Selected Income, GST, Gift, and Estate Tax Proposals in the Greenbook

Capital Letter No. 60

March 30, 2023

Ronald D. Aucutt

The Fiscal Year 2024 Greenbook includes many income, GST, estate, and gift tax proposals, including recognition of gain on gifts, transfers at death, and sales between a grantor trust and the deemed owner, and limitations on the GST exemption, GRATs and CLATs, the annual gift tax exclusion, and private operating foundations.

Dear Readers Who Follow Washington Developments:

The Treasury Department released its “ General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals” (popularly called the “Greenbook”) on March 9, 2023. Many of the proposals in the Greenbook are carried over, sometimes with changes, from last year’s Fiscal Year 2023 Greenbook, and many resemble legislative proposals made in 2021 (including in the Fiscal Year 2022 Greenbook) that were not included in the “Build Back Better Act” (H.R. 5376) passed by the House of Representatives on November 19, 2021.

With a sharply divided Congress, it is very possible that none of the Greenbook proposals will be acted on. Even so, whenever we see legislative proposals articulated like this, it is important to pay attention, because they are constantly evolving and could be pulled from the shelf and enacted, if not this year then in the future when the political climate is different. Such proposals never completely go away. And each time they are refined and updated, we can learn more about what to watch for and how to react.

Capital Letter Number 59 covered the proposals in the Greenbook affecting gift and estate tax valuation. This Capital Letter will cover the other income tax, GST tax, and estate and gift tax proposals that significantly affect estate planning. (Both Capital Letters are adapted from the “Washington Update,” a Bessemer Trust Insight for Professional Partners dated March 13, 2023).

INCOME TAX PROPOSALS

Individual Income Tax Rates, Including Capital Gains

Like the Fiscal Year 2022 and 2023 Greenbooks, the Fiscal Year 2024 Greenbook proposes (at page 77) to accelerate the return of the top marginal individual income tax rate to 39.6 percent (as it was before 2018 and will be again in 2026 under the 2017 Tax Act), effective, somewhat surprisingly, on January 1, 2023. Compared to the Fiscal Year 2022 proposal, however, the current proposal would lower the levels of taxable incomes at which that rate would apply to $450,000 for joint returns, $400,000 for unmarried individuals (other than surviving spouses), $425,000 for heads of households, and $225,000 for married individuals filing separate returns. After 2024, the thresholds would be indexed for inflation using the “Chained CPI” (“C-CPI-U”) that was introduced in the 2017 Tax Act. Over the next 10 fiscal years, this proposal is estimated to raise approximately $235 billion.

Also mirroring the Fiscal Year 2022 and 2023 Greenbooks, the current Greenbook proposes (at page 79) to tax long-term capital gains and qualified dividends at the same rate as ordinary income (that is, 37 percent under current law or 39.6 percent as proposed). This would apply to taxpayers with taxable income over $1 million ($500,000 for married individuals filing separately). It would be effective “for gains required to be recognized and for dividends received on or after the date of enactment” (an improvement over the puzzling “date of announcement” in the Fiscal Year 2022 proposal).

This proposal and the proposed “deemed realization” of capital gains (discussed below) together are estimated to raise approximately $214 billion over the next 10 fiscal years.

Minimum Tax on the Wealthiest Taxpayers

This provision (at pages 82-84), which was new in the Fiscal Year 2023 Greenbook, is an adaptation of Senator Wyden’s “Treat Wealth Like Wages” proposal, rolled out to a very lukewarm reception as his “Billionaires Income Tax“ on October 27, 2021. The Greenbook version proposes a minimum tax, effective January 1, 2024, of 25 percent of total income (up from 20 percent in the Fiscal Year 2023 Greenbook), generally including unrealized capital gains, for taxpayers with “wealth” (that is, assets minus liabilities) greater than $100 million. Taxpayers could choose to pay the minimum tax liability in equal annual installments over nine years for the first year of minimum tax liability and over five years for subsequent years (perhaps because it is assumed that after the first year a taxpayer will be more prepared for it). The minimum tax payments would be treated as a prepayment to be credited against subsequent taxes on realized gains to avoid taxing the same amount of gain more than once.

Taxpayers with tradable assets constituting less than 20 percent of their wealth would be treated as “illiquid” and could elect to include the unrealized gain only for tradable assets in determining the annual minimum tax, subject to a “deferral charge” (not to exceed 10 percent of unrealized gains, but otherwise unquantified) “upon, and to the extent of, the realization of gains on any non-tradable assets.” No estimated payments would be required for the minimum tax. Taxpayers with wealth over the $100 million threshold would have to report annually the total basis and total estimated value of assets in each specified asset class, with alternatives to appraisals available for valuing non-tradable assets.

This proposal is estimated to raise approximately $437 billion over 10 fiscal years. The constitutionality of either the wealth trigger, or the taxation of unrealized appreciation, or both, might be challenged in court.

Statutory language for this proposal, with some embellishments, appeared in the “Billionaire Minimum Income Tax Act” (H.R. 8558), introduced on July 28, 2022, by Representative Steve Cohen (D-Tennessee), with 32 cosponsors (all Democrats). Among the embellishments in H.R. 8558 was a provision requiring the “wealth” used to determine the applicability of the tax to any taxpayer to include (1) any asset of a trust treated as owned by the taxpayer under sections 671-679, (2) any asset of any other trust if the asset or the income (in whole or in part) therefrom is “distributable” to the taxpayer (not including distribution rights that are contingent upon the death of another trust beneficiary), and (3) any gratuitous transfers by the taxpayer within the last five years (other than charitable contributions, transfers to a spouse or former spouse incident to divorce under section 1041, and transfers to a spouse who is also subject to this tax). Under H.R. 8558, the requirement for annual reporting contemplated by the Greenbook would be spelled out in regulations.

Recognition of Gain on Sales Transactions with Grantor Trusts

Mirroring the “Build Back Better” bill the House Ways and Means Committee approved in September 2021, the Greenbook (at page 127) proposes that, “for trusts that are not fully revocable by the deemed owner,” “the transfer of an asset for consideration between a grantor trust and its deemed owner” would result in the recognition of gain. The proposal uses, without elaboration, the term “deemed owner” (which sometimes implies that it includes a person other than the grantor under section 678) and also the term “grantor trust” (which sometimes implies that a trust treated as owned by a person other than the grantor is not included). The proposal would apply to transactions on or after the date of enactment. It would require the recognition of gain both on sales and on transfers in satisfaction of an obligation (such as an annuity or unitrust payment) with appreciated property. But recognition of losses would not be allowed; in a refinement of the Fiscal Year 2023 Greenbook proposal, the current Greenbook proposes an addition to section 267(b) that would disallow recognition of losses in such transactions. The proposal would significantly overlap with the deemed realization proposals for trusts, discussed next.

This proposal would have the effect of overruling Rev. Rul. 85-13, 1985-1 C.B. 184, although the Greenbook does not mention that. The basic premise of Rev. Rul. 85-13 was that “a transaction cannot be recognized as a sale for federal income tax purposes if the same person is treated as owning the purported consideration both before and after the transaction.” The Greenbook does not explain how the legislation it proposes might prevent deemed owners of trusts from in effect buying assets from themselves and thereby obtaining a new basis, which was one of the issues in Rev. Rul. 85-13 and was the main issue in the rather shaky opinion in Rothstein v. United States, 735 F.2d 704 (2d Cir. 1984), which Rev. Rul. 85-13 repudiated. Of course, the need to recognize gain and be taxed on it in order to obtain a new cost basis would typically discourage the use of this technique, except maybe in cases where there were factors like significant offsetting losses.

Deemed Realization of Capital Gains

In terms almost identical to the Fiscal Year 2022 and 2023 budget proposals, the Greenbook (at pages 78-81) again advocates the “deemed realization” of capital gains upon transfers by gift and at death.

Effective Date. The proposal would take effect on January 1, 2024. But it would apply to pre-2024 appreciation; there would be no “fresh start” as, for example, in the 1976 carryover basis legislation.

Realization Events. Gain would be explicitly realized on transfers by gift or at death, equal to the excess of an asset’s fair market value on the date of the gift or death over the donor’s or decedent’s basis in that asset. The Greenbook does not mention holding periods or distinguish short-term and long-term gain. The Greenbook also does not specifically incorporate the alternate valuation date for transfers at death, although it does state generally that a transfer “would be valued at the value used for gift or estate tax purposes.”

Taxpayer, Return, and Deductibility. The Greenbook states that the gain would be reported “on the Federal gift or estate tax return or on a separate capital gains return.” Reassuringly, however, the Greenbook confirms that the gain realized at death “would be taxable income to the decedent” and, consistently with that characterization, explicitly adds that “the tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent’s estate (if any).” That means that, after all exclusions are used, the proposed 39.6 percent capital gains rate and the current 40 percent estate tax rate would produce a combined tax rate on appreciation of 63.76 percent (0.396 + 0.4 × (1 – 0.396)).

Exclusion for Tangible Personal Property. The Greenbook would exclude “gain on all tangible personal property such as household furnishings and personal effects (excluding collectibles).”

Exclusion for Transfers to Spouses. The Greenbook would exclude “transfers to a U.S. spouse.” There is no elaboration of the term “U.S. spouse” (for example, citizen or resident), and there are no special provisions targeted to spousal trusts. Transfers to a spouse would carry over the transferor’s basis. Thus, the effect of excluding transfers to spouses apparently would be simply to defer the application of the deemed realization rules until the spouse’s disposition of the asset or the spouse’s death.

Exclusion for Transfers to Charity. The Greenbook would exclude “transfers … to charity,” adding that “the transfer of appreciated assets to a split-interest trust would be subject to this capital gains tax, with an exclusion from that tax allowed for the charity’s share of the gain based on the charity’s share of the value transferred as determined for gift or estate tax purposes.” Thus, for many purposes, the exclusion would correspond to the allowable gift or estate tax charitable deduction. Like transfers to a spouse, transfers to charity would carry over the transferor’s basis.

Other Exclusions. The Greenbook proposes a unified exclusion of capital gains for transfers both by gift and at death of $5 million per person (up from $1 million in the Fiscal Year 2022 Greenbook), indexed for inflation and “portable to the decedent’s surviving spouse under the same rules that apply to portability for estate and gift tax purposes.” The Greenbook adds that this would “result … in a married couple having an aggregate $10 million exclusion,” but it does not explain exactly how that would be accomplished for lifetime gifts when there has been no “decedent” or “surviving spouse.” The Greenbook does not address whether the use of the exclusion for lifetime gifts is mandatory or elective. But it adds, somewhat quixotically and without further elaboration, that the $5 million exclusion “would apply only to unrealized appreciation on gifts to the extent that the donor’s cumulative total of lifetime gifts exceeds the basic exclusion amount in effect at the time of the gift.” Thus, in effect, a lifetime gift must actually generate a gift tax liability for the donor to use this $5 million exclusion of gain during life. So the first $12 million or so of gifts would trigger recognition of gain, and after that gifts with $5 million of appreciation would escape deemed realization, and after that gifts would trigger gain again. This could significantly influence the selection of assets to use for lifetime gifts.

But in an apparent reversal of the Fiscal Year 2022 Greenbook, the two recent Greenbooks state that “the recipient’s basis in property, whether received by gift or by reason of the decedent’s death, would be the property’s fair market value at the time of the gift or the decedent’s death” (except, presumably, for excluded transfers to spouses and to charity discussed above). The Fiscal Year 2022 Greenbook had included the caveat that “the donee’s basis in property received by gift during the donor’s life would be the donor’s basis in that property at the time of the gift to the extent the unrealized gain on that property counted against the donor’s $1 million exclusion from recognition.” Thus, the recent Greenbooks would increase that proposed $1 million exclusion to $5 million and at the same time allow a stepped-up basis even if the gain is excluded. Although a bit surprising, that would be a significant simplification.

In addition, the Greenbook confirms that the exclusion of $250,000 per person of gain from the sale or exchange of a taxpayer’s principal residence under section 121 would apply to the gain realized under this proposal with respect to all residences, and it adds that that exclusion would be made “portable to the decedent’s surviving spouse.” In this case the application of the portability model to lifetime gifts may be less of an issue because section 121(b)(2) itself doubles the exclusion to $500,000 for joint returns involving jointly used property.

The Greenbook also confirms that the exclusion under current law for capital gain on certain small business stock under section 1202 would apply.

Netting of Gains and Losses. For transfers at death, capital losses and carry-forwards would be allowed as offsets against capital gains and up to $3,000 of ordinary income, mirroring the current income tax rules for lifetime realization events in sections 1211 and 1212. There is no mention of relaxing the rules of section 267 prohibiting the deduction of losses from sales or exchanges between related persons, but it seems almost certain that those rules would be relaxed in any provision for taking losses into account at death, where transfers to related persons are the norm.

Valuation. As noted above, the Greenbook contemplates that a transfer generally “would be valued at the value used for gift or estate tax purposes.” It adds that “a transferred partial interest generally would be valued at its proportional share of the fair market value of the entire property.” In other words, no entity-level discounts. But, in an elaboration of the word “generally,” which was new in the Fiscal Year 2023 Greenbook, the Fiscal Year 2023 and 2024 Greenbooks helpfully add that “this rule would not apply to an interest in a trade or business to the extent its assets are actively used in the conduct of that trade or business.” For more commentary on the treatment of family-owned businesses, see the discussion of the proposed rules for valuation of fractional interests and interests in entities in Capital Letter Number 59.

Special Rules for Trusts and Entities. The Greenbook provides that transfers into, and distributions in kind from, a trust would be recognition events, unless the trust is a grantor trust deemed wholly owned and revocable by what the Greenbook calls “the donor.” Again there is no exclusion or exemption for pre-enactment gain, and indeed the Greenbook explicitly states that the proposal would apply to “certain property owned by trusts … on January 1, 2024.” In other words, this proposed recognition treatment would apply to distributions of appreciated assets to both current and successive or remainder beneficiaries of preexisting trusts, including, for example, a pre-2024 GRAT. With regard to revocable trusts, the deemed owner would recognize gain on the unrealized appreciation in any asset distributed (unless in discharge of the deemed owner’s obligation) to anyone other than the deemed owner or the deemed owner’s “U.S. spouse” (again undefined), and on the unrealized appreciation in all the assets in the trust when the deemed owner dies or the trust otherwise becomes irrevocable.

The Fiscal Year 2022 Greenbook, surprisingly, provided that the rules about transfers into and distributions in kind from a trust would also apply to a “partnership” or “other non-corporate entity,” without further explanation. The subsequent Greenbooks clarify that this extension to such entities applies “if the transfers have the effect of a gift to the transferee.”

The Greenbook also proposes, in effect, a 90-year mark-to-market rule, stating:

“Gain on unrealized appreciation also would be recognized by a trust, partnership, or other non-corporate entity that is the owner of property if that property has not been the subject of a recognition event within the prior 90 years. This provision would apply to property held on or after January 1, 1942, that is not subject to a recognition event since December 31, 1941, so that the first recognition event would be deemed to occur on December 31, 2032.”

Again assets of partnerships and other entities are included, in this case without a gift-equivalent requirement or other explanation. Because December 31, 2032, is 91, not 90, years from December 31, 1941, it appears that the Greenbook contemplates recognition under this proposal only at the end of each year, but the Greenbook does not clarify that. And, because it does not depend on any arguable recognition “event” like a gift, death, or other transfer, this 90-year mark-to-market rule is probably the feature of this proposal that would most likely attract a constitutional challenge.

Deferral of Tax. The Greenbook also provides that “taxpayers could elect not to recognize unrealized appreciation of certain family-owned and -operated businesses until the interest in the business is sold or the business ceases to be family-owned and -operated.” Deferral could increase the amount of tax if there is more appreciation, but it could also prevent the payment of tax to the extent the value of the business declines (which sometimes happens after the death of a key owner). That approach would apparently also tax the realization event at whatever the tax rates happen to be at the time, which might sometimes be a vexing consideration in the executor’s decision to make this election.

If this election is made, would it still be true, as the Greenbook states in the context of exclusions immediately before its discussion of deferral, that “the recipient’s basis in property, whether received by gift or by reason of the decedent’s death, would be the property’s fair market value at the time of the gift or the decedent’s death”? Probably not, because mere deferral of deemed realization (regardless of the amount of gain deferred) is much different from the total escape from realization provided by the limited exclusion. Thus, the loss of a stepped-up basis at intervening deaths could make this ultimate income tax liability much more severe than under current law.

And, of course, like the valuation proposals discussed in Capital Letter Number 59, the statutory language implementing this Greenbook proposal should be expected to include definitions of “business,” “family-owned,” and “family-operated” and possibly rules for the identification of assets that should be excluded from the deferral because they are not used in the business, and such definitions and rules might also create or aggravate challenges over a long-term deferral. The IRS would also be authorized to require reasonably necessary security at any time from any person and in any form acceptable to the IRS, which could be another complication for the family business, for example in raising capital, over a long-term deferral.

In addition, the Greenbook would allow “a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, other than liquid assets such as publicly traded financial assets and other than businesses for which the deferral election is made.” Details about start dates and interest rates are not provided, but the proposal appears much broader and more robust than, for example, section 6166 with its multiple qualification tests.

Administrative Provisions. The Greenbook envisions (but without details) a number of other legislative features, covering topics such as a deduction for the full cost of related appraisals, the imposition of liens, the waiver of penalties for underpayment of estimated tax attributable to deemed realization of gains at death (which, of course, would not necessarily have been foreseeable), a right of recovery of the tax on unrealized gains, rules to determine who selects the return to be filed, consistency in valuation for transfer and income tax purposes, and coordination of the changes to reflect that the recipient would have a basis in the property equal to the value on which the capital gains tax is computed.

Regulations. Treasury would be granted authority to issue any regulations necessary or appropriate to implement the proposal, including reporting requirements that could permit reporting on the decedent’s final income tax return, which would be especially useful if an estate tax return is not otherwise required to be filed. In a tacit acknowledgment of the harshness of enacting such a proposal without a “fresh start” for basis as in 1976, the Greenbook explicitly contemplates that the regulations will include “rules and safe harbors for determining the basis of assets in cases where complete records are unavailable.”

Revenue Estimate. Taxing capital gains at the same rate as ordinary income for taxpayers with taxable income over $1 million (discussed above) and this proposed “deemed realization” of capital gains together are estimated to raise approximately $214 billion over the next 10 fiscal years.

DEEMED OWNER’S PAYMENT OF TRUST INCOME TAX AS A GIFT

The Greenbook (at page 127) proposes that payment by the “deemed owner” of income tax on the income of a “grantor trust” (other than a trust that is fully revocable by the deemed owner, as the Fiscal Year 2024 Greenbook clarifies) would be a gift by the deemed owner “unless the deemed owner is reimbursed by the trust during that same year” in which the tax is paid. Again, the proposal uses the potentially clashing terms “deemed owner” and “grantor trust.”

The Greenbook states that the gift would generally occur “on December 31 of the year in which the income tax is paid.” Acknowledging the need for some exceptions to that rule, the Greenbook adds “if earlier, immediately before the owner’s death, or on the owner’s renunciation of any reimbursement right for that year.” But even with that addition, the Greenbook does not specifically provide for cases where the reimbursement is made only in the trustee’s discretion and not as the deemed owner’s “right,” or where the “reimbursement right” terminates other than by the owner’s renunciation, or when grantor trust (or “deemed owned”) status itself terminates other than by the owner’s death. Likewise, the Greenbook does not address how to determine the year in which the deemed owner pays the income tax on the trust’s income when some of the deemed owner’s income tax liability is paid by quarterly estimated payments, three of which have been made in the year before the income tax return is filed, or by overpayments applied from the previous year’s return. It is almost certain, however, that all such payments would be treated as made in the year the return is filed and the tax is due, because otherwise the notion of being “reimbursed by the trust during that same year” would make no sense.

And of course the annual reimbursement of such taxes pursuant to either a requirement or an exercise of discretion pursuant to an understanding or prearrangement would create a risk of including the value of the trust assets in the grantor’s gross estate under section 2036 as applied in Rev. Rul. 2004-64, 2004-2 C.B. 7.

The Greenbook states that “the amount of the gift cannot be reduced by a marital or charitable deduction or by the exclusion for present interest gifts or gifts made for the donee’s tuition or medical care,” presumably meaning that the deemed owner’s payment of income tax on a trust’s income would be a gift even if the trust’s assets or income are or could be used to make distributions that would not be taxable gifts if made directly by the deemed owner. But the Greenbook clarifies that the gift will be an adjusted taxable gift for estate tax purposes.

This proposal would apply to all trusts created on or after the date of enactment (which, if the proposal gains any traction, could provide an incentive to create and fund grantor trusts before the date of enactment).

LIMITATIONS ON GST EXEMPTION

Like the Fiscal Year 2023 Greenbook, the Fiscal Year 2024 Greenbook (at page 121) muses that “at the time of the enactment of the GST provisions, the laws of most States included a common law Rule Against Perpetuities (RAP) or some statutory version of it requiring that every trust terminate no later than 21 years after the death of a person who was alive at the time the trust was created.” It’s easy to see where that is headed!

Limited Duration of GST Exemption

The Greenbook (at pages 121-122) proposes to

“make the GST exemption applicable only to: (a) direct skips and taxable distributions to beneficiaries no more than two generations below the transferor, and to younger generation beneficiaries who were alive at the creation of the trust; and (b) taxable terminations occurring while any person described in (a) is a beneficiary of the trust.”

Therefore, trusts would not continue to be exempt, for example, throughout the entire applicable rule against perpetuities period, or for the full life of the trust if shorter (or if there is no rule against perpetuities in the applicable jurisdiction). Trusts would be exempt only for the life of any first- or second-generation beneficiary or any younger generation beneficiary who was alive at the creation of the trust. Unlike the typical rule against perpetuities, all grandchildren would be included as measuring lives, even if they were not “lives in being” at the creation of the trust, but, on the other hand, no 21-year period would be added.

The Greenbook also provides that the “reset” rule of section 2653(a) would not apply, apparently meaning that subsequent distributions to members of the then oldest generation would in effect be subject to GST tax twice in the same generation (which is surprising). But it states that the special rule in section 2653(b)(2) for “pour-over trusts” created from a trust (whether under the trust instrument or under a decanting authority) would continue to apply, with such pour-over trusts deemed to have the same date of creation as the initial trust for purposes of determining the duration of the GST exemption.

This provision limiting the duration of the allocation of GST exemption would apply retroactively to existing trusts, but for purposes of determining the duration of the GST exemption “a pre-enactment trust would be deemed to have been created on the date of enactment and … the grantor is deemed to be the transferor and in the generation immediately above the oldest generation of trust beneficiaries in existence on the date of enactment.” For example, if a trust had been created 30 years ago and the grantor and all the grantor’s children had died before the date of enactment, then

the grantor’s grandchildren would be the oldest generation in existence,
the grantor/transferor would therefore be deemed to be one generation above those grandchildren (in other words, in the generation of the deceased children of the grantor), and
the measuring lives for purposes of the new rule would apparently be the grandchildren and great-grandchildren of the grantor (whether or not alive on the date of enactment) and all younger-generation descendants (such as great-great-grandchildren) alive on the date of enactment.

By allowing allocation of GST exemption and only limiting how long it lasts, the Greenbook proposal could be less harsh than, for example, section 9 of Senator Bernie Sanders’ (I-Vermont) “For the 99.5 Percent Act” (S. 994, introduced March 25, 2021), which in effect would deny any exemption allocation if the trust could last longer than 50 years.

Not surprisingly, this Greenbook proposal, focused on trust distributions to generations younger than grandchildren, is not projected to affect revenue over the next 10 fiscal years.

Changing the GST Tax Characterization of Certain Tax-Exempt Organizations

The Greenbook (at page 128) would provide that interests held by “additional tax-exempt organizations” would be ignored for purposes of the GST tax. (Technically, according to a footnote, an organization described in section 501(c)(4) through (9) or 501(c)(11) through (29) would be treated for GST tax purposes like an organization described in section 2055(a).)

For example, a “health and education exclusion trust” (“HEET”) builds on the rule of section 2611(b)(1) that distributions from a trust directly for a beneficiary’s school tuition or medical care or insurance are not generation-skipping transfers, no matter what generation the beneficiary is in. Sometimes, by including charities or section 501(c)(4) social welfare organizations as permissible beneficiaries with interests that are vague enough to avoid being treated as separate shares, the designers of such trusts hope that a non-skip person (the charity or other organization) will always have an interest in the trust within the meaning of section 2612(a)(1)(A), and thereby the trust will avoid a GST tax on the taxable termination that would otherwise occur as interests in the HEET pass from one generation to another. This Greenbook proposal would presumably prevent the inclusion of a section 501(c)(4) social welfare organization, for example, from producing that result.

GST Tax or Inclusion Ratio Affected by Loans from a Trust

The Greenbook (at page 126) notes that “loans to trust beneficiaries are being used to avoid the income and GST tax consequences of trust distributions.” In support of that assumption, it states the obvious fact that “the borrower … is receiving property from the trust,” and then offers the possibly debatable and in any event situational views that “the borrower is unlikely to have been able to otherwise obtain” such a loan and “these loans are often forgiven or otherwise remain unpaid.” Accordingly, the Greenbook (at page 129) proposes further limitations on the GST exemption related to the making and repaying of such loans.

Loans to Beneficiaries. Loans to trust beneficiaries would be treated as distributions, constituting, as appropriate, either a direct skip or a taxable distribution for GST tax purposes. (The making of such loans would also carry out distributable net income for income tax purposes.)

Repayment of Loans Made to Beneficiaries. If a trust beneficiary repays a loan, the payor of any GST tax on the making of the loan could request a refund from the IRS within one year after the final payment on the loan.

Repayment of Loans Made to Deemed Owners. The repayment of a loan made by a trust to a person who is not a trust beneficiary but is a deemed owner of the trust under the grantor trust rules would be treated as a new contribution to the trust, which, like any other contribution, would utilize GST exemption of the borrower, generate a GST tax liability in the case of a direct skip on the borrower or the borrower’s estate, or increase the trust’s inclusion ratio, depending on the borrower’s elections and the generation assignments of the trust’s beneficiaries at the time of the repayment. This is proposed, as the Greenbook puts it, “to discourage borrowing from a trust by [such] a person.” The Greenbook adds:

“Any GST tax payable on such a deemed direct skip that could not be collected from a deemed owner or a deceased deemed owner’s estate (such as, if the time for collecting such a debt from a decedent has expired), would be payable by the trust itself.

“The proposal includes a grant of regulatory authority to identify certain types of loans that would be excepted from the application of the proposal. This authority could be used to exempt short-term loans, which do not raise the same concerns. Similarly, other exceptions might be the use of real or tangible property for a minimal number of days.”

This proposal would apply to loans made, renegotiated, or renewed by trusts after the year of enactment.

Adjustment of a Trust’s GST Inclusion Ratio on Transactions with Other Trusts

The Greenbook (at page 125) notes that a purchase by a GST-exempt trust of assets from, or a remainder interest in, another trust (particularly citing a purchase from a GRAT) is “a popular technique for leveraging the benefit of the GST exemption.” (A sale of assets by one grantor trust to another grantor trust is generally thought to be exempt from recognition of gain under Rev. Rul. 85-13, 1985-1 C.B. 184, as applied, for example, in Letter Ruling 202022002 (issued Feb. 25, 2020; released May 29, 2020).) The Greenbook (at page 128) proposes to limit that leveraging opportunity by requiring a readjustment of the purchasing trust’s inclusion ratio for all such transactions occurring after the date of enactment. Specifically, the value of the purchased assets would be included in the total value of the trust in the denominator of the applicable fraction, and the value of only the portion of those assets excluded from GST tax immediately before the purchase would be added to the numerator of the fraction. A similar readjustment would be required following a decanting.

OTHERWISE LIMITING THE USE OF CERTAIN TRUSTS

The Fiscal Year 2023 Greenbook (at page 40) lamented that “individuals who own assets expected to appreciate in value use two common techniques for reducing estate taxes that exploit the gift and income tax features of grantor trusts to remove value from their gross estates.” Those two exploitative techniques turned out to be GRATs and sales of appreciating assets to grantor trusts.

Many estate planners would point out that GRATs were created by Congress in section 2702(b)(1)) and that sales of appreciating assets to grantor trusts are facilitated by Congress’s use of the phrase “treated as the owner” in sections 673 through 677 and its treatment of income tax as a liability of that owner under section 671.

Be that as it may, the Fiscal Year 2023 Greenbook invited Congress to blaze a new trail with three new proposals. The Fiscal Year 2024 Greenbook (at pages 123-129) follows suit, and even adds four other proposals. Those proposals that are not included in other sections of this Capital Letter are summarized below:

GRATs

Like the Obama Administration Greenbooks, and similarly to section 7 of Senator Sanders’ “For the 99.5 Percent Act,” the Greenbook (at page 127) would impose on GRATs

a minimum term of 10 years,
a maximum term of the life expectancy of the annuitant plus 10 years,
a prohibition on any decrease in the annuity during the GRAT term (which otherwise might be used to reduce the amount includable in the grantor’s gross estate if the grantor dies before the end of the GRAT term),
a minimum remainder value equal to the greater of 25 percent of the assets contributed to the GRAT or $500,000 (but not more than the value of assets contributed to the GRAT), which would put an end to the very common and effective technique of zeroed-out or nearly-zeroed-out GRATs, and
a prohibition on the grantor’s acquisition of any asset from the GRAT in an exchange without recognizing gain or loss on the exchange.

This proposal would apply to GRATs created on or after the date of enactment. If this proposal gained traction and was given a reasonable chance of being enacted, that might encourage the creation and funding of GRATs before enactment, which would avoid the first four limitations, particularly the hugely significant fourth limitation of a minimum 25 percent remainder value. But merely creating a GRAT before enactment would not necessarily avoid the fifth limitation, because proposals discussed elsewhere in this Capital Letter would apparently also require a GRAT to recognize gain if the annuity payments were made with appreciated assets. (The gain recognition risk might be minimized, if feasible, by using a longer term GRAT in which the annuity amounts were low enough that they could be satisfied out of income, not with in-kind distributions.)

CLATs

The Greenbook (at pages 124 and 126) notes the benefits of a charitable lead annuity trust (CLAT), in which appreciation in excess of the annuity payments over the term of the CLAT accrues for the benefit of the noncharitable remainder beneficiaries, especially if the annuity payments begin lower and increase over the term of the CLAT (sometimes, in its most extreme form, referred to as a “shark-fin CLAT”). To address that, the Greenbook (at page 128) proposes that annuity payments must be “a level, fixed amount over the term of the CLAT” and that the value of the remainder interest must be at least 10 percent of the value of the property used to fund the CLAT.

CLATs would also be affected by the proposal to prevent the use of a value formula clause to define the amount of the CLAT annuity, discussed in Capital Letter Number 59.

OTHER PROPOSALS TO “IMPROVE TAX ADMINISTRATION FOR TRUSTS AND DECEDENTS’ ESTATES”

A section of the Greenbook (at pages 115-120) titled “Improve Tax Administration for Trusts and Decedents’ Estates” proposes a number of changes.

Expanded Definition of Executor

The Internal Revenue Code’s definition of executor would be moved from section 2203 to section 7701, and the authorized party could act for all tax purposes (including with respect to pre-death tax liabilities). Elaborating on the helpfulness of this change, the Greenbook (at pages 116-117) adds:

“Because reporting obligations (particularly regarding interests in foreign assets or accounts) have increased, problems associated with this absence of any representative authority are arising more frequently. Additionally, in the absence of an appointed executor, multiple persons may meet the definition of executor and, on occasion, multiple persons have filed separate estate tax returns for the decedent’s estate or have made conflicting tax elections.”

This change would apply after enactment regardless of a decedent’s date of death.

If enacted, this would be a welcome change because, as the quotation from the Greenbook illustrates, it would empower executors to take many actions in representing a decedent’s interests before the IRS that currently might be complicated and difficult or even impossible.

Extension of 10-Year Estate and Gift Tax Lien

The automatic 10-year lien for estate and gift tax would be extended during any deferral or installment period for unpaid estate and gift tax. This provision would apply for existing 10-year liens and for the automatic lien that applies for gifts made or estates of decedents dying on or after the date of enactment.

Although liens sound scary and burdensome, this would also be a welcome change, to the extent it overcomes the IRS’s reluctance to agree to some extensions of payment due dates.

Increased Alleged “Benefit” of Special Use Valuation

Similar to the House Ways and Means Committee’s version of the “Build Back Better Act” in 2021, the Greenbook proposes to increase the limit on the reduction in value of special use property under section 2032A from $750,000 (indexed, $1.31 million in 2023) to $13 million, applicable for decedents dying on or after the date of enactment.

Expanding the application of section 2032A has often been suggested as a “targeted” way to provide relief from the estate tax for family-owned farms and businesses while still maintaining the estate tax. Even so, it must be acknowledged that the proposal would not really reduce the estate tax on a family farm or business as such; it would merely prevent a tax, for example, on a speculative prospect of development that is faced by such farms and businesses very unevenly. Such a tax, it could be argued, is merely “found money” for the IRS in such cases. Thus, this proposal should not be expected to be viewed by owners of family farms and businesses as much of a benefit, or even a consolation.

“Simplify” the Gift Tax Annual Exclusion by Tightening the “Present Interest” Requirement

Like proposals in the Clinton and Obama Administrations and Senator Sanders’ “For the 99.5 Percent Act,” the Greenbook (at pages 119-120) proposes to limit the annual gift tax exclusion to transfers Treasury seems to view as conveying a more genuine present interest. Following closely the explanation on page 171 in the Obama Administration’s Fiscal Year 2015 Greenbook, the Fiscal Year 2024 Greenbook, under the heading “Simplify the exclusion from the gift tax for annual gifts,” states:

“The proposal would eliminate the present interest requirement for gifts that qualify for the gift tax annual exclusion. Instead, the proposal would define a new category of transfers (without regard to the existence of any withdrawal [e.g., Crummey power] or put rights) and would impose an annual limit of $50,000 per donor, indexed for inflation after 2024, on the donor’s transfers of property within this new category that would qualify for the gift tax annual exclusion. This new $50,000 limit would not provide an exclusion in addition to the annual per-donee exclusion; rather, it would be a further limit on those amounts that otherwise would qualify for the annual per-donee exclusion. Thus, a donor’s transfers in the new category in a single year in excess of a total amount of $50,000 would be taxable, even if the total gifts to each individual donee did not exceed $17,000. The new category would include transfers in trust (other than to a trust described in section 2642(c)(2) [a “vested” single-beneficiary trust]), transfers of interests in passthrough entities, transfers of interests subject to a prohibition on sale, partial interests in property, and other transfers of property that, without regard to withdrawal, put, or other such rights in the donee, cannot immediately be liquidated by the donee.”

In other words, the proposal would apparently reverse the IRS’s lack of success in trying to limit the proliferation of Crummey powers in cases such as Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991), and Kohlsaat v. Commissioner, T.C. Memo. 1997-212), and would codify the IRS’s successes in limiting the treatment of interests in passthrough entities as present interests in cases such as Hackl v. Commissioner, 118 T.C. 279 (2002), aff’d, 335 F.3d 664 (7th Cir. 2003) (interests in an LLC engaged in tree farming), Price v. Commissioner, T.C. Memo. 2010-2 (interests in a limited partnership holding marketable stock and commercial real estate), and Fisher v. United States, 105 AFTR 2d 2010-1347 (D. Ind. 2010) (interests in an LLC owning undeveloped land on Lake Michigan).

Like the Obama Administration Greenbooks, the proposal apparently would not change the unlimited exclusion in section 2503(e) for tuition and medical expenses paid directly to the provider, the gift-splitting rules in section 2513, or (unlike Senator Sanders’ bill) the special way in section 2503(c) a trust for a minor can qualify as a present interest.

The proposal would apply to gifts made after December 31, 2023.

Reporting of Estimated Value of Trust Assets

The Greenbook (at pages 118-119) proposes to require trusts to file with the IRS annual reports including the name, address, and taxpayer identification number (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 (which might be satisfied by identifying an applicable range of estimated total value on the trust’s income tax return). The reporting requirement would apply to taxable years ending after the date of enactment for trusts valued over $300,000 or with gross income over $10,000 (with both amounts indexed for inflation after 2024). This change is described in a manner that might suggest it is intended to help the IRS develop a “comprehensive” “statistical data” base about trusts generally, not to target trusts for audit. Nevertheless, this proposed change could be burdensome and, for many, quite ominous.

REFINEMENT OF DISTRIBUTION RULES FOR PRIVATE NONOPERATING FOUNDATIONS

Private nonoperating foundations are required to make qualifying distributions of at least 5 percent of the total fair market value of their non-charitable-use assets each year, or be subject to a 30 percent excise tax on the undistributed amount. Qualifying distributions include amounts paid for religious, charitable, scientific, or educational purposes, as well as reasonable and necessary administrative expenses paid by the foundation to further its charitable purposes.

Limiting the Use of Donor Advised Funds

The Greenbook (at pages 139-140) would clarify that a distribution by a private foundation to a donor advised fund (DAF) is not a qualifying distribution unless the DAF’s assets are expended as a qualifying distribution by the end of the following taxable year and the private foundation maintains adequate records or other evidence to show that the DAF in fact made that qualifying distribution within that time. The proposal would be effective after the date of enactment and is estimated to raise $83 million over the next 10 fiscal years.

Note that this is not the “Accelerating Charitable Efforts Act” (“ACE Act”), like, for example, S. 1981 (117th Cong.), introduced on June 9, 2021, by Senators Angus King (I-Maine) and Chuck Grassley (R-Iowa), which is intended to encourage philanthropic funds to be made available to working charities within a reasonable time by tightening restrictions on donor advised funds (DAFs) and private foundations generally.

Excluding Certain Payments to Family Members

The Greenbook (at page 141) notes that “some private foundations meet their entire payout requirement by hiring family members,” taking advantage of the exception from the self-dealing rules for paying for personal services that are reasonable and necessary to carry out the foundation’s exempt purposes. To curb that practice, the Greenbook proposes that a private foundation’s payment of compensation or expense reimbursement to a disqualified person (other than a foundation manager of the private foundation who is not a member of the family of any substantial contributor) would not count toward the 5 percent payout requirement (although, to the extent reasonable and necessary to carry out the foundation’s exempt purposes, it would still qualify for the exception from self-dealing). The proposal would apply to payments after the date of enactment and is estimated to raise $7 million over the next 10 fiscal years.

Ronald D. Aucutt