Gifts to Irrevocable Trusts Under Proposed Tax Legislation

We recently shared some of the proposed tax law changes related to the estate and gift tax (Proposed Legislation to Change Estate and Gift Tax Planning). This alert covers the proposed changes to certain irrevocable trusts, called grantor trusts, and the changes would be effective upon the date of enactment. As we mentioned before, this is only proposed legislation and will almost certainly change before it is enacted.

Currently, individuals are able to retain certain interests in trusts that cause the grantor to be the owner of the trust for income tax purposes but without resulting in inclusion of the trust assets in the grantor’s taxable estate at death. We refer to these trusts as “grantor trusts.” The proposed legislation would cause the assets of grantor trusts to be brought back into the grantor’s taxable estate at death. In addition, any distribution from a grantor trust to anyone other than the grantor or the grantor’s spouse would be considered a taxable gift by the grantor to that person, and the grantor would be treated as making a gift of all the trust’s assets if the trust ceased to be a grantor trust during the grantor’s lifetime.

Grantor trusts have also had income tax benefits. Individuals who are considered owners of grantor trusts have had the ability to sell assets to the trust and often have retained the power to exchange their own assets with assets of the trust, both with no income tax cost. The new law would trigger gain recognition upon sales and exchanges between the trust and the grantor. These changes, if passed, would be effective upon enactment of the new legislation. While the assets of existing grantor trusts and grantor trusts signed and funded before the effective date would not be brought back into the grantor’s taxable estate, sales to existing grantor trusts would result in gain recognition, and future contributions to existing grantor trusts would cause a portion of the trust’s assets to be taxable at death. We also expect that exchanges of assets between the grantor and the trust would trigger gain recognition. The use of irrevocable grantor trusts would no longer be beneficial, as highlighted below.

Irrevocable Life Insurance Trusts – Individuals create irrevocable life insurance trusts (“ILITs”) to remove their life insurance policies and the proceeds thereof from their gross estates. However, contributions of cash to an ILIT after the effective date would cause inclusion of a portion of the insurance proceeds in the grantor’s taxable estate. Depending on the facts and circumstances of your particular situation, you may consider pre-funding premium payments this year to avoid making contributions in future years.

Grantor Retained Annuity Trusts – A grantor retained annuity trust (“GRAT”) is an irrevocable trust to which an individual contributes appreciating assets with very low gift tax and retains the right to a specified annuity payment for a fixed term of years. At the end of the term, the annuity payments end and the trust beneficiaries receive the remaining trust assets – with no additional transfer tax, the idea being that the assets will appreciate at a rate higher than the annuity. Under the proposed legislation, at the end of the GRAT, the distribution of the remaining trust assets would be considered a gift that is equal to the value of the transferred property. Further, appreciated assets that are used to make an annuity payment to the grantor would be considered a deemed sale and trigger capital gain.

Spousal Lifetime Access Trust – We discussed spousal lifetime access trusts (“SLATs”) in a prior alert (Using Spousal Lifetime Access Trusts to Lock in High Estate Tax Exemption Amounts). SLATs are grantor trusts by virtue of the fact that the grantor is creating a trust for the benefit of the grantor’s spouse. Under the new legislation, a SLAT would no longer be a viable estate planning tool as the assets would be included in the grantor’s taxable estate.

If you are interested in making a substantial gift this year in trust, we urge you to contact us as soon as possible so that we may discuss your options and, if appropriate for your circumstances, sign and fund the trust prior to enactment of the new law.