STEP Act Deep Dive and the For The 99.5% Act

We reviewed the STEP Act last week and Chris Hesse and I just did an Ag Insights video on how this Act may affect your farm operation (CLICK TO WATCH THE VIDEO).

We discussed the STEP Act as an income recognition event on the transfer of assets, whether by gift, upon death, or transfer to trust. It is separate from the estate tax.

Later last week, Senator Bernie Sanders proposed the “For The 99.5% Act”.  This Act would make major changes to estate taxes and would affect many farm families, however more farm families would be affected by the STEP Act (the income recognition on transfer).  

First, the Act proposes reducing the lifetime exemption amount to $3.5 million effective January 1, 2022.  The estate tax rate would become progressive as follows:

• 45% for estates between $3.5 and $10 million,
• 50% for estates between $10 and $50 million,
• 55% for estates between $50 million and $1 billion, and
• 65% for estates over $1 billion.

The exemption would be indexed to inflation.

Instead of having a unified gift and estate tax, the lifetime gift tax exemption would be $1 million, non-indexed to inflation.

Farmers would be able to use special use valuation rules to reduce up to $3 million of value in farm property for the estate tax, however, our reading of the STEP Act would still make this $3 million exemption subject to a transfer tax (less any exemption not used on other assets).

Dynasty trusts ability to postpone estate taxes for multiple generations would be eliminated.  These trusts would essentially owe estate taxes every 50 years.  Remember that the STEP Act has a transfer tax every 21 years.  This extra estate tax would be in addition to that transfer tax.

Grantor Retained Annuity Trusts (GRATs) would lose their appeal.  It would require a minimum 10-year term and the remainder interest must have a minimum value of at least $500,000 or 25% of the FMV of the trust property, whichever is greater.

The appeal of using an intentionally defective grantor trust would be gone.  Contributions to those trusts move assets out of your estate, yet the income of the trust continues to be reported on your return.  The tax that you pay on this income reduces your estate, but under current law, it is not considered a gift.  This Act would eliminate that benefit.

Section 10 of the Act is titled “Simplifying Gift Tax Exclusion for Annual Gifts”.  Anytime politicians use the word “simple”, it means your tax is going up.  This Act allows you to gift $10,000 per year to individuals but caps the total at $20,000 per year.  This limit applies to (1) transfers to a trust, (2) transfers of any pass-through entity, (3) a transfer of an interest subject to prohibitions on sale, and (4) any other transfer that cannot immediately be liquidated by the donee.  This essentially eliminates trusts with Crummy provisions for transfers of these assets.  Gifts of cash and other assets would still be under the current annual exclusion ($15,000 per donee and no cap in 2021).

Finally, valuations rules will tighten.  Any passive or investment type assets held in a pass-through entity will now be valued at 100%.  Entities that hold at least a 10% interest in another entity will value that interest without discounts.  Minority and lack of marketability discounts will be severely curtailed or eliminated for any family owned entities.

Our ability to place farmland into LLCs and take a 35% discount will be gone.  Closely held farm operations will now be valued at full fair market value, however, they may continue to still be valued using some type of earnings capitalization versus raw land value so there may still be a benefit from placing it into an LLC.

Most of Sen. Sanders’ Act simply shows how much extra tax would be owed by wealthy people at their death.  For example, Warren Buffet is listed with a net worth of $96.5 billion and Sen. Sanders indicates that his heirs would pay an extra $24 billion of estate tax under his Act.  However, Mr. Buffett has already indicated his net worth is going into a Private Foundation which will likely mean that no extra estate tax will be paid and in fact, no estate tax will be owed.  Unless rules are changed to prevent a deduction for transfers to private foundations or other charitable entities, wealthy taxpayers will continue to escape this extra tax.

However, farmers with estates in the $10 to $25 million range likely will end up paying substantially more if this Act is passed.  Again, this Act will not pass as is, but caution is warranted.  We have already seen that Senator Manchin of West Virginia is opposed to some of the corporate tax increases but is willing to allow taxes on “wealthy” individuals to increase.  This Act may appeal to him.