The STEP Act and What it Might Mean to You

Senators Chris Van Hollen, Cory Booker, Bernie Sanders, Sheldon Whitehouse and Elizabeth Warren introduced the Sensible Taxation and Equity Promotion (STEP) Act yesterday.  Here is a quick synopsis of the proposal.

A Section by Section explanation is here and the actual bill language is located here.

The Act proposes to tax any transfer of property either during lifetime or at death that has a net gain associated with the transfer.  At death, there is an exclusion of the first $1 million of gain.  However, during lifetime any completed transfer to a trust or to any individual other than a spouse will allow for the first $100,000 of cumulative gain to be tax-free.  After that amount, any excess will be subject to a transfer tax.

We are calling this a transfer tax since the tax will be due on a transfer of property.  This includes transfers to trusts that would not be included in the transferor’s estate, including an intentionally defective grantor trust.  These trusts have been very popular since you can transfer your assets out of your estate yet owe no income tax if you sell the assets to the trust.  This Act would eliminate the ability to use these trusts. Transfers to a revocable trust (including a living trust) would not be subject to this transfer tax.

Additionally, all non-grantor trusts would have to report gain on all of their appreciated assets every 21 years.  Any trust formed before 2005 would automatically report this gain in 2026.  Trusts with more than $1 million of assets or more than $20,000 of gross income would now be required to provide a balance sheet, income statement, and list all trustees, grantors, and beneficiaries to the IRS. This will be a boon for valuation businesses, but the senators would allow an itemized deduction for the valuation costs.

Items transferred to charity, spouses, charitable trusts, qualified disability trusts and cemetery trusts are exempt from the tax.  Gains on a personal residence would be exempt up to $250,000 or $500,000 for a married couple.

Transfers of illiquid property such as farms and certain farm assets would be allowed to pay the tax over a 15-year period.  It would be interest only for up to five years and then ten equal payments for the remaining 10 years.  Selling the property would require payment in full.  There would be a lien attached to any property which would likely prevent you from refinancing the property without paying off the loan to the IRS.

Any transfer tax owed at death would reduce the estate value subject to estate taxes.

This transfer tax would apply to any gifts or inheritances after December 31, 2020.  In other words, we are looking at a retroactive provision.  

There also appears to be no $15,000 annual exclusion per donee similar to the current gift tax rules.  This means that farmers who typically gift grain to their children will eventually reach the $100,000 lifetime exemption amount and have the remaining amounts subject to tax.

Here is an example:

Bill and Mary have four children and they usually gift $15,000 of grain to each child annually to help fund their college expenses.  Bill and Mary each gave $60,000 of grain in 2021.  This reduces their lifetime transfer exemption to $40,000.  If they give the same amounts in 2022, they will each have $20,000 of ordinary income to report and it may be subject to self-employment taxes.

The bottom line.  Will this Act pass?  Not likely in its current form, however, President Biden and the Democrats have a new $3 trillion dollar infrastructure and child care policies that need to be funded.  This is one option that will likely get passed in some form.  The goal is that this be effective after 2021 and remember there is no such thing as permanence in estate taxes.

We will keep you posted on this Act or other like it.  Be forewarned that making major gifts this year may result in a large income tax bill if this Act passes in its current form.