Take-Away: While President Biden’s recent budget proposal contained many new tax proposals, it also included some provisions, aka ‘revenue generators,’ that result from changes to some common estate planning concepts. Many of these ‘estate planning’ curtailments repeat what the President proposed a year or so ago. The proposed Budget Plan is only 247 pages, so a short summary of just a few proposals follows. This summary skips the proposals that were summarized a few days ago shortly after the President’s proposed 2024 Budget was released.

Gift Taxes: The proposal  eliminates the $17,000 per year per donee annual exclusion amount. The donor’s annual exclusion would be replaced with an annual exclusion limit of $50,000 per donor. This annual exclusion limitation to $50,000 would also apply to any GST transfers made by the donor.

Valuation of Partial/Fractional Interests in Intrafamily Transactions: The proposal would replace IRC 2704(b)  which disregards the effect of liquidation restrictions on fair market value, and instead provides that the value of a partial interest in non-publicly traded property (real, personal, tangible or intangible) transfer to of for the benefit of a family member of the transferor, would be the interest’s pro-rata share of the collective fair market value of all interests in that property held by the transferor and the transferor’s family members, with that collective fair market value being determined as if it was held by a sole individual. In effect, this would pretty much eliminate lack of control or lack of marketability valuation discounts in an intra-family transaction.

GST Trust Duration: The proposal would greatly limit the duration of a Trust’s federal generation skipping transfer (GST) tax exemption that would apply only to: (i) direct skips and taxable distributions from a Trust to beneficiaries who are no more than two generations below the transferor; and (ii) taxable terminations that occur while any person described in (i) is a beneficiary of the Trust.

Annual Trust Reporting: The proposal imposes a tax and filing requirements on an irrevocable Trust with assets more than $300,000 on the last day of the prior year; this fixed amount would be adjusted for inflation. [IRC 6048(b).] Alternatively, the Trust would have to file an annual report if the Trust’s income for the prior taxable year exceeds $10,000 (as adjusted for inflation.) The Trust’s report would be filed in conjunction with the Trust’s annual income tax return. The information on the Trust’s report would include the name, address and TIN of each trustee and grantor of the Trust, and ‘general information with regard to the nature and estimated total value of the Trust’s assets’ [whatever that means!]

Donor Advised Funds: The proposal limits the use of a donor advised fund to avoid the private foundation annual payout rule of 5%.

Special Use Valuations: Special rules for the valuation of some properties would be revised. Specifically, the special use valuation rule for federal estate taxes, e.g. real estate used in connection with a closely-held business, has the reduction, from its ‘highest and best use’ value go from $750,000 to the current $1.31 million, due to inflation adjustments. The proposed change would ‘disconnect’ this annual valuation adjustment of this special use valuation amount from the current inflation escalator that has been used since 1997. The purported reason for this change is because the formula that is used to adjust the valuation exclusion amount does not reflect the actual increase in value of real estate over the past decades.

Federal Tax Liens: Federal tax liens for the installment payment of transfer taxes associated with a farm or closely-held business that is the subject of a gift or bequest would be changed to continue for so long as the installment payment of the federal transfer tax liability remains unpaid. Currently the IRS’ lien ends after 10 years, regardless of whether the federal transfer tax liability remains unpaid. The automatic federal tax lien would continue until the delayed tax was paid in full.

Statutory Executor: The definition of a statutory executor, e.g. when the decedent uses a revocable Trust to avoid the need to appoint a Personal Representative, but the IRS wants to be able to hold someone accountable for the non-payment of taxes. The concept of statutory executor is expanded under the proposal  to include the trustee of the decedent’s Trust, the recipient of an IRA, the beneficiary of life insurance death benefits, or the surviving owner of jointly held assets with the decedent. Authority is given to these statutory executors, along with responsibilities, to report to the IRS, and also to make decisions on behalf of the decedent’s estate, e.g. the authority to extend the statute of limitations; to claim a tax refund; to agree to a compromise or assessment; to report interests in foreign assets, etc. The statutory executor rules are also to be clarified to avoid an apparent problem the IRS experiences when multiple persons have filed separate estate tax returns for the decedent’s estate, or who have made conflicting tax elections, using their status as a statutory executor.

Defined-Value Clauses: The proposal effectively eliminates the use of a define-value clause that is used to avoid gift tax assessments on audit, or federal estate taxes when the subject of the gift is a hard-to-value asset, like an interest in a closely-held business. A limited exception would permit the continued use of a defined-value clause for purposes of defining a marital deduction amount or an exemption equivalent bequest at death based on the decedent’s remaining transfer tax exemption. However, the sweep of this proposal would pretty much stop the use of define valuation clauses to minimize exposure to unexpected federal transfer taxes.

Grantor Trusts: Four common planning techniques that exploit the grantor trust rules are addressed in the proposal: (i) GRATs that zero-out the value of the remainder interest in the GRAT that is subject to a current federal gift tax; (ii) the grantor-settlor’s sale of appreciating assets to their grantor Trust, where the sale is disregarded for federal income tax purposes as a transaction between the same person;  (iii) the settlor’s repurchase of low-basis assets from their grantor Trust shortly before the settlor’s death; and (iv) the deemed owner’s payment of the income tax on the Trust’s income and gains each year, considered as the owner’s payment of their own income tax liability, and therefor is not a gift. The GRAT proposal would: (i) require a minimum value for the GRAT remainder equal to 25% of the value of the assets transferred to the GRAT or $500,000; (ii) require the GRAT to have a minimum term of 10 years; and (iii) require the GRAT’s annuitant to have a life expectancy of more than 10 years. With regard to transfers and ‘sales’ to a grantor Trust, capital gain would be recognized by the transferor on funding the grantor Trust. And with respect to the grantor paying the grantor Trust’s income tax liability, the grantor would be treated as having made a taxable gift.

Loans from a Trust: The proposal addresses loans from a Trust to a trust beneficiary which are used to avoid the income and GST tax consequences of trust distributions, e.g. a loan is used rather than a distribution from a GST trust to avoid the imposition of the GST tax. The proposal requires that the  loan will be treated as a GST taxable distribution to the trust beneficiary.

Intra-Family Loans: The proposal addresses intra-family loans by imposing a consistency rule to provide that the lender must treat the promissory note as having a sufficient rate of interest to avoid the treatment of any foregone interest on the loan as income, or any part of the transaction as a gift, that the note subsequently must be subsequently valued for federal gift tax and estate tax purposes by limiting the discount rate to no more than the greater of the actual rate of interest rate on the note, or the applicable minimum interest rate for the remaining terms of the note on the date of the lender’s death. This rule of consistency is intended to prevent different interest rates used to lower the present value of the note on the lender’s death.

Opportunity Fund Investments: The proposal extends the period for assessment of income tax deficiencies for some Qualified Opportunity Zone investors.

Life Insurance: Change the rules for insurance products that fail to meet the statutory definition of a life insurance contract. One change under the proposal is that the definition of income on the failed insurance contract would be modified by substituting ‘net investment value’ for ‘net surrender value.’ The upshot is that the policyholder of any failed life insurance contract would be subject to current taxation on the earnings credited to that insurance contract. In addition, amounts distributed as policy loans from a failed contract would be deemed amounts distributed or loaned under a modified endowment contract (MEC). All future earnings credited to a ‘frozen cash value’ insurance policy owned by a U.S. individual would be included in the policyholder’s ‘income on the contract’ for the taxable year. Thus, any distributions and policy loans from such contracts would come from amounts attributed to investment in the contract and would not be taxable.

Closing Comment: Almost all of these proposals carry an effective date as of the date the proposal is enacted into law. Given the current gridlock in Congress, it will come as a big surprise if any of these proposals become the law prior to the next general election. Nonetheless, these proposals should be considered as an outline to what we might expect to deal with as part of estate planning reform if President Biden is re-elected.