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.