Closing Gaps in the Estate and Gift Tax Base

14 Pages Posted: 16 Aug 2021 Last revised: 24 Nov 2021

See all articles by Daniel J. Hemel

Daniel J. Hemel

University of Chicago - Law School

Robert Lord

Americans for Tax Fairness

Date Written: August 13, 2021

Abstract

Three transfer tax minimization mechanisms—zeroed-out grantor retained annuity trusts (GRATs), intentionally defective grantor trusts (IDGTs), and family-controlled entities with steep valuation discounts—significantly shrink the federal estate and gift tax base. This white paper explains how Congress can close all three loopholes. We estimate that these actions—along with complementary base-protecting and base-expanding proposals—would raise more than $65 billion over the fiscal year 2022 to fiscal year 2031 window (and possibly much more than $65 billion). They also would enhance the progressivity of the federal tax system and bolster the long-term revenue-raising capacity of the estate and gift taxes.

To summarize key conclusions:

— Congress should repeal section 2702(b)(1), the provision that enables high-net-worth individuals to achieve extraordinary transfer tax savings via GRATs;

— Congress should harmonize the income tax and transfer tax treatment of IDGTs,
preferably by treating these trusts as nongrantor trusts for income tax purposes;

— Congress should limit lack-of-marketability discounts and eliminate lack-of-control discounts with respect to transfers of interests in family-controlled entities; and

— Congress should supplement these three reforms with additional base-protecting and base-broadening measures: shifting to a tax-inclusive base for gift taxes; limiting the gift tax annual exclusion for transfers in trust; and expanding the requirement of consistency in value for transfer and income tax purposes.

All of these steps remain relevant—and in some respects, even more urgent—if Congress enacts the Biden-Harris administration’s capital income tax reform proposal, which would limit the tax-free step-up in basis at death to the first $1 million of unrealized gains ($2 million per couple). Unless Congress secures the estate and gift tax base, high-net-worth taxpayers will respond to stepped-up basis reform by exploiting transfer-tax loopholes even more aggressively. For this reason, estate and gift tax loophole closers and stepped-up basis reform should be considered complements, not substitutes.

Keywords: estate tax, gift tax, grantor-retained annuity trusts, grantor trusts, tax reform

JEL Classification: K34

Suggested Citation

Hemel, Daniel J. and Lord, Robert, Closing Gaps in the Estate and Gift Tax Base (August 13, 2021). University of Chicago Coase-Sandor Institute for Law & Economics Research Paper No. 937, Available at SSRN: https://ssrn.com/abstract=3904454 or http://dx.doi.org/10.2139/ssrn.3904454

Daniel J. Hemel (Contact Author)

University of Chicago - Law School ( email )

1111 E. 60th St.
Chicago, IL 60637
United States

Robert Lord

Americans for Tax Fairness ( email )

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