A new proposal threatens tax exemptions for the donor fund


Investors who have a certain confidence, or are considering creating a credit, should be aware of the dramatic tax changes that are part of a tax proposal making its way through Congress, warned Warren Rakusen, partner in the trust and real estate practice at Lowenstein Sandler, a national law firm based in Roseland, N, J,

Donor trusts are often created to control how much income tax and estate tax the owner or heir has to pay. Rakusen said in a recent interview that the proposed changes to the Better Rebuild Act would reverse some of those tax benefits, eliminating the primary reason for creating the trust. In some cases, he said, any trust income over $12,750 can be taxed at the highest tax rate of 37%.

The bill also proposes halving the gift and estate tax exemption for each spouse, currently set at $11.7 million, effective January 1, 2022.

Since the bill has not yet been finalized, Rakusen, who is advising individuals and their families on the bill, said there is no way of knowing what it would be if it were signed into law by President Biden, but investors should consider their options now. Change tax laws to help them protect assets through estate and tax planning. The bill is currently before the Ways and Means Committee.

“There will not be a one-size-fits-all solution to tax options once the bill is enacted, but individuals and their advisors need to do a risk-benefit analysis now,” he said. “It’s like trying to build a house without a plan, but the options have to be considered.”

The changes will affect donor trusts, which are trusts in which the individual creating the trust is the owner of the assets for income and estate tax purposes. Grantor trusts, which can be revocable or non-cancellable, include life insurance funds, lifetime spouse access funds, grantor-retained annual trust funds, and grantor charitable annuity funds.

Rakusen said one of the changes could harm individuals who have established irrevocable life insurance trusts and who continue to fund premium payments or make contributions to owned insurance policies through annual gifts. He explained that a credit is being created with an insurance policy to remove it from property taxes, but the proposed bill could change the tax treatment.

The proposed change in the bill would increase the income tax imposed on contributions. Therefore, individuals who own these types of trusts will want to consider making contributions before the bill becomes law.

Additionally, if a person is considering setting up a new donor trust, he or she must complete this planning before the proposal becomes law if at all possible.

Consultants will also want to help their clients determine whether their trusts are considered separate taxpayers for IRS purposes or if the trust is considered part of the originator’s income, Rakusen said. Additionally, if the assets are sold to a trust, the advisor will need to consider whether the assets are subject to capital gains taxes.

“The proposed changes don’t just affect the wealthy,” Rakusen said. “They can hurt those who don’t consider themselves wealthy either.”

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