IRS Announces Inflation-Adjusted Amounts for 2023

By: Steven M. Cunningham Jr., Sullivan & Worcester LLP

On October 18, 2022, the IRS released Revenue Procedure 2022-38 which outlines various inflation-adjusted amounts for 2023.  This blog post highlights the provisions that trusts and estates practitioners encounter the most, namely the provisions which deal with the estate, gift and generation-skipping transfer (“GST”) taxes as well as personal and fiduciary income taxes.  Needless to say, inflation has had a noticeable impact on these amounts.

Estate, Gift and GST Taxes

  • For 2023, the federal estate and gift tax exemption for U.S. citizens and U.S. residents will be $12,920,000 per person. This is an increase of $860,000 from 2022.  The GST exemption for U.S. citizens and U.S. residents will increase to $12,920,000 as well.
    • Curiously, the federal estate and gift tax exemption for non-U.S. citizens and non-U.S. residents will remain the same ($60,000 per person).
  • The annual gift tax exclusion amount will be $17,000 per non-spouse recipient (up from $16,000 in 2022), and $175,000 per non-U.S. citizen spouse recipient (up from $164,000 in 2022).
  • Key Takeaways:
    • A U.S. citizen or U.S. resident married couple who elects to gift-split will be able to gift up to $34,000 in 2023 without having to use any gift tax exemption. Similarly, they will be able to transfer up to $25,840,000 in 2023 before having to pay any gift tax or estate tax.
    • Practitioners should continue to encourage their high net worth and ultra-high net worth clients to review and revisit gifting to make sure that they are maximizing their respective gift and GST exemptions during this high exemption / high inflation climate.

Income Tax

  • Income Tax Brackets:
    • For 2023, unmarried taxpayers whose income exceeds $578,125 (up from $539,900) will be subject to the top-level income tax rate (37%). Married taxpayers who file jointly and whose income exceeds $693,750 (up from $647,850) will be subject to this rate as well, as will estates and trusts with income of more than $14,500 (up from $13,450).
  • Standard Deduction:
    • For 2023, the standard deduction single taxpayers and married taxpayers who file separately will be $13,850 (up from $12,950 for 2022). The standard deduction for married filing jointly will be $27,700 (up from $25,900 for 2022), and for heads of households it will be $20,800 (up from $19,400 for 2022).
  • Key Takeaway: Although the amount of income estates and trusts need in order to reach the top-level income tax rate will increase from $13,450 in 2022 to $14,500 in 2023, income from estates and trusts still will reach the top-level rate at a much lower amount than will other taxpayers.
  • For that reason, trustees and their advisors should continue to consider the benefits of shifting income to beneficiaries (who, presumably, are taxed at lower income tax rates) by way of distributions outweigh the sometimes punitive effect of the compressed income tax brackets that are applicable to trusts. Similarly, trustees should continue to have conversations with their beneficiaries about whether cash needs are being met in this high-inflation climate or whether the trust needs to help supplement the higher costs of living.

Massachusetts Voters Pass “Millionaires Tax”

By: Jared A. Bishop, Rubin & Rudman LLP

Earlier this week, Massachusetts residents voted to pass an amendment to the Massachusetts constitution that has the effect of implementing the highly discussed “Millionaires Tax.”

What is the Millionaires Tax?

The Millionaires Tax is a surtax that will be assessed on taxpayers who have more than $1 million of taxable income in a tax year, as adjusted for inflation.  Prior to the passing of the Millionaires Tax, Massachusetts only imposed a 5% income tax on taxable income other than short-term capital gains (which has been taxed at 12%).

The new tax will yield an additional 4% on any amount that exceeds the $1 million threshold.

What are Proponents of the Tax Saying?

Proponents of the Millionaires Tax have argued that the amendment will ensure that the state’s wealthiest residents pay their “fair share,” and, in fact, some have referred to the amendment as the “Fair Share Amendment.”  In furtherance of this, the amendment states that the amounts generated by the new tax will be used to provide for public education and infrastructure repair and maintenance.  Thus, proponents have argued that the revenue generated by the new tax will be used to aid in popular issues, education and infrastructure.

What are Opponents of the Tax Saying?

Naturally, opponents of the amendment have argued that the wealthy already pay their fair share as the percentage of tax they previously have paid was the same as everyone else (i.e., 5%) and regardless of the amount of income.  In addition, opponents have argued that while the amendment states that the tax is to be used on education and infrastructure, the additional amount generated is subject to appropriation by the state legislature.

What is the Effective Date of the Tax?

The amendment to the Massachusetts constitution that adds the Millionaires Tax will go into effect on January 1, 2023 and will first apply to the 2023 tax year.

What Now for Practitioners?

Now that the amendment has been passed, clients may be asking whether there is any planning they can do to help reduce the burden that is imposed by the new tax.  Of course, one option always will be to move outside of Massachusetts and, no doubt, some clients may be looking for advice on that option.  Depending on a client’s lifestyle that may not be a viable option.

A second option, if applicable, is to recognize gain now before the surtax goes into effect on January 1, 2023.

A third option will be for clients to explore the use of a so-called “incomplete non-grantor trust” (commonly known as an “ING trust”).  An ING trust allows a grantor to create a trust in a jurisdiction that does not impose a state-level income tax.  If properly drafted and administered, the assets held by the trustees of the ING trust could avoid Massachusetts income tax even if the grantor is a Massachusetts resident.  However, in order to enjoy the benefits of an ING trust, there is some complexity that clients will need to undertake and accept and so it is not a one-size fits all option.

New Developments Committee of T&E Section Seeking Members

By: Aimee Bryant, Fiduciary Trust Company and Bryce Helfer, Nixon Peabody LLP.

The New Developments Committee of the Trusts and Estates Section is seeking new members! If you are interested in getting more involved with the BBA or pursuing writing or speaking opportunities, please reach out to the committee chairs, Maggie Lopez of ArentFox Schiff at maggie.lopez@afslaw.com, and Keirsa Johnson, of Hemenway & Barnes, at kjohnson@hembar.com.

Upcoming Trusts & Estates Events at the BBA – November 2022

By: Bryce Helfer, Nixon Peabody and Aimee F. Bryant, Fiduciary Trust Company, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

 

BBA Webinar: Fiscal Sponsorship: A Dynamic Tool for a Rapidly Evolving Nonprofit

November 10, 2022 2:00 pm – 3:30 pm | Zoom

The nonprofit sector is impactful especially in Massachusetts, yet extremely fragmented and fragile.  Small organizations lack the resources to maintain their own back offices to manage risk, ensure compliance, report to funders and the government and, most importantly, support the people delivering on programs and mission. By developing and sharing nonprofit infrastructure and assuming fiduciary responsibility, fiscal sponsorship can address these problems. This 90-minute program will cover the legal fundamentals of the different models of fiscal sponsorship, industry trends, dos and don’ts, and offer pointers when advising clients considering these types of relationships.  Josh Sattely, Co-founder and Chief Legal Steward of Social Impact Commons, will lead the presentation and conversation.  Social Impact Commons works with nonprofits, funders, and service providers nationwide to help build healthier fiscal sponsorship practices.  Josh was previously Legal Counsel at Third Sector New England.

 

IRS PROPOSES ANTI-ABUSE EXCEPTION TO ANTI-CLAWBACK REGULATIONS

By: Megan C. (Neal) Knox, McDonald & Kanyuk, PLLC

In April 2022, the IRS issued a proposed regulation (REG-118913-21) that would provide an exception to the anti-clawback regulations that were adopted in November 2019.  The proposed regulation would except from the anti-clawback rules “transfers includible in the gross estate, or treated as includible in the gross estate for purposes of section 2001(b).” 

  1. Background – The Anti-Clawback Rule.

Under the Tax Cuts and Jobs Act (“TCJA”), beginning on January 1, 2018, the basic exclusion amounts (“BEA”) for gift and estate tax purposes temporarily increased from $5 million (indexed for inflation) to $10 million (indexed for inflation).  On January 1, 2026, the BEA will automatically decrease to $5 million (indexed for inflation). 

As a result of the TCJA, practitioners were concerned that a portion of a donor’s gifts made after January 1, 2018 and before to January 1, 2026 might be “clawed” back into such donor’s estate at death if he or she died after January 1, 2026, thereby denying the donor of the full benefit of the higher BEA amount on the previous gifts.  In November of 2019, the IRS adopted “anti-clawback regulations” that allow a decedent’s estate to calculate its estate tax credit using the higher of the BEA applied to lifetime gifts or the BEA applicable at death. See Treas. Reg. §20.2010-1(c).   

In the preamble to the anti-clawback regulations, the IRS foresaw certain potential abuses of these regulations.  For certain inter-vivos transfers made during the increased BEA period that are included in the decedent’s estate after the BEA has decreased, the anti-clawback regulations actually produce a “bonus” because in calculating the estate tax for these types of transfers, the gift is excluded from “adjusted taxable gifts” on line 4 of the estate tax return.  The IRS declined to address these potential abuses in the anti-clawback regulations, opting instead to reserve them for further consideration after proper notice and commenting.

  1. The Proposed “Anti-Abuse” Exception.

In part to prevent the abuse foretold in the preamble of the anti-clawback regulations, the proposed regulation would add a new subparagraph (3) to Treas. Reg. §20.2010-1(c), excepting “transfers includible in the gross estate, or treated as includible in the gross estate for purposes of Code §2001(b)” from the anti-clawback regulations.  The proposed regulation specifically lists (without limitation) four specific categories of transfers that are excepted from the anti-clawback regulations.  The four non-exhaustive categories of transfers that fall within the anti-abuse exception are as follows:

  1. Transfers included in the gross estate under Code §§2035 – 2038 and §2042 regardless of whether all or any part of the transfer was deductible under Code §2522 (charitable deduction) or Code §2523 (marital deduction);
  2. Transfers made by enforceable promise to the extent they remain unsatisfied as of the date of the decedent’s of death;
  3. Transfers described in Treas. Reg. §§25.2701-5(a)(4) or 2.2702-6(a)(1), i.e., certain applicable retained interests in corporations or partnerships (Code §2701) or trusts (Code §2702); and
  4. Transfers that would have been described in Paragraphs 1 – 3 above “but for the transfer, relinquishment, or elimination of an interest, power or property, effectuated within 18 months of the date of the decedent’s death by the decedent alone, by the decedent in conjunction with any other person or by any other person…. [unless] effectuated by the termination of the durational period described in the original instrument of transfer by either the mere passage of time or the death of any person.”

However, the anti-clawback regulations will continue to apply to transfers includible in the gross estate when the taxable amount of the gift is not material, i.e., when the taxable amount is 5 percent or less of the total amount of the transfer. 

The proposed regulation would apply only to estates of decedents dying on or after April 27, 2022 but would apply even if the gift subject to the anti-abuse exception to the anti-clawback rules was made before April 27, 2022.  This regulation is a proposed regulation and is subject to change.  Proposed regulations are not binding.  They carry no more weight in court than a position advanced in a brief.

Upcoming Trusts & Estates Events at the BBA – May 2022

By: Bryce Helfer, Nixon Peabody and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

Planning With Nongrantor Trusts. Monday, May 16, 2022, 12:00 PM to 2:00 PM. Industry expert and ACTEC Fellow Jere Doyle will walk attendees through the basics of nongrantor trusts, which are anything but basic.  Discussion will cover federal and state income tax considerations, planning for qualified small business stock, special deductions available to trusts, charitable deductions, capital gains and DNI, bequests, expenses and other rules unique to nongrantor trusts.

 

IRS Issues Proposed SECURE Act Regulations

By: Patricia E. Malley, Burns & Levinson LLP

In late February 2022, the IRS released proposed regulations under the SECURE Act which has proven to be one of the most significant pieces of retirement benefits legislation in recent years.  The proposed regulations (which consist of 275 pages) address how the required minimum distribution (“RMD”) rules will work for defined contribution plans (i.e. IRAs, 401(k)s and 403(b)s) and their owners, plan participants and beneficiaries.

This blog post will highlight some of the key clarifications addressed by the proposed regulations.

Clarification Regarding Birthdate

The SECURE Act raised the age for which retirees must start to withdraw money from applicable retirement plans from age 70 ½ to 72.  Thus, under the Act, where an individual reached the age of 70 ½ in 2019, they were required to take their RMD by April 1, 2020.  However, if an individual reached age 70 ½ in 2020 or later, they would be required to take their RMD by April 1 of the year after reaching age 72.

Practitioners raised concerns over how this change in the required beginning date would impact surviving spouses who were named as the sole beneficiary of an employee’s retirement account.  Previously, the law allowed a spouse to delay distributions if the deceased employee was not receiving RMDs during lifetime until such time as the deceased employee would have been required to receive such RMD (i.e. at age 70 ½).  The concern raised was whether the change would mean that spouses who had previously inherited their interest in a deceased employee’s retirement account prior to the effective date of the SECURE Act might still be required to receive distributions based on the 70 ½ age rule.  The proposed regulations clarify that surviving spouses may delay distributions until the end of the calendar year in which the employee would have attained age 72.  Similarly, a spouse who has elected to roll over a retirement account into his or her own name may delay distributions until the surviving spouse reaches their own required beginning date.

Clarification Regarding 10-Year Rule

A key component of the SECURE Act was its elimination of the ability of beneficiaries other than a spouse or other so-called “eligible designated beneficiary” (“EDB”) [1] to “stretch” distributions over their life expectancies.  Now, under the SECURE Act, distributions to non-spouse and non-EDB individuals must be completed within 10 years following the death of a plan participant or IRA owner (distributions to spouse or EDB beneficiaries may be stretched over their life expectancies).

When the SECURE Act was enacted, there was some confusion over the 10-year period particularly the timing of when distributions were required to be made from the account to the beneficiaries.  As drafted, the proposed regulations clarify that if an account owner dies before his or her required beginning date (typically April 1st of the year after his or her 72nd birthday), the 10-year rule requires that the account be distributed by December 31st of the tenth year following the year of death.  However, if an account owner dies after his or her required beginning date, the 10-year rule applies and the beneficiary must take annual RMDs in years one through nine.

Clarification Regarding Age of Majority

 When enacted, the SECURE Act failed to define the age of majority for a child named as a beneficiary of an employee’s retirement plan. 

As drafted, the proposed regulations clarify that a child of an employee will be considered to be above the age of majority on his or her 21st birthday and therefore will no longer be considered an EDB unless he or she is disabled.[2]  While this age is somewhat inconsistent with what is considered the age of majority in most states (and, to a certain extent, what practitioners thought would be the applicable age for purposes of determining whether a child would be considered an EDB excepted from the 10-year rule above) it is worth noting that it is consistent with what is considered the age of majority in the gift tax context.

Clarification Regarding Definition of Disability

Currently, the SECURE Act relies on the Internal Revenue Code definition of disability (provided under section 72(m)(7) of the IRC) which provides a standard of disability based on whether an individual is unable to engage in “substantial gainful activity.”  However, this standard can be difficult to apply particularly when the individual in question is under the age of 18.  Thus, the proposed regulations provide rules for determining whether an individual who is under the age of 18 is disabled for purposes of being considered an EDB.  In addition, the proposed regulations impose a new documentation requirement for chronically ill and disabled beneficiaries.

Additionally, the proposed regulations provide a safe harbor for determining whether a beneficiary is disabled.  If, as of the date of the employee’s death, an individual has been determined to be disabled within the meaning of 42 U.S.C. 1382c(a)(3), then that individual will be considered disabled for purposes of being considered an EDB.

(Additional) Clarification regarding Trusts as Beneficiaries

It is worth noting that the proposed regulations continue to maintain the concept of a see-through trust whereby certain beneficiaries are treated as direct beneficiaries of an employee if the trust meets the see-through trust requirements.  Although consistent with the examples that are in the current regulations, the proposed regulations provide additional fact patterns that are intended to address issues raised in private letter rulings particularly where a trust has EDB and non-EDB beneficiaries.

Applicability

The proposed regulations will apply for purposes of determining RMDs and for distributions on or after January 1, 2022.  For 2021 individuals must continue to apply the current regulations but take into account a reasonable and good faith interpretation of the SECURE Act amendments, which compliance with the proposed regulations will satisfy.

Comments

As a reminder the regulations discussed above are proposed regulations and therefore are subject to change as a result of comments submitted by the public.

Members of the public who wish to submit comments on the proposed regulations will have until May 25, 2022 to submit written or electronic comments.

Commenters are encouraged to submit public comments electronically via the Federal eRulemaking Portal at www.regulations.gov however paper submissions may be sent to: CC:PA:LPD:PR (REG-105954-20), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.  A public hearing is scheduled for June 15, 2022

[1] For purposes of the SECURE Act, EDBs are defined as: (i) the employee’s surviving spouse; (ii) the employee’s child who is under the age of majority; (iii) a disabled individual; (iv) a chronically ill individual; or (v) an individual no more than 10 years younger than the employee.

[2] Please note that the proposed regulations do appear to allow defined benefit plans that have used the prior definition of age of majority to retain that plan provision, thus, grandfathering their definition of “age of majority”.  Therefore, some care will need to be exercised when a minor child becomes the beneficiary of an owner’s retirement account.

Upcoming Trusts & Estates Events at the BBA – March 2022

By: Bryce Helfer, Nixon Peabody and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

BBA Webinar: Turning 18 – Guardianship, Benefits and Housing for Young Adults with Special Needs. Tuesday, March 15, 2022, 12:00 PM to 1:00 PM.  For children with special needs, turning 18 is a major turning point. Now that the child is no longer a child, the parent or other caregiver will need to address changes in available benefits, needs, as well as their ability to make medical and financial decisions on behalf of the disabled person who is now a legal adult.  Join our panelists as they discuss three of the major planning points: government benefits, housing and guardianship. Attendees will also receive a “Turning 18” checklist specifically drafted for special needs families.

BBA Webinar: The Delaware Advantage for Personal Trusts Monday, March 28, 2022, 10:00 AM to 11:00 AM. Delaware is generally renowned for its trust and tax law advantages and its innovative estate planning vehicles. Further, it is regarded as one of the best places for trust administration. Even if your clients do not live in Delaware, there are reasons to consider establishing a trust in Delaware or moving an existing trust to Delaware. Delaware has over 100 years of established trust law and Wilmington Trust is one of the firms that has helped to develop these laws. Jeff Wolken, Wilmington Trust’s national expert in Delaware trust planning, along with Kerry Reeves, will go over everything you ever wanted to know about Delaware trusts.

 

The Massachusetts Estate Tax, the Governor’s Proposal, and Out-of-State Real and Tangible Personal Property

By: Paul M. Cathcart, Jr., Hemenway & Barnes LLP

The Massachusetts Estate Tax, the Governor’s Proposal, and Out-of-State Real and Tangible Personal Property

In late January 2022, the Baker-Polito Administration filed a “comprehensive tax proposal” which would make several changes to the Massachusetts estate tax, including by increasing the Massachusetts exemption amount; eliminating the so-called “cliff effect” of the Massachusetts estate tax; and modifying the method for taking into account a resident decedent’s out-of-state real and tangible personal property when computing Massachusetts estate tax.[i]  House Bill 4361, 192nd Gen. Ct. §§ 11–12 (filed Jan. 26, 2022).  The first two proposed changes have been publicized and covered elsewhere, whereas the third proposed change has not been and is discussed in this post.

The Massachusetts estate tax is computed based on a decedent’s federal taxable estate, see G.L. c. 65C, § 2A; former I.R.C. § 2011, which in the case of a Massachusetts resident decedent may include value attributable to real or tangible personal property located in states other than Massachusetts.  If those other states also tax the decedent’s estate, Massachusetts allows a credit for taxes paid.  If they do not, the Massachusetts statute purports to subject the out-of-state property to tax in the same manner as the decedent’s other (in-state) property.

Since at least 2016, executors of the estates of Massachusetts resident decedents have been well-advised to consider deviating from what the statute purports to require.  That year, the Middlesex Probate and Family Court held that a resident decedent’s interest in a foreign entity that held foreign real property was an interest in foreign real property and, consequently, not subject to Massachusetts estate tax.  Dassori v. Commissioner of Revenue, Docket No. MI14E0042QC (June 30, 2016).  In that case, the taxpayer argued that the United States Constitution prohibited Massachusetts from taxing out-of-state real property, and the Commissioner of the Massachusetts Department of Revenue did not dispute that argument.  Eric T. Berkman, Estate Tax Application Ruled Unconstitutional, Mass. Law. Wkly., Aug. 29, 2016 (quoting counsel for the taxpayer).  So, although the court did not hold that out-of-state real property is not subject to Massachusetts estate tax, the case further popularized this proposition.

Consistent with Dassori, at least some executors have been advised to report a value of $0 for real and tangible personal property located outside of the Commonwealth.  Compared to reporting at fair market value, this generally has the effect of reducing Massachusetts tax at the highest marginal rate that would otherwise apply.

The Administration’s proposal calls for a resident decedent’s Massachusetts estate tax instead to be reduced in proportion to the value of the decedent’s out-of-state real and tangible personal property (whether or not any other jurisdiction subjects that property to tax).[ii]  Compared to reporting such property at fair market value, this would have the effect of reducing Massachusetts tax at the average rate to which the decedent’s estate is otherwise subject.  Depending on how an executor of a Massachusetts resident decedent previously has reported out-of-state real and tangible personal property, this could result in more Massachusetts estate tax being reported than under current practice (because that average rate is lower than the highest otherwise-applicable marginal rate), or less if the executor has been reporting in accordance with the current statute notwithstanding the Dassori argument.

If adopted, the proposal may be subject to challenge.  However, the proposal appears to be on at least more solid constitutional footing than the current statute.  See generally Jerome R. Hellerstein et al., State Taxation ¶ 21.10 (3d ed. 2001 with updates through January 2022, online version accessed on Checkpoint).

[i] Another lesser-known quirk would also be eliminated:  The exemption would no longer be reduced by lifetime taxable gifts.

[ii] This mirrors how Massachusetts taxes nonresident decedents on their in-state real and tangible personal property.

Upcoming Trusts & Estates Events at the BBA – February 2022

By: Bryce Helfer, Nixon Peabody and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

BBA Webinar: “Fixing” Irrevocable Trusts: Decanting, Non-Judicial Settlement Agreements, and Other Tools.  Thursday, February 10, 2022 12:00 PM to 1:00 PM.  This program will provide an introduction to various methods for changing the course of an existing Massachusetts irrevocable trust, including how and when to consider: (1) modification, (2) reformation, (3) decanting, and (4) a non-judicial settlement agreement.

BBA Webinar: The Messy Intersection of Divorce and Trust Law – Everything but PfannenstiehlTuesday, February 15, 2022 12:00 PM to 1:00 PM.  Panelists will discuss various estate and trust related issues that might arise during divorce proceedings, including conflicts between the terms of marital/divorce agreements and estate planning documents as well as the rights of non-parties in divorce proceedings when trust interests are implicated.