Significant Changes Expected to Estate and Gift Tax Laws

Adam J. Centner
01.07.2021

Two months after the November elections, we finally have some clarity: Democrats will control the White House, Senate, and House of Representatives. 

So, what does this mean for Federal estate and gift tax laws?  Likely, a lot.

Current Law.  As of today, the Federal estate, gift, and generation-skipping transfer tax exemption amount is $11.7 million per person, meaning that any American can transfer up to that amount during life or at death free of any transfer taxes.  Assets beyond the exemption amount are taxed at 40%. 

Campaign Proposals.  During the campaign, then-candidate Joe Biden proposed reducing the exemption amount to 2009 thresholds, when the exemption was $3.5 million per person and the tax rate was 45%.  Although no legislation has been proposed to date, the current expectation is that the exemption will fall to anywhere from $3.5 million to $6 million (the approximate exemption amount prior to the 2017 tax act).  President-elect Biden has also proposed eliminating the step-up in basis at death.  Because Democrats hold a smaller-than-anticipated majority in the House and a razor-thin majority in the Senate, any tax law changes will likely be tamped down from the campaign rhetoric.

Where To Go From Here.  First and foremost, most experts in this area do not expect any legislation that is enacted to be made retroactive, meaning that if legislation is enacted in September, gifts made in February, for example, will be made under the current tax regime and not subject to the new legislation.  If this holds true, clients will have time to make gifts this year prior to the effective date of any new tax laws.  This is always subject to the will of Congress, of course – as recently as 2010 newly-enacted estate tax laws were made retroactive, but taxpayers were given a choice in applying the law, and because of the lapse of the estate tax at that time, many believe that situation to be much different than the current tax environment. 

Use It Or Lose It.  For clients who hold assets in excess of the current Federal exemption amount of $11.7 million, now is the time to consider gifting assets to take advantage of the full exemption before it decreases.  The IRS has stated that it will not recapture or “claw back” assets gifted in excess of a decreased exemption amount. 

Take this example: a client has $15 million in assets and gifts $11.7 million to an irrevocable trust for the client’s children, and the exemption amount then deceases to $6 million and the client dies.  At death, the $11.7 million (plus any appreciation) is outside of the client’s gross estate and is not subject to transfer taxes.  The assets remaining in the client’s gross estate at death ($3.2 million) will be subject to estate tax (assume 40%), so $1.32 million will be paid to the government, resulting in a total of $13.68 million passing to heirs.  Had the client not used the full exemption amount prior to the decrease, only $6 million would be exempt and the remaining $9 million would be subject to estate tax.  In this second scenario, $3.6 million would be paid to the government and $11.4 million would transfer to heirs.

The decision as to whether a client should make a significant irrevocable gift should be made on a case-by-case basis, considering, among other factors, the client’s willingness and comfort level in parting with assets (and being sure that the client can relinquish sufficient control to not re-include the assets in the client’s estate), the total assets available to the client, whether the client would have sufficient assets remaining after the gift, the client’s age and family situation, and the type and expected appreciation of the gifted assets.  Consideration should also be given to how the gift will be made, whether to a trust for a surviving spouse and descendants, in conjunction with gifts made by the spouse, outright to beneficiaries, etc.

Other Planning Tools.  For clients with substantial wealth that may not be in a position to make a gift of the full exemption amount for one reason or another, the client should consider other tools to reduce his or her estate over the long-term. 

Annual Exclusion Gifts.  The simplest tool available is the use of annual exclusion gifts.  As of this year, each individual can gift up to $15,000 per year to any number of donees ($30,000 collectively for a married couple) without any tax consequence.  At the 40% estate tax rate, each gift of $15,000 saves a taxable estate $6,000 in estate taxes.  These gifts can be made in cash, securities, or business interests, and may be made directly to individuals or to trusts for their benefit.  Over the long-term, careful and continuous annual gifting can transfer substantial sums of wealth and significantly reduce a client’s estate tax burden.

Life Insurance Trusts.  With any decrease of the exemption amount we will see an increase in the number of taxable clients.  Irrevocable life insurance trusts (ILITs) will be one way to reduce a client’s estate tax exposure.  ILITs allow the death benefit of an insurance policy owned by the trust to transfer to the trust beneficiaries outside of the insured’s estate, meaning that these proceeds will not use any of the deceased’s exemption amount, with proper planning.  Because of the administrative burdens associated with ILITs, many advisers and clients have shied away from this planning in recent years given the high exemption amounts, but ILITs will likely play a more prominent role moving forward.  A new insurance policy can be held by an ILIT from day one, but existing policies can also be transferred to an ILIT and receive the same benefits as long as the insured survives three years from the date of transfer.

Maximize Low Interest Rates.  Given the historically-low interest rates resulting from the coronavirus pandemic, the early months of 2021 are also a good time to consider estate planning tools that rely on IRS-published interest rates.  These tools include intra-family loans, grantor retained annuity trusts, and charitable remainder trusts.  For the latter two trusts, appreciation of transferred assets in excess of the IRS interest rate will transfer to trust beneficiaries free of any transfer taxes, and the donor is made whole through annuity payments returned to the donor during the term. 

Remaining Estate Planning Priorities.  For most clients and the vast majority of Americans, changes to estate tax laws will have no impact on their planning.  For these clients, we should continue to focus on flexible planning that incorporates estate tax planning into the estate plan but that also prioritizes the efficient transfer of assets, maximizes any available basis adjustment at death, and provides asset protection and probate avoidance. 

To discuss how the election will affect your clients, or any other estate planning matters, please call Adam Centner at 513.579.6488 or email Adam at acentner@kmklaw.com.

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