By Steven J. Oshins, Esq., AEP (Distinguished)

At the time of the writing of this article, the proposed Build Back Better Act includes an income tax surtax of 5% on taxable income (actually Modified Adjustable Gross Income) above $10 million and an 8% surtax on taxable income above $25 million.

However, the current language applies the same 5% surtax to taxable income above $200,000 of taxable income and the same 8% surtax to taxable income above $500,000 in a non-grantor trust regardless of the wealth or taxable income of its beneficiaries. This includes a simple trust for the benefit of a person’s children who may be in very low tax brackets.

Therefore, the proposed Build Back Better Act, as currently drafted, sets the taxable income level for an individual at exactly 50 times that of a non-grantor trust! Clearly, something is wrong with this difference.

POLICY REASONS

The policy behind this is that if non-grantor trusts have lower tax brackets than high earners, then those high earners will shelter taxable income using the trust’s lower tax bracket.

This must be weighed against the adverse effects that it has on trust beneficiaries, most of whom are in low tax brackets. The draftsman of this language in the proposed legislation have chosen to tax the wealthy over protecting the less wealthy, thereby potentially harming people’s children and other intended trust beneficiaries who would be better off having the trust income accumulated for their benefit.

Certainly, it would be fruitful to find a different statutory definition to assess such a large surtax so as not to unfairly affect the less wealthy who should be taxed at a lower rate.

THE DOMINO EFFECT

If Build Back Better Act passes with this language included, it will affect a trustee’s decisions about how much to distribute to the beneficiaries.

What if the beneficiaries are young or otherwise financially irresponsible? The trustee will have to decide whether the beneficiaries’ lower tax brackets offset the risk of giving them too much, thereby causing them to lose their incentive to be productive and simply live as trust fund babies.

If the tax savings is great enough, we may start seeing large distributions made to beneficiaries who agree to immediately transfer most of the distributed funds to an irrevocable trust that such recipient does not control. This might be an acceptable middle ground.

What if the beneficiaries are being sued or going through divorces or going through bankruptcy? Wasn’t one of the primary objectives of giving them assets in trust to protect those assets from these problems?

What about a special needs beneficiary? Should the trustee use the special needs beneficiary’s tax bracket and lose government assistance for that beneficiary?

DEALING WITH THE TRUST SURTAXES

If this passes, we will likely see more trustees buying life insurance, investing in tax-free bonds, investing in low dividend paying stocks and exchange traded funds, and buying assets where there is a depreciation deduction to offset taxable income.

We will also see trustees borrowing on margin rather than selling capital assets.

Estate planning and financial planning advisors will be monitoring the upcoming Presidential and Congressional odds carefully in order to anticipate when the Republicans will regain control and likely change the trust tax brackets back to more normal levels of taxation.

CONCLUSION

It is this author’s opinion that the members of Congress should give this proposal more thought and arrive at a more workable solution that doesn’t harm trust beneficiaries, but yet fulfills the policy reasons for doing it.

This might include reducing the surtax to rates in the 1% or 2% or 3% range where it’s tolerable. It might also include increasing the amount of Modified Adjustable Gross Income to much higher numbers, such as in the millions of dollars. It might also include a definition that bases a trust’s income tax rate surtax on the taxable income of the settlor of the trust.

RELATED EDUCATION

If you found this article interesting, you might also be interested in these other educational programs and products by Steve Oshins:

• The Spousal Lifetime Access Trust: A Gifting and Creditor Protection Technique
• Estate Planning Techniques in a Time of Low Interest Rates
• The Installment Sale to an Intentionally Defective Grantor Trust
• The Grantor Retained Annuity Trust: Significant Estate Tax Savings with Nearly Zero Gift Tax Risk
• Steve’s FREE State Rankings Charts

ABOUT THE AUTHOR

Steven J. Oshins, Esq., AEP (Distinguished)  is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011.  He has been named one of the 24 “Elite Estate Planning Attorneys” and the “Top Estate Planning Attorney of 2018” by The Wealth Advisor and one of the Top 100 Attorneys in Worth. He is listed in The Best Lawyers in America® which also named him Las Vegas Trusts and Estates/Tax Law Lawyer of the Year in 2012, 2015, 2016, 2018, 2020 and 2022.  He can be reached at 702-341-6000, ext. 2, at soshins@oshins.com or at his firm’s website, www.oshins.com.