The US House Committee on Ways and Means has proposed a raft of US tax changes intended to help fund the new administration’s grand infrastructure programme. Contained within the proposals are significant changes to some key estate planning tools that are frequently used by Americans.
The following two proposals, in particular, will require many Americans to review their estate plans urgently:
- Assets in certain grantor trusts, which were previously treated as gifts, may be included back into the grantor’s estate for US gift and estate tax purposes.
- The US lifetime gift and estate tax allowance may be reduced from currently $11.7m (£8.6m) to just over $5m. This would in effect be an acceleration of a reduction that is already due to take place on January 2026.
As with any cross-border matter, making anticipatory changes to avoid tax in one jurisdiction can result in adverse and unexpected tax consequences in another. Any US taxpayer with an actual or potential UK tax nexus should therefore proceed cautiously and take US and UK advice before acting.
Will my family’s trust be caught?
Some grantor trusts are already included in the grantor’s estate for US estate tax purposes. So-called ‘living trusts’ are commonly used to circumvent the costly and lengthy US probate process.
Although not the focus here, UK advice should be sought if living trusts have an actual or potential UK nexus (such as UK situs assets or UK resident grantors, trustees or beneficiaries). HM Revenue & Customs’ ever-hardening view of living trusts increasingly places them within the scope of the UK’s complex offshore trust tax framework.
A class of trusts very much at risk are so-called ‘defective’ grantor trusts. The assets of these trusts currently fall outside the grantor’s estate for US gift and estate tax purposes, but the grantor continues to be liable to US tax on the trust’s income and gains. In meeting this ongoing tax liability personally, the grantor frees up more trust wealth to be reinvested, allowing the trust to grow in value more rapidly.
Grantor trusts are also commonly used for holding life insurance policies; known in the industry as irrevocable life insurance trusts (ILITs). In placing the life policy in trust, the policy proceeds, on the death of the grantor, are held outside the grantor’s estate for US estate tax purposes. To fund the policy, many grantors pay the annual premium directly on behalf of the trustees.
What will happen if I do nothing?
These changes, if introduced as proposed, would have wide-ranging consequences for US estate planning. Not only will a grantor’s estate be inflated by the re-inclusion of trust assets, but the reduction to the tax allowance would further increase the exposure to US estate tax.
For estates over the allowance, US federal estate tax is levied at 40 per cent on an American’s worldwide estate (subject to any relief under, for example, the US/UK gift and estate tax treaty), and thus the ability for Americans to give away wealth tax-efficiently during their lifetimes will be diminished by these changes.
The expectation is that the changes will only affect new trusts settled on or after the effective date of the changes (possibly January 1 2022), and that trusts already in existence by that date will be ‘grandfathered’.
However, existing trusts may be brought into the new regime if funds are added to the trust after the effective date. The way grantors commonly pay the premiums on ILIT policies means that existing ILITs are therefore at particular risk of being dragged into the new regime.
What should I do now?
Existing grantor trusts: Most urgently, all grantor trusts at risk of being affected should be reviewed as soon as possible to ascertain the potential impact of the changes. Given that these changes may be introduced very soon, any reviews (and consequential amendments) should be carried out urgently. One option, to avoid re-inclusion of a defective grantor trust within the grantor’s estate, would be to convert it into a non-grantor trust.
Reduction of the tax allowance: Given the size of the proposed reduction, US taxpayers are faced with a significant ‘use it or lose it’ dilemma and may seek to use up their allowance in several ways, for example:
- They might choose simply to make outright gifts to their children (or their grandchildren, thus skipping a generation for US estate tax and UK inheritance tax purposes).
- For more substantial gifts, individuals might consider settling a new, non-grantor trust for their children and grandchildren. This may be particularly effective as this may put the assets permanently outside the scope of US estate tax and UK IHT.
Whether creating new trusts or amending existing ones, if US trusts have a UK nexus then they should also be reviewed urgently in the UK. Care must be taken though, because amending existing trusts prior to the changes may give rise to adverse UK tax consequences, for example if the grantor is now UK domiciled or deemed UK domiciled. It is thus critical that US and UK advisers work together closely to advise on any such amendments.
It should be stressed that US trusts can still be highly UK tax efficient in the right circumstances. For example, non-UK assets settled by US parents for the benefit of their now UK-resident children and grandchildren can be placed forever outside the scope of UK IHT.
That said, although US trusts can be highly efficient from a UK IHT perspective, there is a risk of double taxation for US/UK income tax and capital gains tax purposes.
Careful planning is therefore needed, if US trusts have UK resident beneficiaries, to maximise the availability of foreign tax credits and minimise double taxation. Similar care should be taken if US trusts have UK-resident trustees, which may bring a US trust unexpectedly within the scope of UK taxation.
Will anything derail these changes?
It is well known that President Biden has a tough job appeasing every faction in his party, let alone the Republican Party, and thus these proposals are always at risk of becoming political leverage. As such, we may yet see a softening of some of the more dramatic changes.
In new proposals published at the end of last month it seems that the US administration may have indeed dropped some of the more unpopular ideas previously mooted.
Only time will tell what finally makes it into law but, until that date, Americans should proceed quickly and cautiously, as the window within which to enact any planning is closing quickly.
Aidan Grant is senior associate and Daniel Simon is a senior partner at Collyer Bristow LLP
