Woes for the Wealthy – If Grantor Trusts Fall, Life Insurance Could Become Part of Taxable Estates

Woes for the Wealthy – If Grantor Trusts Fall, Life Insurance Could Become Part of Taxable Estates

It’s an issue that will touch only the wealthiest taxpayers. Yet I feel the hit; how much can they take?

New Englanders ever sympathize with sadness and loss.

The Boston Red Sox, who allured with the fragrance of Impossible Dream Season II, are out of the playoffs. The Celtics appear to have declared war on China, and without Red Auerbach at the helm, it’s hard to imagine us prevailing. Don’t get me started on the faltering Patriots. How much can a Concord boy take?

That’s as close as I come in my income bracket to empathy. Today, we return to the poison well for another odious sip: the House Ways & Means Committee’s report, “Responsibly Funding Our Priorities; Part 2 – Tax Increases for High-Income Individuals.” Oof, there’s a gut punch for our wealthier readers.

In the challenger’s corner: “Sec. 138209. Certain Tax Rules Applicable to Grantor Trusts.” Wealthy taxpayers have traditionally used grantor trusts to keep assets out of their estates, while retaining control of the trust. Under the Committee’s proposal, assets in grantor trusts created after the effective date – January 1, 2022 – would be included in the grantor’s estate.

Grantor trusts are a good vehicle to shield life insurance policies (which are commonly worth millions and can easily push an estate above the exemption limit) from inclusion in one’s taxable estate. At least, they are now, but if Congress gets past today’s red-knuckle infighting – between Democrats, if you please – and passes the proposal into law, a venerable estate planning tool will drop to the mat.

We know the story: President Joe Biden has submitted a $3.5 trillion budget to Congress, aimed at improving access to housing, education, and healthcare, repairing national infrastructure, redressing income and racial inequality, funding military expansion, supporting minority businesses, and achieving 100% national broadband coverage. There’s so much on the list, it’s unlikely one single human has read all of it.

This inexhaustible list expresses a vital and laudable, scandalous and lamentable, idealistic and partisan agenda. Business as usual in Washington, at a premium price.

I’ll give Big Joe credit: he has a plan to fund it. I hear creaking old heads shaking, but we speak here of intentions, though we know where those lead us. Here, it’s the hell of high taxes: $2.1 trillion in the Ways & Means Committee’s draft.

Most will fall on the wealthy. There’s a curious phenomenon here: even when a tax falls on someone else, it makes people uneasy. It’s the principle, the word itself – ‘taxation’. It’s like a virus, we think: it preys on one population at first, then eventually goes global.

I’ve encountered this quirk in private conversation. I’ll say, “They’re going to tax the rich,” and everyone, even the wealthy ones, chime in, “Good.” Then, there’s a wee flinch; it’s that word again – there must be a gene that makes ‘tax’ knot up our stomachs. I’m sure it’s a multilingual phenomenon.

There is a stealthier way to raise revenue without inciting this twitch: close up tax loopholes. I see a historical trend shaping up here, and I suspect it has bipartisan allure: ‘Close off those sly tax-advantageous alleyways and gain more income to govern’. Supporters will lean on civic morality to justify it, but that’s all a smokescreen; they just want the money. I predict ever-more loophole sealing in the future, no matter which party has the majority.

Back to the grail: find $2.1 trillion. Draining affluent taxpayers’ estates is today’s trendy gambit. Grantor trusts allow the grantor to park life insurance policies in trust, make payments to the trust to cover premiums, while keeping those policies out of one’s taxable estate. The trust distributes the death benefits to heirs. Neat, sweet, yet soon dead on its feet.

Estate taxes haven’t been a concern recently. The Tax Cuts and Jobs Act doubled the exemption to $10 million (doubled for spouses); inflation adjustment brings it to $11.7 million today. The TCJA was scheduled to ‘sunset’ on January 1, 2026, assuming it wasn’t extended. The House is considering an early dusk on New Year’s Day 2022, which would shrink the exemption to $5.85 million.

Individuals whose assets exceed these amounts face a stiff federal estate tax, never mind state levies, where applicable. Right now, the top rate is 40%. Democrats initially wanted to raise it, but today, it looks set to stand pat, though there’s no saying what might happen in the final minutes ahead.

If you have more than six million to share with loved ones or charity, it might be best to distribute it now, while the tax-free giving is easy; the last day of the year is your deadline.

Let’s shift to our bread-and-butter: life insurance. If life policies are no longer shieldable in grantor trusts, what can we do? Estate planners seem unsure. Some say there’s always a way and they can turn any new rules to advantage. The pessimists counter: if we cannot make contributions to the trust to fund premiums, the life policy trust strategy is dead.

Where is the optimism? I don’t see much positive; no matter how long Congress dawdles this proposal looks ready to pass. For wealthier taxpayers, there is still time to act, and you’d better: the New Year will not dawn to your advantage.

Pondering so may changes to taxation and planning, I’ve thought: ‘We’ll always have Paris’ – a time when exclusions were high, loopholes wide, and ‘sunset’ a horizon away. Yet even this thought is disquieting: France’s estate tax is 60%. As Halloween draws near us – that day of freed terrors – I’m relieved that some nightmares reside across a very wide sea.

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