Estate Tax Planning in Advance of the 2020 Presidential Election

Many high net worth clients are taking advantage of the heightened Federal Estate/Gift Tax exemption through lifetime giving to their intended beneficiaries (or a trust for their benefit) prior to any planned (or unplanned) drop in the Federal Estate/Gift Tax exemption.

 Background:

• The Tax Cuts and Jobs Act (TCJA) enacted by President Trump in 2017 increased the Federal Estate/Gift Tax exemption (“Federal Exemption”) (the amount you can pass to beneficiaries free from estate/gift tax either during lifetime or at death) to $10 million indexed for inflation (currently $11.58 million for 2020), an increase from $5 million indexed for inflation in 2017. The Maryland Estate Tax Exemption remains at $5 million per spouse. Distributions to spouses and charities are exempt from tax.

• All assets transferred either during lifetime (or at death) in excess of the Federal Exemption are subject to a 40% Federal Estate/Gift tax plus any state level estate tax. Assets in excess of the Maryland Estate Tax Exemption will be taxed at 16%.

• The Federal Exemption is set to “sunset” back to $5 million indexed for inflation in 2026, absent legislative action.

• Vice President Biden, if elected, has proposed a reduction in the Federal Exemption back to $5 million prior to 2026.

Impact of a Drop in Federal Exemption? For high net worth clients with assets in excess of the current Federal Exemption, the proposed reduction, could result in an increased estate tax liability at death of $2 million per spouse (or $4 million per couple).

How are High Net Worth Clients Planning? Many clients are considering gifting to fully utilize their increased Federal Exemption before it drops in 2026 (or earlier). To gift an asset outside of your estate, you must give up control and the right to benefit from a gifted asset. The Treasury has issued regulations that any gift completed prior to the “sunset” of the Federal Exemption will not be “clawed back” into the estate.

 Opportunities for gifting include:

• Outright to children, grandchildren or other beneficiaries – often not advised for substantial gifts due to creditor concerns and future estate tax considerations.

• In trust for children, grandchildren or other beneficiaries – which can be helpful to control use of funds for a minor or spendthrift beneficiary. Oftentimes lifetime/dynasty trusts (as opposed to trusts that provide for a mandatory distribution of assets when a beneficiary reaches a certain age) are used to preserve creditor protection and estate tax efficiency.

• Spousal Lifetime Access Trust (SLAT) for the benefit of your spouse for lifetime – which helps to maintain access and control over the gifted funds through a spouse. Both spouses can create and fund SLATs for the other spouse if the trusts are drafted properly to avoid the Reciprocal Trust Doctrine.

• Grantor Retained Annuity Trusts (GRAT) – A GRAT is a trust to which the Grantor transfers property and from which the Grantor receives an annuity payment each year for a term of years. The retained annuity payment has the effect of reducing the value of any gifted asset.

Intentionally Defective Grantor Trusts (“Grantor Trusts”) – often when lifetime gifts are made in trust, they are made to Grantor Trusts. Assets gifted to a Grantor Trust are removed from the Grantor’s estate for estate tax purposes, yet still part of the Grantor’s estate for income tax purposes. All income generated by the trust will continue to be taxed back to the Grantor. The Grantor could be reimbursed from the trust for this tax liability or alternatively could pay the tax on behalf of the trust which has the effect of an indirect gift (without any additional gift tax consequence). In addition, Grantor Trusts allow a Grantor to sell an asset to the Grantor Trust without recognition of gain/loss.

How Much to Gift? – As mentioned above, to fully utilize the heightened Federal Exemption to its fullest, the entire $11.58 million exemption would need to be gifted. A gift for less than the full Federal Exemption will reduce your remaining Federal Exemption following any sunset. Therefore, if you gift $1 million before the end of 2020 and the Federal Exemption drops to $5 million in 2021, your remaining Federal Exemption at that time will be $4 million. To avoid Buyer’s Remorse, flexibility in the gifting strategy should be considered. In addition to the Federal Exemption, each spouse is currently permitted to gift $15,000 per person per year, without any reduction of the Federal Exemption.

Which Assets to Gift? – Ideally, there are three factors that make an asset a target for gifting, including (1) the ability to devalue the “fair market value” of the asset due to a low appraisal and/or valuation which incorporates discounts for lack of marketability and lack of control on a business valuation, (2) an asset that is likely to appreciate in value in the future, and (3) an asset that is cash flowing.

How to Prepare? –

• Prepare a detailed financial statement with asset information, ownership titling and estimated value to determine the need for gifting;
• Schedule a meeting with your estate planning professional at Bagley Rhody to review your financial statement and goals for planning;
• Formulate a gifting plan and begin drafting Irrevocable Trusts, as needed;
• Obtain appraisals/business valuations for identified gifting targets; and
• Finalize execution of gifting transaction and file Form 709 Gift Tax Return.

* The above is not legal advice and a personalized review is necessary to determine the exact impact of the Federal Estate/Gift Tax on your estate.