Last year, the perfect storm of COVID-19 and election uncertainties had attorneys scrambling to fine tune clients’ estate plans.
The impetus was the anticipated “last hurrah” for the $11.7 million lifetime estate, the gift and generation-skipping transfer tax exemption for individuals, and the $23.4 million exemption for couples, made possible through the Tax Cuts and Jobs Act of 2017 (TCJA).
With COVID-19 vaccination distribution issues, the economic relief package and the impeachment trial all taking priority, federal tax reform has been pushed off until later in 2021.This effectively hands affluent clients a bonus year to minimize their taxable estates by retooling their gifting.
The expected changes illustrate why they should consider doing so.
Exemptions Projected to Fall; Estate Tax Expected to Rise
Although at this writing, the Biden administration has not issued a formal proposal, the Tax Policy Center, the Urban Institute and the Brookings Institution, have projected:
• A dramatic reduction in the estate tax exemption to just $3.5 million for individuals ($7 million for couples) and a gift tax exemption of $1 million. This alone is an incentive to recalibrate plans; clients should be deciding whether they want to use up their exemption during 2021. The eventual sunset of the current estate and gift tax exemption of a $11.7 million maximum to about $6 million on January 1, 2026 should also factor into their decisions.
• The highest federal estate tax rate may increase from 40% to 45%.
Basis for Change
Moreover, the Biden administration could be eliminating the current step-up in basis for inherited property that has appreciated.
That step-up has enabled high-net-worth clients to save on capital gains taxes by holding onto these assets — knowing that eventually, their beneficiaries will be able to sell them without being taxed on the gains.
Going forward, though, the equation could be changing. The step-up may be replaced by carryover basis — so whether a client or his/her beneficiaries choose to sell, they will trigger a gain. If this happens, decisions about owning or gifting appreciated stocks will become more nuanced. In many cases, clients will be better served through more liberal gifting.
State taxes will add more complexity to decision making with the carryover factored in.
For example, in Massachusetts, where Bowditch is headquartered, there is a 5%-16% tax on estates valued over $1 million, and also a 5% capital gains tax. Without the step-up, additional gifting may be indicated to minimize Massachusetts clients’ state estate tax obligations.
These same parameters could be relevant in other states — again tilting the scales toward gifting—if the carryover basis is implemented.
Adapting to Potential New GRAT Terms
With the lifetime exemption expected to go down, the maximum estate tax potentially rising, and the step-up possibly going away, what other instruments may be advantageous for high-net-worth clients? Should they be diverting funds into grantor retained annuity trusts (GRATs), for example?
Over the years, individuals have created these GRATs to quickly chisel a boatload of assets out of their estates, gift gains to heirs tax-free, and enjoy regular annuity payments. For clients with significant wealth to protect, GRATS have provided “the best of all possible worlds” — but some potential changes may affect who finds them most beneficial in the future.
The Biden administration, like the earlier Obama administration, may propose these requirements for new GRATs:
• Remainder interest valued at more than zero when created
• No reduction in the annuity over the course of its term
• 10-year minimum terms (versus just two years at the present time)
The minimum ten-year term, in particular, could make them riskier for the oldest seniors who want to realize their full benefits while they are alive.
Given their advantages, though, clients should take another look at opening two-year GRATs for estate freezing while they can.
Leveraging a SLAT for a Safety Valve
For clients that want to use up their whole exemption, benefit both their spouse and children, and ensure their family’s access to the funds they have gifted, setting up a Spousal Lifetime Access Trust (SLAT) is another strategy to consider right now.
What makes these irrevocable trusts so appealing is the safety valve they offer to those who aren’t ready to give up a significant portion of their wealth. Donors can gift assets to their spouse — or spouse and children — who can benefit from ongoing distributions while everyone is living.
Moreover, should the beneficiary spouse pass away, the SLAT will not be considered part of his/her taxable estate.
All this is a bonus for clients who would like to be strategic about estate planning during 2021, with the goal of continuing to enjoy their accumulated assets.
Take the Bonus Year and Act Now
Whatever clients’ individual situations may be, this is the year to be as agile with estate planning and gifting as with business.
It’s time for clients to take a harder look at their assets, identify those that are most likely to appreciate, and consider gifting them under the larger tax exemption while it still exists.
Kristin Wildman Shirahama is a partner and trust and estate lawyer with Bowditch & Dewey. She can be contacted at [email protected].