Proposed Tax Law Changes: Grantor Trusts and Gifts to Irrevocable Trusts

Grantor trusts have been a key tool for estate planning attorneys to reduce the taxable estate of high net worth individuals, but a new bill could drastically change this existing wealth transfer strategy. 

On Sept. 15, 2021, the House Ways and Means Committee introduced a new “Infrastructure Financing and Community Development” bill that proposes to include assets transferred to grantor trusts (trusts that are not treated as separate from the donor/grantor for income tax purposes because the donor/grantor pays the income tax owed by the trust, but are separate entities for estate tax purposes) in the estate of the grantor/donor. 

This bill attacks estate freezing and estate reduction techniques that estate planning attorneys have utilized in the past, such as gifts to irrevocable trusts where the donor retains an interest in the trusts. 

How do grantor trusts work to reduce the taxable estate of high-net-worth individuals? 

Traditionally, estate planning attorneys have utilized grantor trusts to exchange appreciating assets with an income stream for a note bearing a low interest with no appreciation over time.  

For example, assume that a high-net-worth individual has $15 million in investments. Also assume that these investments will earn an annual return of 6 percent. The donor/grantor places the investment into a Family Investment LLC. The donor/grantor then gifts 99 percent of the LLC’s non-voting member interest to an irrevocable grantor trust where the beneficiaries are the donor/grantor’s descendants.  

Because the 99% LLC membership units are non-voting (i.e., cannot control the operations of the LLC), and not marketable (i.e., easily sellable) the donor/grantor can discount the gift of 99 percent of the LLC interest by up to approximately 20 percent. Thus, the donor/grantor has transferred approximately $15 million in assets to his/her descendants and the gift is only valued at approximately $11.8 million.  

By making the gift, the donor/grantor would be using all of his/her lifetime Estate and Gift Tax Exclusion and would only pay a small amount of Gift Tax ($100,000) for transferring $11.8 million of assets. This effectively freezes the donor’s/grantor’s estate by reducing his/her estate by $15 million and transferring it to his/her descendants. This would allow the donor/grantor to utilize the full $11.7 million dollar Estate and Gift Tax Exemption before Congress possibly reduces it to $5.85 million in January 2022.  

Additionally, estate planning attorneys can incorporate a promissory note while using the grantor trust. After funding the Grantor Trust with the LLC units, the donor/grantor can then sell selected assets to the trust in exchange for a cash down payment and a promissory note representing the balance of the purchase price. This way, the donor/grantor would have converted the appreciating asset with a 6 percent return for a fixed asset with a 2 percent return. The donor/grantor would continue to pay the income tax liability of the grantor trust.  

As mentioned above, this bill is attacking this kind of trust arrangement by requiring the grantor to include in his/her taxable estate assets transferred to trusts in which the donor/grantor pays the income tax liability. The new bill would also eliminate valuation discounts to reduce the fair market value of assets transferred to the grantor trusts unless the asset gifted or sold is an “active trade or business.” 

The new bill also affects other grantor type trust arrangements, including Grantor Retained Annuity Trusts (GRATs), Spousal Lifetime Access Trusts (SLATs), Charitable Lead Annuity Trust (CLATs), Qualified Personal Residence Trusts (QPRTs), and Irrevocable Life Insurance Trusts (ILITs).  

Finally, the bill also proposes to impose income tax on sales to grantor trusts by treating sales to grantor trusts as sales to third parties and would impose income taxes on the grantor for the sale of the asset to the grantor trust.  

If you would like assistance in implementing grantor trust arrangements prior to the proposed changes becoming law, contact the estate planning attorneys at Milton Law Group to review your existing estate plan and to determine whether one of these advance grantor trust estate plans can help you reduce or eliminate the estate tax assessed on your assets prior to passing to your descendants.  

Named to the Power List of Tax Attorneys in Missouri, Shine Lin successfully represents individual and business clients in all phases of federal tax controversy, including examination, appeals, collections, and litigation by using his more than 15 years of knowledge of IRS administrative procedures.

**Read our full series of articles on how the proposed bill could impact estate planning strategies:

New Bill Could Have Drastic Changes to Estate and Gift Tax Exemptions

Proposed Tax Law Changes: Grantor Trusts and Gifts to Irrevocable Trusts

Proposed Spending Bill: The Good, The Bad, and The Ugly Effects on Estate Planning