Tuesday’s federal election places a Republican in the White House and shifts control of the Senate to the Republican party. As the results come in, it appears the Republicans will also retain control of the House of Representatives.

What does this all mean for the future of estate planning and in particular for steps that should be considered today?

Estate Tax Exemption
The federal estate tax exemption is scheduled to be $14 million in 2025, and it will likely remain on its inflation-adjusted course for at least four more years and not sunset in 2026 (as it was originally scheduled to). That means certain gifting strategies will likely need to be re-examined and put on hold in all but the largest estates (where the gifts have likely already been made).

When combined with the existence of the so-called spousal portability election (where a surviving spouse can, in effect, elect to add a predeceased spouse’s inflation-adjusted estate tax exemption onto his or her own), the families of married couples with combined taxable estates of $28 million or less can be significantly damaged, on an after income and estate tax basis, by the couple making significant lifetime gifts of appreciated assets. Especially if future federal estate tax exemptions continue to be adjusted for inflation, it is very possible that a single individual with an estate of less than $14 million, or a married couple with an estate of less than $28 million, could save little in federal estate taxes for their families by making large lifetime transfers. Instead, it could cause the family members to eventually pay significant capital gains taxes when the gifted assets are finally sold by them. This is because appreciated assets which are gifted away during an individual's lifetime do not receive an income tax basis "step-up" the way assets retained by the individual until death do. 

Income Tax Rates
Also likely to survive a 2025 sunset are the lower federal income tax rates set by the 2017 Tax Cuts and Jobs Act. And this presents an important tax strategy in the area of Roth conversions. Retired individuals especially can see long-term tax benefits by converting taxable IRA and 401(k) plan benefits to nontaxable Roth IRAs over four years or longer—rather than doing it all before 2026. That’s especially critical since federal income tax rates will no doubt rise in the long term. Such moves will also produce significant after-tax benefits for the account owners’ spouses and other heirs.

A related option currently available is to convert all or some of the individual’s taxable IRA or 401(k) funds to nontaxable life insurance. This strategy is useful because it’s still possible to have the life insurance policy owned outside of an individual’s taxable estate—for example, by the policyholder’s children or by an estate tax-exempt life insurance trust set up to benefit the policyholder’s spouse or descendants. If the current large federal estate-tax exemption does go away eventually, converting all or a portion of the taxable IRA or 401(k) benefits to life insurance in the near term will result in income tax-exempt life proceeds of these policies which would be excluded from the individual’s taxable estate. The family wouldn’t lose a step-up in income-tax basis—because the life insurance proceeds they’re getting aren’t taxed anyway.

Structuring Trusts
In light of these advantages, those drafting trusts for surviving spouses or descendants should always consider the income tax basis of what they’re drawing up and make sure to create transfers with step-ups when the beneficiaries die, as long as it doesn’t generate an estate tax liability for them. The trust agreements should also be structured to intentionally cause the income of the trusts to be taxed at the beneficiary’s federal income tax rates, as long as these rates remain lower than the federal income tax rates applicable to trusts.

Trust creators should also consider modifying existing irrevocable trusts, either under their state’s “trust decanting” rules or under a similar provision included in the trust agreement itself, to achieve all these desired tax benefits for the existing trust and its beneficiaries. For example, a trustee might be able to modify an existing irrevocable trust and create an income-tax-basis step-up for the assets in it when the beneficiary dies—or at least cause the income of the trust to be taxed at the individual beneficiary’s lower federal income tax rates, not at the higher trust federal income tax rates.

Revised Thinking

These are only a few of the decisions that could be influenced by Tuesday’s election results. It means current plans and large lifetime gifts must be re-examined so that you can see what the federal estate tax exemption and income tax ramifications for your clients will be over the next four years at least. You’ll also want to explore all available techniques for taking advantage of the current low federal income tax rates during that time.

 

James G. Blase, CPA, JD, LLM is a principal at Blase & Associates LLC, a law firm in St. Louis.