where gift tax is actually paid, then the deemed sale rule will not apply
  • Tangible Personal Property: The deemed sale rule will not apply to the transfer of tangible personal property, other than collectibles, nor to tangible personal property that is used in a trade or business.
  • Marital Deduction Transfers: A transfer to a spouse, or a surviving spouse that qualifies for the marital deduction under IRC 2056(b)(5) [estate tax] or IRC 2523(e) [gift tax] will not trigger the deemed sale rule. However, when the spouse or surviving spouse later transfers the asset, the deemed sale will apply. The acceleration of a remainder interest in a ‘marital’ trust or the death of the beneficiary-spouse will also cause the deemed sale rule to apply.
  • QTIP Trusts: A qualified terminable interest (QTIP trust), one created during lifetime [IRC 2523(f)(2)] and one created on the deceased spouse’s death [IRC 2056(b)(7) is similarly excluded under the same rules and conditions for marital deduction transfers.
  • Non-Citizen Spouses: These exceptions to the deemed sale rule will not apply where the spouse, or the surviving spouse, is not a U.S. citizen or a long-term resident. A long-term resident is defined in the Bill to be a spouse who has permanently resided in the United States for 8 of the last 15 years.
  • Charities: Transfers of assets to charities [death or lifetime] also will not be treated as a deemed sale by the donor.
  • Dollar Exemption: This exemption is pretty hard to follow. If I am interpreting the provisions correctly [and that’s a big if], there is a exempt amount of $100,000 that is available each year when dealing with the deemed sale rule. This dollar amount is to be adjusted annually by cost-of-living. There also appears to be a $1,000,000 exemption from deemed sale rule at the time of the owner’s death, but it appears to be offset by the $100,000 annual exemption that is excluded for all preceding taxable years. [This is admittedly a hard to decipher exemption.]

Payment of Capital Gains Tax: The Bill would add a new section to the Tax Code, Section 6668, that would provide for the installment payment of the deemed sale capital gain tax over a period of 10 years. This proposed new Code section looks much like the existing IRC 6166 which permits the payment of some federal estate taxes over a period of 15 years related to closely held business interests.

Conclusion: Like Senator Sander’s proposed “For the 99.5 Percent Act”, Senator Van Hollen’s proposed “Sensible Taxation & Equity Promotion Act of 2021” indicates that at least the Senate is gearing up to make major changes to the ‘step-up’ in basis on death rule around which much estate planning relies. The retroactivity of Senator Van Hollen’s Bill is what frightens me, with so many clients who have been encouraged this calendar year to make large lifetime gifts using their available applicable exclusion amounts, e.g. funding SLATs. And Congress is just getting started.