How Will New Congress Impact Tax and Estate Planning Strategies?

With the looming elections, tax planners have taken time to consider what the future of Estate and Gift Tax planning might be under the new Congress.[1] Every new Congress considers changes to the Internal Revenue Code of 1986, as amended (the “Code”), and the Treasury Regulations, which they will either propose or endorse. In general though, wealthy Americans — and not just billionaires — should expect their taxes to rise in the next four years. Current economic woes resulting from an inflationary period are only compounded by the coming sunset of key provisions of the Tax Cuts and Jobs Act (“TCJA”), particularly the TCJA’s expanded Estate and Gift Tax exclusion. With those factors in mind, a particular tool for estate planners is in jeopardy: devaluation of assets through diffusion of ownership.

In order to minimize Estate and Gift Tax exposure, a common technique has been to diffuse ownership in certain assets, particularly closely-held family-run companies and real estate, in order to lower their assessed value. This stems from the idea that, if an asset has restrictions on its sale and control due to diffused ownership, it is less valuable to a prospective buyer than an asset which the seller owns outright and maintains absolute control over (such as rental property or a business). Often, this planning tool is accomplished through use of a family limited partnership (“FLP”); the owner of the assets contributes the assets to the FLP and then proceeds to grant limited partnership interests to family members. Because the recipients of such gifts have diminished control (or no control) over the underlying assets, the value of the gifted FLP interest is likely to be appraised lower. For example, if a parent transfers by deed a 1/4 interest in a rental property worth $400,000 to each of their three children, each child has received a gift of $100,000. If instead, the parent contributes the rental property to an FLP, then transfers by assignment a 1/4 limited partner interest in the FLP to each of the three children, then an expert could determine that the gift to each child was worth $80,000 (due to the lack of control and minority interest in the FLP).

However, the Treasury’s proposals in its “General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals”[2] (the “Greenbook”) identify changes to valuation and attribution rules which could be quite damaging to this tax mitigation strategy. The Greenbook has consistently over the last decade identified provisions that are frequently relied upon for wealth preservation and wealth transfer. The proposals include modifying attribution rules for families who hold interests in certain assets to treat them as though held by a single person. “While valuation discounts for lack of marketability and lack of control are factors properly considered in determining the [fair market value (“FMV”)] of such interests in general, they are not appropriate when families are acting in concert to maximize their economic benefits.”[3].

In effect, the proposed rule would:

[P]rovide that the value of a partial interest in non-publicly traded property (real or personal, tangible or intangible) transferred to or for the benefit of a family member of the transferor would be the interest’s pro-rata share of the collective FMV of all interests in that property held by the transferor and the transferor’s family members, with that collective FMV being determined as if held by a sole individual. Family members for this purpose would include the transferor, the transferor’s ancestors and descendants, and the spouse of each described individual.[4]

In addition to expanding attribution for purposes of valuation to include interests transferred to parents, grandparents, children, grandchildren, and the spouses of each, the rule also provides certain qualifications, including that passive assets will be segregated and valued separately from a trade or business, and that the rule would apply “only to intrafamily transfers of partial interests in property in which the family collectively has an interest of at least 25 percent of the whole.”

In effect, this would diminish the ability of taxpayers to use this devaluation strategy, which when coupled with the expected decrease in the Estate and Gift Tax exclusion after the TCJA sunsets at the end of 2025, will make it much harder for taxpayers to pass on partial interests in businesses to their heirs while minimizing their Estate and Gift Tax exposure.

Though there have been several attempts to legislate into existence the proposals contained in the Greenbook in the last 12 years, the political will has always faltered. With the current economic atmosphere, however, it is reasonable to expect the beneficial TCJA provisions will not be extended and the detrimental Greenbook proposals will be promulgated. Although the IRS has stated that those making larger gifts while the TCJA’s Estate and Gift Tax exclusion is still available will not be adversely impacted after the exclusion drops back down to pre-TCJA levels in 2026,[5] these two combined factors nonetheless present a worrying decrease in the ability of American families to plan the effective transfer of assets to their heirs. However, given the timetables involved, 2025 may represent a window of opportunity, though a rapidly closing one, during which to take advantage of the greater TCJA Estate and Gift Tax exclusion before it sunsets, even if efforts to devalue transferred assets may be restricted.

There will still be tax planning opportunities that can enable taxpayers in specific industries, and with specific asset holdings, to achieve a similar tax effect through a combination of business and estate tax planning, even after TCJA provisions sunset; however, the cost of effectuating such tax strategies can be many times more costly and administratively burdensome than the planning opportunities currently available.

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[1] Harris’s “A New Way Forward For The Middle Class” proposal (hereinafter “Harris Way”) is vague in its references to the much touted policies which are aimed at increasing taxes for billionaires, and does not expressly reference the so-called “Billionaire Minimum Income Tax Act” introduced to Congress last year. For more information on Harris Way, see A New Way Forward For The Middle Class, available at https://kamalaharris.com/wp-content/uploads/2024/09/Policy-Book-Economic-Opportunity.pdf.For more information onf the Billionaire Minimum Income Tax Act, see H.R.6498 — 118th Congress (2023-2024).

[2] Greenbook, p. 136. This includes removing Code § 2704(b) and replacing it with the proposed rule.

[3] Greenbook, p. 135.

[4] Greenbook, p. 136.

[5] IRS, Estate and Gift Tax FAQs, https://www.irs.gov/newsroom/estate-and-gift-tax-faqs (last updated September 13, 2024).