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Democrats could thwart tactics used by the wealthy to give assets to heirs with little or no tax, part of a broader plan to raise money to expand the US safety net.
In particular, the party is considering banning some complex trust planning techniques used by wealthy Americans to avoid inheritance tax, according to a discussion list of potential tax reforms by CNBC.
Democrats in Congress can also ask the Treasury Department to update regulations to "prevent the abuse of non-economic haircuts," the list said. This concept applies, for example, to entrepreneurs who give their children a minority stake in their company at a discounted price.
The reforms are aimed primarily at multimillionaires or billionaires who use the strategies to remove assets from their estates and transfer them to heirs tax-free, according to inheritance tax experts.
"Basically, you have this basket of loopholes that can be used collectively to defeat inheritance tax on every level, even for billionaires," said Robert Lord, advisor to the progressive group Americans for Tax Fairness.
The list, a draft of ideas that lawmakers put together before formally presenting them to the House or Senate, is not very detailed. It identifies "grantor-retained annuity trusts" and "intentionally defective grantor trusts" as the trusts in question.
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Interestingly, the Democrats don't seem to be weighing up inheritance tax reforms themselves, such as a higher tax rate or a lower wealth limit that would make more estate subject to state taxes.
A federal tax rate of 40% currently applies to estates and gifts worth more than $ 11.7 million for individuals and $ 23.4 million for married couples.
This asset threshold will decrease after 2025 even if the Democrats don't touch it due to forfeiture provisions in the Tax Cut and Employment Act of 2017. (At this point, approximately $ 6 million or $ 12 million would be tax exempt – half the current value.)
Senator Bernie Sanders, I-VT, and Senate Majority Leader Chuck Schumer, D-NY, on Capitol Hill on August 9, 2021.
BRENDAN SMIALOWSKI | AFP | Getty Images
The proposed inheritance tax reforms are part of the Democrats' broader theme of raising taxes on the rich to fund climate, paid vacation, childcare and education, which can cost up to $ 3.5 trillion.
President Joe Biden said households earning less than $ 400,000 a year would not pay higher taxes.
Some of the potential inheritance tax reforms share elements of recent Democratic proposals, such as the "For the 99.5% Act," approved by several lawmakers including Senator Bernie Sanders, I-Vt.
Critics argue that the burden of some inheritance tax reforms would not only hit the rich, but would spread to others such as family farmers.
"Many Democrats like to talk about taxing the richest of the rich, but in reality their proposals would harm Main Street far more than Wall Street," said Rep. Glenn Thompson, R-Penn., Senior member of the House of Representatives' Agriculture Committee recent inheritance tax proposals.
Retirement fund with retention
As an example, consider how individuals sometimes use trusts to protect assets from taxes.
These trusts – also known as GRATs – have been used by numerous millionaires and billionaires, including the Trump family, Facebook CEO Mark Zuckerberg, the Walton family (from Wal-Mart), and former Goldman Sachs chairman Lloyd Blankfein. Casino magnate Sheldon Adelson, who died earlier this year, has reportedly used the trusts to protect billions of dollars from taxes.
According to Charlie Douglas, a certified financial planner who runs a family office in Atlanta, individuals often use the trusts to transfer assets that are expected to grow significantly in value.
Heirs typically benefit from tax-free appreciation, and the owner reduces or avoids state inheritance or gift taxes. (The concept is similar for the intentionally flawed grantor trusts and valuation haircuts mentioned above, Douglas said.)
Let's say a person puts $ 1 million of stock into a GRAT with a term of two years. The stock grows 50%, or $ 500,000, over that period. The benefit of the trust is twofold: heirs get the $ 500,000 growth tax-free and the appreciation is removed from the owner's estate, limiting or even eliminating the tax the estate owes after the owner's death. It is treated as a tax-free gift. (The owner would get the principal of $ 1 million plus a small amount of interest.)
Tax experts say gambling can also occur where owners get the value of an asset (e.g. heirs would get more tax-free wealth as a result.
The For the 99.5% Act, a guide to how Democrats might think about new rules, would restrict these trusts as an asset transfer tool.
The law would increase the length of time assets remain in the trust to at least 10 years – a potential deterrent as tax benefits are lost if the owner dies before the term expires. The increase in asset value, for example, would no longer be 100% tax-free.
However, these guidelines may not end in final democratic bill or can be changed significantly if it does.
"If someone says they know what's going to happen, they're crazy," said Douglas.