How does a new administration possibly affect Estate planning?
Updated: Apr 14, 2021
How does a new administration possibly affect Estate planning?
Here are some main takeaways and what could possible happen
(see below for full overview):
1.The Estate Tax Exemption COULD DECREASE!
a.CURRENT: tax exemption amount for 2021 is $11.7 million per individual or $23.4 million for a married couple and increase by inflation each year.
Indexed for inflation annually
b.PROPOSED CHANGE: tax exemptions to $3.5 million per individual or $7 million for a married couple and a reduction of the lifetime gift tax exemption to only $1 million per individual or $2 million for a married couple.
c.BOTTOM LINE: USE IT OR LOSE IT
2.Family Partnerships/LLCs. Limit valuation discounts for closely held business interests, including family limited partnerships (“FLP”) and family limited liability companies (“FLLC
Proposal limiting valuation Individuals who own closely held business interests should consider making gifts now, while they can still potentially benefit from valuation discounts.
3.Increased Income Tax Rates. The current administration has proposed increasing the top federal income tax rate from 37 percent to 39.6 percent for taxpayers who make more than $400,000 a year.
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When the political and economic environment shifts and leans towards tax increases, estate planning professionals advise strategic planning and monitoring of proposed legislation that may impact client’s estate and financial planning. The new administration has made moves to enact legislation sooner than expected and these proposed changes could have a significant impact on estate planning:
Reduced Transfer Tax Exemptions: Under current law, the federal gift, estate, and generation-skipping transfer (“GST”) tax exemption amount for 2021 is $11.7 million per individual or $23.4 million for a married couple and increase by inflation each year, but only until January 1, 2026, when the exemption amounts will automatically be reduced to 2017 levels. The Biden campaign proposed an immediate reduction in the estate and GST tax exemptions to $3.5 million per individual or $7 million for a married couple and a reduction of the lifetime gift tax exemption to only $1 million per individual or $2 million for a married couple.
These changes could legally be made retroactive to January 1, 2021, although it is hoped the changes will be made prospectively—either effective at a later date (for example, later in 2021 or perhaps on January 1, 2022), or when the change is first publicly introduced in Congress.
Does this matter now? The IRS has already opined that if a taxpayer does not take advantage of the currently high gift exemption amounts before they are reduced, the benefit will be lost forever. A taxpayer who utilizes the higher gift exemption amounts while they are still available will not be penalized if they die after the reduction takes place. The bottom line: USE IT OR LOSE IT.
Currently, gifts or estates in excess of the exemption amount are taxed at a flat rate of 40 percent. In addition to reducing the estate, gift, and GST tax exemption amounts, these proposals include increasing the tax rate to 45 percent.
The current administration is also reportedly considering revisiting earlier tax proposals that could repeal or curtail several key planning techniques:
Grantor Retained Annuity Trusts. Eliminate the use of short-term Grantor Retained Annuity Trusts (“GRATs”) by increasing the minimum term from two years to 10 years and by requiring a gift value of at least 25 percent of overall value. A GRAT is an estate planning technique whereby the grantor transfers property to a trust while retaining the right to annuity payments for a term of years. At the end of the trust term, any remaining principal will be distributed to the trust beneficiaries. If the grantor dies before the end of the trust term, the trust property is included in his or her estate for estate tax purposes at its then value, eliminating any gift/estate tax benefit. Extending the minimum GRAT term to 10 years may effectively eliminate the utility of the GRAT given the increased mortality risk associated with longer-term GRATs.
Dynasty Trusts. Curtail the use of perpetual trusts by eliminating GST tax exempt status for trusts with a duration of more than 90 years. The GST tax imposes an additional transfer tax (at a 40 percent tax rate in addition to the 40 percent estate tax rate) on transfers made during lifetime or at death to persons more than one generation below the donor. Long-term GST tax exempt trusts, frequently referred to as “dynasty” trusts, allow for trust assets to pass from generation to generation without the imposition of transfer tax. If this proposal were enacted, it would greatly diminish the effectiveness of long-term “dynasty” trusts.
Family Partnerships/LLCs. Limit valuation discounts for closely held business interests, including family limited partnerships (“FLP”) and family limited liability companies (“FLLC”). Individuals who own closely held business interests should consider making gifts now, while they can still potentially benefit from valuation discounts. Further, individuals who own a controlling interest in an FLP (e.g., as a general partner) or in an FLLC (e.g., as a managing member) should consider making gifts now to relinquish control of these entities to both lock in a discount and eliminate the risk that the retained control will cause the entire FLP or FLLC to be subject to estate tax.
Increased Income Tax Rates. The current administration has proposed increasing the top federal income tax rate from 37 percent to 39.6 percent for taxpayers who make more than $400,000 a year. Additionally, they propose increasing the tax on capital gains and qualified dividends from 20 percent to 39.6 percent for taxpayers who make more than $1 million a year.
Repeal of Step-Up in Basis at Death. Another proposal looks to repeal the long-standing step-up in basis for the capital gains tax, which would have dramatic impacts across the board. Under current law, inherited assets receive a basis equal to their fair market value as of the decedent’s date of death. As a result, a beneficiary does not have to pay capital gains tax on any pre-death appreciation in the asset’s value. If eliminated, a beneficiary inheriting a highly appreciated asset will likely have to pay much higher income taxes when the asset is ultimately sold.
How can I plan for these changes?
Although it is possible that any tax law changes could be made retroactive to January 1, 2021, it is more likely that any changes would be effective upon the date that legislation is introduced or enacted. As such, there still may be time to take advantage of planning opportunities before changes are enacted into law.
Use it or Lose It: The high transfer tax exemptions are scheduled to be reduced by 50 percent in 2026 but will more than likely be reduced sooner and more possibly by more than 50 percent. Individuals must therefore use their increased exemptions before the law changes, or risk losing them forever. individuals and married couples should consider making gifts now while they still can, recognizing the fact that the gifted assets will be received by the donee with a carry-over tax basis.
Low-Interest Rates: Due to current economic conditions, interest rates are at historically low levels. While the rates have been slowly increasing, they are expected to remain low for some time. This low interest environment is ideal for implementing new intrafamily loans, as well as refinancing existing loans with higher interest rates. This technique is suitable for all clients, even those who have already used all or most of their tax exemptions.
GRATs: A GRAT is an estate planning technique that allows for the transfer of appreciation of assets at minimal or no gift tax cost. In order for a GRAT to be effective, its assets must grow at a greater rate than the Section 7520 Rate, which is 120 percent of the mid-term AFR. For March 2021, the Section 7520 Rate is only 0.8 percent. Therefore, any appreciation of the GRAT’s assets in excess of 0.8 percent per annum will pass to the GRAT’s beneficiaries free of any gift or estate tax. This technique is also suitable for all clients, even those who have already used all or most of their tax exemptions.
Spousal Lifetime Access Trusts (“SLATs”): A SLAT involves a gift from one spouse to an irrevocable trust from which the other spouse may benefit in the future. The gift to the SLAT will utilize the donor’s exemption and the post-transfer appreciation on the trust’s assets that is not distributed to the spouse will not be subject to future gift, estate, and possibly GST tax. One of the major benefits of a SLAT is that it allows your spouse continued (though limited) access to trust income and/or principal. A SLAT is a great tool for high-net-worth clients who want to take advantage of the increased exemption amounts but feel financially uncomfortable relinquishing access to the gifted assets if needed in the future.