Kelly M. Perez (J.P. Morgan) recently published an article, Grantor Trusts: The MVP of the IRC, 15 Est. Plan. & Comm. Prop. L.J. , 2023. Provided below is an introduction to the Article:
Since the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), taxpayers have enjoyed the benefit of increased exclusion amounts for the combined gift and estate tax, and the generation-skipping transfer (GST) tax (collectively referred to herein as transfer taxes). The terms “lifetime exclusion” or “exclusion amount” generally refer to the amount that an individual can give or pass on to others during one’s lifetime or at death without triggering the payment of transfer tax, currently at a rate of 40%. This ever-changing exclusion amount has been a huge focus for wealthy families, tax and estate planning practitioners, and Congress over the last few decades.
We live in an era of heightened “bonus exclusion,” where the current exclusion is at an all-time nominal high (since the introduction of the estate tax in 1916) of $12.06 million in 2022, going to $12.92 million per person for 2023. Like most of the individual tax benefits under the TCJA, this increased exclusion amount is scheduled to sunset after December 31, 2025, reverting to pre-TCJA amounts. When Joe Biden won the Presidency in 2020 and the Senate flipped to a very narrow Democratic majority in 2021, including any tie-breaking vote by Vice President Kamala Harris, the planning community was upended. It was fully expected, based on then Candidate Biden’s platform and comments made by the Biden-appointed Secretary of Treasury, Janey Yellen, that any tax package proposed by a Biden Administration would include some form of reduction of this bonus exclusion, or an earlier sunset. Exclusion reduction, as well as fear of the elimination of the “step-up” in basis at death rule under Section 1014 of the Internal Revenue Code (the Code), was fully anticipated by taxpayers and resulted in a flurry of anxious tax consulting and planning at the end of 2020.
While everyone was focused on the exclusion and basis planning, Democrats in Congress, with the support of the Biden Administration, also had plans to make substantial changes to the grantor trust rules under Subpart E or Part I of Subchapter J of the Code. Many of these proposed changes seemed to come out of left field. On September 13, 2021, the House Ways and Means Committee introduced a bill known as the Build Back Better Act (BBBA), which threatened to effectively gut the efficacy of grantor trust planning. The bill itself was expected; it included some ideas from the Obama Administration’s General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals (the 2015 Green Book), as well as revenue-raising packages enacted in 2020 and 2021. What was not predicted by most were the proposed changes to the grantor trust rules.
These proposals were, without a doubt, more profound than a proposed rollback of the gift, estate, and GST tax exclusion amounts because of the sheer broad design of a grantor trust generates endless planning opportunities for families of wealth. Once a taxpayer uses all of his or her gift tax exclusion amount, planning techniques involving the use of grantor trusts can take wealth transfer into “extra innings,” because they offer opportunities to shift additional wealth without the use of the exclusion. Arguably, there is no better estate planning tool than a properly structured irrevocable grantor trust to transfer wealth from grantor’s taxable balance sheet to the non-taxable side of the family’s balance sheet. This is why grantor trusts are the most valuable player of the Internal Revenue Code for purposes of wealth transfer. The possibilities are almost endless.
This Article briefly reviews the grantor trust rules contained in Subpart E of the Code, and specifically focuses on the current legislative standing of grantor trusts, as well as some of the more detailed nuances of grantor trust planning. Some of these special considerations are techniques such as: (1) terminating grantor trust status; (2) “toggling” grantor trust status on and off; (3) income tax consequences; (4) the efficacy of tax reimbursement clauses; and (5) other special considerations.