The New Bernie Sanders Estate Tax Act
In case you were wondering what Democrats are thinking about where they would like to take the estate tax laws, Thursday Senator Bernie Sanders (I-Vt.) clarified that by filing S. 309 named “For the 99.8% Act.” The act would radically modify federal estate, gift and generation-skipping transfer taxes.
The name of the act is interesting. IRS filing statistics can be interpreted to imply that 99.8% of the population pays no federal transfer tax. While the act clearly would raise revenue, it’s also clear that a large percentage of the 99.8% would again be taxed.
Key parts of it include:
- eliminating GST exemptions for trusts lasting longer than 50 years,
- requiring estate inclusion for assets inside an irrevocable grantor trust,
- lowering the estate tax exemption to 2009 levels,
- lowering the gift tax exclusion even further,
- raising the tax rates from 40% to at least 45% and as high as 77%,
- creating a clawback tax for large gift amounts,
- applying the basis consistency rules to gifts,
- eliminating many valuation discounts,
- establishing a 10-year minimum for grantor retained annuity trusts,
- treating distributions from an irrevocable grantor trust as taxable gifts,
- changing the annual gift exclusion, including eliminating Crummey trusts.
- raising the amount to which the farm and ranch provisions under 2032A apply, and
- changing amounts in conservation easements.
Many news outlets have cast the Sanders act as a tax on billionaires. While it would raise the taxes on estates in excess of $1 billion to 77%, it also has the potential to impact much smaller estates in a very negative way. Most important among its provisions is the change in the GST exemption. For tax professionals assisting in planning larger estates, perhaps first in importance to them are the changes to the grantor trust rules combined with the lowering of the estate and gift exemptions and the raising of rates.
GST Limit
For trusts lasting longer than 50 years, transferors would no longer be able to allocate any GST exemption to that trust. In tax jargon, the inclusion ratio would be 1. Such trusts would be deemed to be non-qualifying, and transfers such as distributions to beneficiaries made from a non-qualifying trust would be subject to GST tax. The rate of tax would be the rates for estates under the Sanders act.
While such tax rates could be as high as 77% for distributions of $1 billion or more, more troubling is the impact this change will have in the small trusts already embedded in thousands, if not millions, of wills and revocable trusts already in place. It’s common for parents to create trusts for children that will last for the lifetime of the child and then for a grandchild until a certain age, such as age 30. Imagine if the child is 30 years old. If that child lives to age 80, the trust won’t qualify for any GST exemption, no matter how small it might be. The distributions at the death of the child to the grandchild will be fully taxable.
The tax rates will be the rates in 2001(c). Those start at 18% for amounts up to $10,000, increase to 20% for amounts over that up to $20,000, and so on. Imagine the amount passing to the grandchild might be a mere $100,000. The tax would be $23,800.
The 50 years would be measured from the date on which the trust is created. Grandfathering is limited, providing that trust created before the date of enactment shall be deemed to be qualifying for a period of 50 years after the date of enactment. Presumably that means after 50 years, it would be non-qualifying and all distributions subject to GST tax.
Lowered Exemption
The current exemption of $11.4 million would be reduced to $3.5 million. Presumably the indexing of that amount to inflation would stay in place, retroactive back to 2010.
IRS statistics indicate that about 4,000 estate tax returns have been or will be filed for people who died in 2018. Out of that, less than half or about 1,900 returns will be taxable, meaning that 0.1% of the 2.7 million people who died in 2018 will pay tax.
Clearly that galls people like Senator Sanders. However, while lowering the exemption to $3.5 million sounds like it would produce a huge increase in tax, it’s likely that the increase in revenue will be less than 10%. In 2009, when the exemption was $3.5 million, IRS statistics show that 12,900 returns had to be filed, 5,700 were taxable and the estimated tax liability was $13.6 billion. In 2018 when the exemption was over 3 times higher at $11.12 million, the estimated tax liability was only $14.9 billion, just 9.55% more.
Portability is not mentioned in the Sanders act. The act may have the effect of causing more portability returns to be filed.
Lowered Exemption for Gifts
The current exemption for gifts would be reduced to $1 million. It appears that would also be inflation adjusted.
Raised Rates
Transfers at death in excess of the exemption would be taxed at higher rates. Currently, the rate for amounts exceeding the exemption is 40%. Under the Sanders act, the rate increases would be:
- amounts over $3.5 million up to $10 million, from 40% to 45%,
- amounts over $10 million up to $50 million, 50%,
- amounts over $50 million up to $1 billion, 55%, and
- amounts over $1 billion, 77%.
In 2011, the staff of the Joint Committee on Taxation released its report entitled “Present Law and Historical Overview of the Federal Tax System.” In it, we can see that 77% rate was part of the law prior to the enactment of the Tax Reform Act of 1976, when the estate tax exemption was $60,000. The 77% rate applied to estates over $10 million. In today’s dollars, that’s $47 million.
Clawback
The new statute would create a clawback for the aggregate of gifts over $3.5 million. For example, if a donor gave gifts in 2019 of $11.4 million, using his/her entire exemption under the current law, and died at a time when the Bernie Sanders act was in place, the estate would pay an extra tax of $465,000 because of those gifts. That tax is computed by subtracting the gift tax that would be calculated for 2019, as though the exemption were $3.5 million but using the 2019 rate, from the tax that would be computed using higher rates under the Bernie Sanders act.
Basis Consistency
Estate tax attorneys and CPAs are familiar with the basis consistency rules added by the Service Transportation and Veterans Health Care Choice Improvement Act of 2015, especially Form 8971 and its Schedule A. Those statutes and regulations require that values reported on a federal estate tax return must be used by parties receiving capital assets as their income tax basis in the assets. The Form 8971 and the Schedule A that goes with it are required to be given by the executor of the estate to the beneficiaries to advise them of their basis. The Sanders act would extend those rules and reporting requirements to gifts.
Proposed regulations on the estate tax side include controversial elements such as $0 basis for assets that are not included on the estate tax return regardless of their actual basis or value, and a requirement that estate beneficiaries must prepare and file their own Form 8971 and Schedule A if assets received are later transferred to another. Some feel that additional reporting requirement, which finds no basis in the statute, will be eliminated when the regulations are finalized. On the other hand, commentators argue about the justice of the $0 basis rule.
Elimination of Valuation Discounts
The act would provide that a transfer of a business interest would be treated as a direct transfer of non-business assets inside the entity from the donor to the donee, undiscounted for any purpose. The business itself would be valued as though it did not own the non-business assets. Certain assets are excluded from the rule such as accounts receivable, inventory and a reasonable amount of working capital. This is a direct attack on the use of entities to create valuation discounts.
GRAT Term
Under current rules, grantor retained annuity trusts or GRATs can have terms as short as two years (some argue that one year and a day is sufficient). The Sanders act would require a minimum 10-year span of time.
Grantor Trusts
Under current rules, a person (the “grantor”) can create an irrevocable trust for the benefit of others (the “beneficiaries”), the assets of which are not countable as belonging to the grantor for estate tax purposes, but the income of the trust is treated as the income of and taxable to the grantor. The beneficiaries can then receive income and distribution of principal from the trust, without the trust or the beneficiaries having to pay income tax. Rev.Rul. 2004-64 held that the payment of that income tax by the grantor is not treated as a gift to the beneficiaries. The only gifts under current law are the gratuitous transfers of assets from the grantor to the trust. In many cases, the grantor also sells assets to the trust and, because of the special income tax status of such trusts, that transaction is not treated as a sale triggering income tax.
The Sanders act would change all of those results. Under his proposed legislation, the assets in the trust would be countable as belonging to the grantor for estate tax purposes at the grantor’s death. The text of the statute seems to indicate that the value would be the value as of the date of death, and not the value at the time the grantor transferred the assets to the trust. In addition, distributions from the trust to a beneficiary would be treated as gifts from the grantor to the beneficiary. Presumably, the grantor would have to file gift tax returns annually to report those gifts, utilizing the grantor’s lifetime gift tax exclusion (which would be $1 million under the Sanders act) and paying gift tax on amounts in excess of that. In addition, if the grantor were to attempt to terminate the special income tax status (as is done in some cases where grantors don’t wish to continue being liable for the income tax of the trust), the grantor would be treated as making a taxable gift of all of the trust assets to the beneficiaries.
If passed in this act, or in any similar form in any other legislation, sales to grantor trusts would be eliminated.
Annual Gifts
The Sanders act would remove the concept of present interest. It would provide simply that gifts made to any person by the donor during the calendar year would be exempt for the first $10,000. The amendment is written in such a way so that indexing would still be in place, presumably meaning that, this year, the $15,000 figure would still be in place. What’s new would be a cumulative limit on donors. Transfers to a trust (without regard to the number of beneficiaries), transfers of an interest in a pass-through entity, transfers of an interest subject to a prohibition on sale and any other transfer where the donee cannot immediately liquidate the asset received would be subject to a maximum annual gift exclusion of twice the annual exclusion amount. In other words, $30,000 this year. The last line of the limitations section relating to transfers where the donee cannot immediately liquidate includes the phrase “without regard to withdrawal, put, or other such rights in the donee…” That appears to be a direct attack on Crummey trusts. In other words, the fact that a beneficiary can withdraw the annual gift exclusion amount is irrelevant. The maximum that a donor can transfer to the trust is $30,000.
Special Use Valuation for Farms and Ranches
The $750,000 figure currently set forth in 2032A(a) would be increased to $3 million, the inflation adjustment reset to begin after 2018.
Changing Amounts in Conservation Easements
The act would increase the amount that might be excludable from an estate where an election is made for a conservation easement. Current law allows an exclusion of up to $500,000. The Sanders act would increase the ceiling on the exclusion up to $2 million. In addition, the Sanders act would put into place a 50% increase in the so-called “applicable percentage.” That percentage reduces the amount that can be excluded if the value of the qualified conservation easement is less than 30% of the value of the land determined without regard to the value of the easement. That percentage would rise from 40% up to 60%.
The New Elizabeth Warren, Kirsten Gillibrand and Ed Markey Estate Tax Act
Not to be outdone, Sen. Elizabeth Warren (D-Mass.), Sen. Kirsten Gillibrand (D-NY) and Sen. Ed Markey (D-Mass.) have buried some of their own estate and generation-skipping transfer tax changes in the back end of their American Housing and Economic Mobility Act of 2019, which is not yet officially showing up on federal government websites, but probably will be S. 787. Allegedly, only 14,000 American families would be affected. But that just isn’t true given the way the GST provisions are written (see above).
Like the Sanders act, it:
- eliminates GST exemptions for trusts lasting longer than 50 years,
- requires estate inclusion for assets inside an irrevocable grantor trust,
- lowers the estate tax exemption to 2009 levels,
- raises the tax rates from 40% to at least 55% and as high as 75%,
- creates a clawback tax for large gift amounts,
- establishes a 10-year minimum for grantor retained annuity trusts,
- treats distributions from an irrevocable grantor trust as taxable gifts, and
- changes the annual gift exclusion, including eliminating Crummey trusts.
The provisions related to grantor trusts, GST exemptions and the annual gift tax exclusion are duplicates of what is in the Sanders act, with one important exception concerning the GST provisions. The Warren-Gillibrand-Markey act, like the Sanders act, has a special provision for billionaires but it would also impact much smaller estates in a very negative way. Because so much of this act is similar to the Sanders act, the following is simply a brief explanation of the parts that differ.
GST Provisions – Higher Tax Than Sanders Bill
In the Sanders act, trusts that fail to meet the requirements and for which there can be no GST exemption are taxed at rates in 2001(c) starting at 18%. The Warren-Gillibrand-Markey act completely eliminates all of the lower rate brackets so that the lowest rate is 55%. Using the same example in the analysis of the Sanders act above with $100,000 passing to a grandchild, the tax would not be $23,800 as it would be under the Sanders act but instead would be $55,000.
Tax Rates
The Warren-Gillibrand-Markey act would set a minimum estate tax rate of 55% for all estates up to $13 million. In other words, for a $13 million estate, the tax would be $7,150,000. Between $13,000,000 and $93 million, the rate would be 60%. Over $93 million up to $1 billion, the rate would be 65%.
Billionaire Surtax
On top of the increased rates, estates over $1 billion would pay an additional surtax of 10%.
Clawback
The way the Warren-Gillibrand-Markey act is written, there would be a clawback. The act doesn’t spend the time detailing how it would be computed and so it appears there would be no credit whatsoever for the higher exemptions now.