Back in the old days when income tax rates were as high as 91% (Holy Mama!) income-shifting was the flavor-of-the-month as high-net-worth taxpayers took steps to get income attributed to persons or entities in lower brackets. A popular depository was a trust which, back then, was taxed at much lower rates than individuals.
In response the “grantor trust rules” were implemented. Now when a grantor retains too much power over or benefit from trust assets the trust is deemed his or her alter-ego for income tax purposes. Gains and losses incurred by the trust now flow through and are reported on the grantor’s tax return.
But as subsequent changes in the law dramatically reduced individual rates and compressed the trust tax brackets, paying the income tax for the trust became preferable and most trust were set up as intentionally defective grantor trusts.
Payment of the trust taxes was, in effect, a gift to the trust that didn’t require use of annual exclusions or lifetime exemptions to protect the transaction from gift taxation.
In addition, alter-ego income tax status allowed the grantor to sell appreciated assets to the trust without a recognition of capital gains. And the sale could be done with a low-interest promissory note where interest payments were not income to the grantor.
Add to all that the fact that the trust could be structured to keep any assets it held out of the taxable estate of the grantor.
The proposed Build Back Better Act released from the House Ways and Means Committee on September 13, could shut down the playground if ultimately passed in anything resembling its current form.
Some considerations:
Any property held in a grantor trust created on or after the final bill’s enactment would be includible in the grantor’s taxable estate. Any distributions from the trust (other than to the grantor or his/her spouse) would be a gift subject to gift tax. Sales to the trust would trigger capital gain or, in the case of a life insurance policy, create a transfer-for-value. And the list goes on.
Existing grantor trusts would be grandfathered, but any future contributions to those trusts could be affected by the new law (try to figure that one out!). And the BBB would not affect planning with traditional vanilla irrevocable trusts (those taxed in the trust income tax brackets and without the powers or benefits held by the creators of grantor trusts).
If a grantor trust is needed and in the works, the best path is to attempt completion and start-up prior to final passage of new legislation. Meanwhile the bill must make its way through the House Rules Committee, then the full House before being passed to the Senate. We will keep you in touch. Call with questions or information on the most current circumstances at 706-354-0401 or tom@cpsadvancedmarkets.com.