United States: New U.S. Capital Gains Tax Proposals For Gifts, Inheritances And Trusts

President Biden's American Families Plan set out a proposal for the imposition of a new capital gains tax on appreciated assets passing to family members in connection with a decedent's passing and was worded vaguely enough that the proposal might also apply to appreciated assets gifted during lifetime. The U.S. Treasury Department's recently released 'Green Book' (an explanation of the tax proposals in the Biden Administration's Fiscal Year 2022 budget) now confirms that the proposed intent is indeed to apply capital gains tax to both lifetime gifts and transfers at death and also to extended holding periods for assets in trusts, partnerships and other non-corporate entities. These new capital gains taxes would be in addition to those generally applicable under the existing gift and estate tax regime.

As for capital gains tax rates themselves, while a 20% capital gains tax rate currently applies to most capital assets, the Biden administration also is more generally proposing to increase the top income tax rate from 37% to 39.6% and tax capital gains at ordinary income tax rates for taxpayers with incomes over $1,000,000 (with existing additional 3.8% net investment income tax charge also continuing to apply).

Under the Green Book proposal, the donor of an appreciated asset generally would recognise a capital gain when a gift is made, with the amount of the gain being the then current market value of the gifted asset less the donor's historic basis in the asset. Similarly, a decedent generally would recognise a capital gain on appreciated assets at death.

Also, transfers of appreciated assets to and distributions of appreciated assets from trusts, partnerships and other non-corporate entities would generally be recognition events. Special rules would though apply for revocable grantor trusts (presumably so as to allow their use to eliminate the need to probate assets held by the these trusts on the decedent's passing). These provisions would seemingly limit future U.S. gift and estate planning opportunities for grantor retained annuity trusts ('GRATs') and so called 'intentionally defective grantor trusts', though most traditionally life insurance trust planning may not be affected.

Further, appreciated assets held by trusts, partnerships and other non-corporate entities also would generally be subject to gain recognition if that asset has not been the subject to gain recognition within the last 90 years. The testing period would start 1 January 1940 such that the first possible recognition event under this sub-provision would be 31 December 2030. Note that under this sub-provision the mere ongoing ownership of appreciated assets would be taxable at the specified time (regardless of whether the asset was distributed from the trust, partnership or other non-corporate entity owning the asset).

Appreciated assets transferred to a U.S. spouse or a qualifying charitable organization would not be subject to capital gains treatment, though the recipient would take a carryover basis in the assets. Special rules would apply for transfers to 'split interest' trusts (i.e. trusts partially for family and partially for charity) with the general intention that the value attributable to the family's share be subject to capital gains tax but the value attributable to the charitable share not be subject to capital gains tax.

A $1,000,000 per person ($2,000,000 per married couple) exclusion from recognition of unrealised capital gains on the transfer of appreciated assets would be available and would be indexed for inflation. Special rules would apply to family owned businesses with the capital gains tax generally not being due until the interest in the business is sold or the business ceases to be family owned and operated. There also would be further exclusions for gains on tangible personal property such as household furnishings and personal effects (but not collectibles) as well as the existing $250,000 per person exclusion for capital gains on personal residences.

The proposal also would allow for a 15 year fixed rate payment plan for the tax on appreciated assets transferred at death, other than liquid assets such as publicly traded financial assets and family businesses for which a deferral election is made.

The recipient's basis in assets received by reason of the decedent's death would be stepped up to the market value as of the date of the decedent's death, even where the $1,000,000 exclusion applied such that no capital gains tax was actually due. However, for appreciated assets gifted during lifetime, to the extent the donor's $1,000,000 exclusion applied, the recipient would take a carry-over basis in such assets. Once the $1,000,000 was fully utilized, gifted appreciated assets would then receive a market value basis in the recipient's hands.

These proposals would be effective for gains on assets transferred by gift and on assets owned at death by decedents dying after 31 December 2021, and on certain assets owned by trusts, partnerships and other non-corporate entities on 1 January 2022.

The full text of the Green Book is available here with the discussion of these capital gains tax proposals starting on page 62.