It has been said that you can predict anything but the future. So it is with estate and tax planning. That being said, let's look to see what some of the tax law changes might be in 2021 and beyond.
In addition to various proposals related to income taxes, there have been several proposals put forth regarding estate, gift and generation-skipping taxes, some of which were first proposed years ago but never enacted, including:
- Reduce the current estate and gift tax (and presumably generation-skipping tax) exemption from $11.58 million per person (or $23.26 million for a married couple) to an inflation adjusted $5.49 million per person (or $10.98 million for a married couple.) ... or even lower.
- Increase the current estate, gift and generation-skipping tax rates from a flat 40% to a progressive scale with rates from 40% to 77%. ... or higher.
- Limit the number of $15,000 annual exclusion gifts.
- Eliminate the use, or reduce the effectiveness, of valuation discounts.
- Eliminate the use, or reduce the effectiveness, of Intentionally Defective Grantor Trusts ("IDGT") and Grantor Retained Annuity Trusts ("GRAT").
- Eliminate the basis step-up at death.
- Impose a capital gains tax at death on unrealized gain.
If these proposals are of concern to you and you want to take action before any changes can be enacted, here are some planning thoughts that could be implemented before the end of 2020:
- Make gifts to use up some or all of your $11.58 million exemption. The IRS has already said that gifts in excess of a future reduced exemption amount will NOT be "clawed-back" for purposes of computing the estate tax on your estate.1
- Make gifts in excess of your $11.58 million exemption and pay a gift tax at a 40% rate. Unless you believe that the gift and estate taxes will be repealed or that rates will be reduced, paying a gift tax is less expensive than paying an estate tax.2
- If a married couple is concerned that the gifts would reduce their cash flow to a precarious level, consider creating a Spousal Lifetime Access Trust ("SLAT") where one spouse uses his/her gift tax exemption to create a trust for the other spouse.
- Make gifts of other than cash or marketable securities in order to take advantage of valuation discounts.
- With interest rates at historical lows (the September Applicable Federal Rates ("AFR") are 1% or less), make AFR loans to family members and/or create GRATs.
- Make your gifts into IDGTs, where you are taxed on the income and the trust beneficiaries pay no tax on the income during your life. In effect, by you paying the income tax on trust income, you are making a gift to your children but it is not treated as a gift under the gift tax rules.
- Sell low basis assets to an IDGT in exchange for an AFR interest-only note, thereby removing the asset from your estate and avoiding the possibility of a tax at death on the built-in gain (or possibly later exchanging high basis assets for them which would not trigger any adverse income tax consequences but allow the IDGT to avoid the potential capital gains tax on those low basis assets and by reacquiring them, they will receive a basis step-up in your estate).
You could be thinking—let's wait and see what tax law changes are made in 2021 and then act. But beware—tax law changes can be effective retroactively to January 1, 2021. As the Congressional Research Service wrote in a 2012 report, It is clear there is no absolute constitutional bar to retroactive tax legislation. Nonetheless, it is possible, albeit rare, for retroactive tax legislation that increases a taxpayer's tax liability to violate the Constitution.
In 2012, when many thought that the then $5 million gift and estate tax exemption would be lowered to $1 million in 2013, there was a year-end scramble to create trusts, make gifts and obtain appraisals. While things might be clearer after the election, waiting until then (and the counting of the mail-in ballots) could result in a similar scramble and acting before then will assure that you can accomplish whatever you want to do before year-end. We look forward to hearing from you and discussing your thoughts and the available planning options.
1. If you are a NY resident and survive the gift by three years, the gift will not be taken into account in computing the NY estate tax on your estate. The result in IL is more complicated, but generally speaking, gifts in excess of the IL exemption amount (currently $4 million) will reduce the IL estate tax burden.
2. For example, if you have used up your gift and estate tax exemption, then the next $1 million of your estate will be taxed at 40% so that $400,000 is paid to Uncle Sam and $600,000 passes to your children. If, instead, you were to use $1 million to make a gift of $714,286 to your children, you would pay a gift tax of $285,714 (=40% of gift) and your children would net $114,286 more than in the estate tax example above. If you thought that you should hold on to the $1 million because it would double by the time of your death—think again. If it is worth $2 million at your death, Uncle Sam gets $800,00 and your children get $1.2 million. Had you made the gift of $714,286 and it, too, doubled as of the date of your death, your children would have $1.43 million.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.