[Editor’s note: This article is part of a series we are running on the new tax proposals. Look tomorrow for a detailed follow up on the AICPA’s take.]
With Congress wrangling over tax-law changes that may have considerable negative impact on current estate-planning strategies of high-net-worth individuals, financial advisors face pressing time constraints to meet with clients and retool existing plans.
Transfer tax planning has become more urgent for advisors and their clients since statutory language was issued in September by the House Ways and Means Committee that would increase federal taxes for individuals and businesses.
The tax proposal that is now being debated would reduce the gift and estate tax exclusion amount from the current $11.7 million level to about $6 million. What’s more, the proposal could significantly alter — or even eliminate — certain benefits of grantor trusts that are widely used in estate plans for high-net-worth clients.
As matters currently stand, there is a distinct possibility that the tax bill now being debated could be enacted by October 31.
Our view is that planners who have not yet met with potentially affected clients should do so immediately because those individuals might not have certain crucial estate-tax strategies in place by the time of enactment, and thus miss out on leveraging valuable tax-reduction tools.
Further, it is important to understand that, if passed, portions of the law would take effect when the bill is enacted rather than at the end of the year, as some may believe.
This May Be “Use-It-Or-Lose” Time
As attorneys specializing in estate planning, we recognize that there has been confusion about the timing of the bill’s enactment. The suggested tax law is complex, and the back-and-forth in Congress has only added to the confusion about the status and the elements of the tax proposal.
It could be costly if advisors and their clients are aware of the enactment date but still want to wait for more information instead of acting now.
For those who have the means to fully fund the lifetime exclusion, we recommend that they do so immediately. This may be a “use-it-or-lose-it’’ time, and advisors must grab the attention of their clients.
If nothing else, this is a valuable opportunity for advisors to take a deep dive into clients’ current estate and trust plans and consider possible strategies that could arise with any new tax legislation.
Take Time to Understand Changes to Grantor Trust Laws
Even though the impact on the $11.7 million exclusion amount has been the focus of most of the current discussion, if the proposed tax bill remains in its current form there would be restrictions in the existing tax benefits of grantor trusts that estate planners and advisors have relied on in their work with wealthy clients.
Gifting assets into an intentionally defective grantor trust currently allows a grantor to fund a vehicle that is not included in their taxable estate, which creates a significant benefit for estate beneficiaries. The grantor retains ownership of the trust’s assets for income tax purposes while removing the assets transferred from the grantor’s taxable estate.
In effect, intentionally defective grantor trusts magnify the gift to beneficiaries because the grantor pays the income and capital gains taxes on the trust over the grantor’s lifetime. However, post-enactment funding of grantor trusts could trigger a capital gain and termination of grantor-trust status could trigger a completed gift. Furthermore, grantor trusts would be included in the grantor’s taxable estate.
The change affecting grantor trusts would take place at the time of the law’s enactment — which could be October 31. That timing issue relating to the establishment and funding of a grantor trust has considerable estate, income and capital gains tax implications.
Advisors might want to discuss the timing of funding so-called ILITs — Irrevocable Life Insurance Trusts. ILITs are typically grantor trusts and favored in estate planning because they can provide the liquidity to help pay the estate taxes when they come due.
Under current law, ILITs are designed to be outside of a taxable estate. But their use could be curtailed with the new tax-law proposal because contributions to a grantor trust after the date of the law’s enactment would be includable in the grantor’s taxable estate. Contributions are generally made to an ILIT on an annual basis when life insurance premiums are paid.
But there are many grantor trusts that warrant discussion other than ILITs. Advisors should discuss the possible impacts of other grantor trusts, such as Grantor Retained Annuity Trusts (GRATs) that allows grantors to transfer assets to a trust while retaining annuity payments for a specified period of years, SLATS (Spousal Lifetime Access Trusts), and Dynasty Trusts, among others.
Additional Reading: Eleven Changes in House Tax Proposal May Affect Your Clients
Speak Up and Act Quickly
Considering the importance of tax reform to certain members of Congress, there is significant pressure on many elected officials to act swiftly, which puts pressure squarely on estate planning. As is the case with any topic surrounded by significant risk and uncertainty, the surest way to clarity is to begin direct communication and conduct the appropriate research. Attorneys specializing in estate and trust can work with individuals and their financial advisors as the moving target of tax-law change comes closer to reality.
Kristin W. Shirahama, practice area leader for Estate, Financial & Tax Planning, is an attorney at Massachusetts-based Bowditch & Dewey.