The blue storm is now on the horizon with the Democratic control in both Congressional houses. The actual timing and extent of any income tax and estate tax legislation is still uncertain, and there still may be time to take advantage of planning opportunities before changes are enacted.

We expect more income tax breaks for the lower income earners who spend all their dollars to help economic recovery and increased rates on the high-income earners to replenish our government coffers depleted by the pandemic. Changes to the estate tax rules that impact the ultra-high-net-worth individuals may also come, but I understand that the revenue increased by estate tax changes is dwarfed by any income tax changes and hence a lower priority for Congress to change. Note that income and estate tax planning must address the possibility that Congress can enact retroactive tax law changes, but normally changes become effective on the date enacted by Congress or the beginning of the next calendar year.  Sweeping changes have been proposed by Biden’s administration and now it is just a matter of when and how much. 

The current gift, estate and generating skipping tax (GST) exemption amount is $11,700,000 per individual. This exemption amount is currently required under the law to be cut by 50% in 2026, to about $6M per person depending on the inflation adjustments. This reduction is under the law, and it has created a use-it or lose-it opportunity for high-net-worth individuals. However, the following Biden campaign proposals are much more dramatic and may change the estate tax rules this year or next:

• Reduce the estate and GST exemption to $3,500,000, and only permit $1M in tax-free lifetime gifts.
• Increase the estate tax rates significantly from 40% to unknown percentages.
• Eliminate the stepped-up basis rules at death. This would be a massive change and a carryover basis may create an income tax at death or later sale on all appreciated property – details unknown.
• Limit valuation discounts between family members.
• Include grantor trusts in the grantor’s estate, and eliminate use of short-term grantor retained annuity trusts (GRATs).
• Limit duration of GST Trusts.

The above proposals make it urgent to address your estate tax planning now versus in the future. Addressing your estate and succession planning now is always best, but it is not easy to find the time and make a lot of tough decisions. High-net-worth parents always stress over gifts and whether trusts should be established and what kind, with concerns about diminishing their children’s incentive to fully develop themselves.

Estate planning is a process, not a one-time trust agreement, and as you become more educated in the process through your trusted advisors including your attorney, accountant, wealth and insurance advisors, your ability to make the decisions will become easier.

Some estate and gift opportunities to consider under current law:

• Use your annual exclusion gifts of up to $15,000 per person, $30,000 if both parents make gifts to that person. Over time, these gifts accumulate into significant amounts. Direct payments to a provider for medical services or educational tuition for anyone, related or not, are not considered gifts.

• Make large gifts of assets with depressed values and subject to discounts. Leverage the current $11,700,000 unified credit amount with gifts of fractional interests in real property and/or ownership interests in a family or closely-held business that qualify for valuation discounts.  To protect against retroactive changes to the $11.7M gift exemption amount planners need to consider use of disclaimers, formula gifts, and/or use of life-time qualified terminal interest property (QTIP) trust elections, as part of the planning with trusts.

• Make low-interest loans to children. Loans for homes or business opportunities are very attractive, with January 2021’s Applicable Federal Rates (AFRs) at .14% for loans three years or less, .52% for loans more than three years and not more than nine years, and 1.35% for loans more than nine years.

• Take advantage of grantor trusts to minimize your estate taxes:

• Spousal lifetime access trust (SLAT) for a married couple takes advantage of the current high gift tax exemption of $11.7 million when you put that amount into a trust for your spouse. This grantor trust permits your spouse continued access to the income to sustain your current cash flow, as long as divorce or premature death are not concerns. The risk of a premature death can usually be addressed with life insurance owned through of an irrevocable life insurance trust (ILIT). It is possible to have each spouse create a SLAT for the other spouse, but each SLAT must have substantially different assets, different trustees, different terms, and the trusts must be established at different times to avoid the Reciprocal Trust Doctrine rules. This should be addressed with your estate tax advisors.

• Irrevocable life insurance trusts (ILITs) are used in conjunction with many estate planning strategies to provide liquidity and to address the risks of premature death. The ILIT can be a grantor trust and is typically funded using annual exclusion gifts to pay the premiums on first or second-to-die life insurance policies owned by the trust; the policy proceeds are not included in the insured’s estate. The trust beneficiaries can use the life insurance proceeds to purchase estate assets to provide cash to pay estate taxes.

• Grantor retained annuity trusts (GRATs) are used to transfer assets that have a high potential for appreciation from parent to child. Current low interest rates and low values make these trusts attractive, and any asset appreciation over the current low values is passed on to GRAT beneficiaries without a downside, i.e., if the assets fail to appreciate, the entire asset returns to the grantor. Rolling GRATs with short terms of three years or so are often used for shares of stock with the expectation of high appreciation. If the there is none, the shares come back to the grantor and are placed into a new GRAT.

• Gifts and Sales to intentionally defective grantor trusts (IDGTs) can be used to transfer large business interests, real property and other investment assets that have strong cash flow. The sale of assets from the parents/grantors to IDGTs for the benefit of their children is not subject to income tax, but is respected for estate or gift tax purposes. The cash from the business interests to the IDGTs remains in trusts for the children and grows outside the parents’ estates. The parents/grantors continue to pay the income taxes related to the assets gifted or sold to the IDGTs, and making these income tax payments on behalf of their children’s trusts is a powerful tool for burning down the value of large estates.

Opportunities for estate planning still appear to exist for now, but for how long is uncertain. Before legislation closes the door, reach out to trusted advisors for more information.

Joe Kitts is an Of Counsel of Tax with accounting and advisory firm BPM LLP. He is a specialist in the planning of estates and trusts. He may be reached at [email protected].