On May 28, 2021, the U.S. Treasury Department released its General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals (which is popularly called the “Green Book”). Significantly, the Green Book does not propose any changes to federal estate and gift taxes—in stark contrast to the previous Green Book that the Obama administration had released back in 2016, which had proposed vast changes to the estate and gift tax system. Rather, relevant to the taxation of gifts and transfers at death, the Biden administration’s Green Book focuses on a different type of tax that was likewise proposed in the Obama Green Book, but without generating much fanfare at the time. 

The Biden Green Book contains a proposal to increase the top marginal individual income tax rate to 39.6% (as it was before the 2017 Tax Act), effective January 1, 2022, and to tax capital gains at the same rate as ordinary income for taxpayers with adjusted gross income greater than $1 million ($500,000 for married filing separately), effectively making their capital gains tax rate, taking into account the 3.8% tax on net investment income, 43.4%. There would also be a retroactive component involved, as the Biden Green Book makes that increase effective “for gains required to be recognized after the date of announcement” (presumably April 28, 2021, when according to the White House fact sheet, the administration “announced the American Families Plan”).

Realization Events

The Biden Green Book proposal, however, goes far beyond that. Gain would be expressly recognized on transfers by gift or at death, equal to the excess of an asset’s fair market value on the date of the gift or death over the donor’s or decedent’s basis in that asset. Losses would also be recognized if basis exceeds fair market value because the Green Book refers to “the use of capital losses … from transfers at death” as an offset. The Green Book does not mention holding periods or distinguish short-term and long-term gain. The Green Book also does not specifically incorporate the alternate valuation date for transfers at death, although it does state generally that a transfer “would be valued using the methodologies used for gift or estate tax purposes.”

The deemed realization proposal would take effect on January 1, 2022.

Other Proposals in Congress

This deemed realization proposal in the Biden Green Book comes on the heels of similar proposals that have recently been advanced in Congress.  On March 29, 2021, Ways and Means Committee Member Bill Pascrell, Jr. (D-N. J.) introduced H.R. 2286, described as a bill “to amend the Internal Revenue Code of 1986 to treat property transferred by gift or at death as sold for fair market value, and for other purposes.” On the same day, Sen. Chris Van Hollen (D-Md.) addressed “the stepped-up basis loophole,” calling it “one of the biggest loopholes in the U.S. tax code, which subsidizes America’s wealthiest heirs.” He released a discussion draft titled the Sensible Taxation and Equity Promotion (STEP) Act of 2021.

H.R. 2286 would take effect on January 1, 2022, while the STEP Act purports to be retroactive and would take effect on January 1, 2021.

To complete the picture of what is currently on the table in Congress, on March 25, 2021, Sen. Bernie Sanders (D-Vt.) introduced the For the 99.5 Percent Act, which would generally be prospective in its application.  In stark contrast to the above proposals, the For the 99.5 Percent Act does not address deemed realization, but instead focuses on transfer tax concepts and calls for the following:

• estate and generation-skipping transfer (GST) tax exemptions of $3.5 million, and a gift tax exemption of $1 million, with no indexing;
• a 55% tax rate that would apply to transfers over $50 million, and a 65% tax rate that would apply to transfers over $1 billion; and
• substantial limitations on the use of certain common estate planning techniques, that would significantly curtail the ability to plan going forward with intentionally defective grantor trusts (IDGTs) and grantor retained annuity trusts (GRATs), to use valuation discounts in connection with transfers of interests in family-controlled entities, and to use Crummey powers of withdrawal on gifts to trusts.

Reporting and Deductibility

The Green Book states that the gain would be reported “on the Federal gift or estate tax return or on a separate capital gains return.” The Green Book confirms that the gain “would be taxable income to the decedent” and provides that “the tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent’s estate (if any).”

Exclusions

The Green Book contains a number of exclusions, as detailed below:

Transfers to Spouses

The Green Book would exempt “transfers by a decedent to a U.S. spouse.” There is no elaboration of the term “U.S. spouse” (for example, a citizen or resident), and there are no special provisions that address trusts established for the benefit of one’s U.S. spouse.

Transfers to Charity

The Green Book would exempt transfers to charity.  However, the Green Book provides that “the transfer of appreciated assets to a split-interest trust would generate a taxable capital gain, with an exclusion allowed for the charity’s share of the gain based on the charity’s share of the value transferred as determined for gift or estate tax purposes.”

Tangible Personal Property

Tangible personal property such as household furnishings and personal effects (excluding collectibles) would be exempt.

Residences

In addition, the Green Book confirms that the exclusion of $250,000 per person of gain from the sale or exchange of a taxpayer’s principal residence under section 121 would apply to the gain realized under this proposal with respect to all residences, and notes that this exclusion would be made “portable to the decedent’s surviving spouse.”

Small Business Stock

The Green Book also confirms that the exclusion under current law for capital gain on certain small business stock under section 1202 would apply.

General Exclusion

The Green Book proposes a single unified exclusion of capital gains for transfers both by gift and at death of $1 million per person, indexed for inflation after 2022 and “portable to the decedent’s surviving spouse under the same rules that apply to portability for estate and gift tax purposes.” The Green Book adds that this would “mak[e] the exclusion effectively $2 million per married couple,” but does not elaborate.  The Green Book also does not address whether the use of the exclusion for lifetime gifts is mandatory or elective.

To the extent that exclusion applies, the Green Book proposes to retain the current basis rules under sections 1014 and 1015.

Netting of Gains and Losses

For transfers at death, capital losses and carry-forwards would be allowed as offsets against capital gains and up to $3,000 of ordinary income, mirroring the income tax rules that currently apply.

Valuation

The Green Book contemplates that a transfer generally “would be valued using the methodologies used for gift or estate tax purposes.” The Green Book adds that “a transferred partial interest would be its proportional share of the fair market value of the entire property.” That would seem to indicate that discounts are not available. The Green Book does not indicate whether a “partial interest” is meant to be limited to undivided interests in property such as in tenancies in common, or whether it might include interests in closely held partnerships, limited liability companies, and corporations.

Special Rules for Trusts and Entities

Trusts

The Green Book provides that transfers into, and distributions in kind from, a trust would be recognition events, unless the trust is a grantor trust deemed wholly owned and revocable by “the donor.” There is no mention of “grandfathering” irrevocable trusts in existence on the date of enactment; therefore, this Green Book feature would apparently apply to distributions of appreciated assets to both current and successive or remainder beneficiaries of preexisting trusts. The deemed owner of a revocable trust would recognize gain on the unrealized appreciation in any asset distributed (unless in discharge of the deemed owner’s obligation) to anyone other than the deemed owner or the deemed owner’s “U.S. spouse,” and on the unrealized appreciation in all the assets in the trust when the deemed owner dies or the trust otherwise becomes irrevocable.

Partnerships

The Green Book’s rules about transfers into and distributions in kind from a trust also apply to a partnership or “other noncorporate entity.” The Green Book does not elaborate further.

The Green Book also states:

“Gain on unrealized appreciation also would be recognized by a trust, partnership, or other non-corporate entity that is the owner of property if that property has not been the subject of a recognition event within the prior 90 years, with such testing period beginning on January 1, 1940. The first possible recognition event for any taxpayer under this provision would thus be December 31, 2030.”

Deferral of Tax

Family Businesses

The Green Book further provides that “payment of tax on the appreciation of certain family-owned and -operated businesses would not be due until the interest in the business is sold or the business ceases to be family-owned and operated.” Providing that the payment of tax is not “due” (rather than merely providing for a section 6166–like “extension of time for payment”) seems to suggest that there might not be any interest charged.

Other Nontraded Assets

The Green Book proposal would allow “a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, other than liquid assets such as publicly traded financial assets and other than businesses for which the deferral election is made.”

Security

The IRS would be authorized to require reasonable security at any time from any person and in any form acceptable to the IRS.

Administrative Provisions

The Green Book also envisions (but without providing any details) a number of other features, such as a deduction for the full cost of related appraisals, the imposition of liens, the waiver of penalties for underpayment of estimated tax attributable to deemed realization of gains at death, a right of recovery of the tax on unrealized gains, rules to determine who selects the return to be filed, consistency in valuation for transfer and income tax purposes, and coordination of the changes to reflect that the recipient would have a basis in the property equal to the value on which the capital gains tax is computed.

Regulations

The U.S. Treasury Department would be granted authority to issue any regulations necessary or appropriate to implement the proposal, including reporting requirements that could permit reporting on the decedent’s final income tax return. The Green Book specifically provides that the regulations will include “rules and safe harbors for determining the basis of assets in cases where complete records are unavailable.” 

Kevin Matz, Esq., CPA, LLM (taxation), is a partner in the Private Clients,Trusts and Estates Department at the national law firm of Schiff Hardin LLP, based in its New York City office, where his practice is principally devoted to domestic and international estate and tax planning, family office services, estate administration and related litigation.  Kevin earned his JD from Fordham University School of Law (where he was a Notes & Articles Editor of the Fordham Law Review) and his LLM in Taxation from New York University School of Law.  He is a Fellow of the American College of Trust and Estate Counsel (“ACTEC”), in which connection he is the Chair of ACTEC’s Business Planning Committee.  Kevin is also Co-Chair of the Taxation Committee of the Trusts and Estates Law Section of the New York State Bar Association, and the Chair of the UJA-Federation of New York’s Trusts and Estates Group.  In addition, Kevin is a CPA, in which regard he is a former Treasurer and Secretary of the NYSSCPA, a former chair of its Estate Planning Committee, the current chair of the Trust and Estate Administration Committee and a past President of FAE.  Kevin also currently serves as a Vice-President of the NYSSCPA and as a trustee on the FAE Board of Trustees.  Kevin has published extensively as an author, and has helped to draft a multitude of comment letters for ACTEC, various bar associations and the NYSSCPA.  Mr. Matz may be contacted at 914-380-2140 or kmatz@schiffhardin.com.