Advisor discussing estate planning

Authored by Randi Schuster and Michael Lum

Time is ticking on estate planning as we know it. Soon, one of the most favorable planning eras will likely come to an end. Recent months have seen a myriad of tax proposals seeking to eliminate many popular wealth-transfer techniques.

Tax proposals

Since March of this year, no fewer than four proposals have been released to modify current gift and estate tax rules. Most recently, on Sept. 12, 2021, the House Ways and Means Committee issued its proposal for the budget reconciliation bill. The draft legislation includes several significant changes affecting high-income and high-net-worth individuals, but from an estate planning perspective, it proposes to:

  • Add a surcharge high-income trusts and estates: The proposal would apply a 3% surtax on trusts and estates with adjusted gross income over $100,000. This change would be effective for tax years after Dec. 31, 2021.
  • Reduce the gift, estate and GST tax exemptions: The proposal would reduce the gift, estate and generation-skipping transfer (GST) tax exemptions to their 2010 levels. Indexed for inflation, this would result in the 2022 exemptions equal to approximately $6 million per person, or $5.7 million less than the 2021 amount of $11.7 million per person.
  • Pull grantor trusts into decedent’s estates: The proposal would require grantor trusts to be included in their deemed owner’s estate. This change would apply to grantor trusts created after the date the provision is enacted (which could be this year) or to any portion of a grantor trust created before enactment attributable to a contribution made on or after such date. Although not clear at this point, the proposal could eliminate planning with grantor-retained annuity trusts (GRATs), qualified personal residence trusts (QPRTs) and certain charitable lead trusts.
  • Tax certain sales between grantor trusts and their owners: The proposal would cause sales between grantor trusts and their deemed owners to be taxable. Traditionally, taxpayers have been able to sell assets to their grantor trusts without recognition of gain and without receiving taxable income on any corresponding note payments. This provision, which could be effective this year (on the date of enactment), would change that.
  • Eliminate valuation discounts for nonbusiness assets: The proposal would effectively eliminate valuation discounts for passive assets not used in an active trade or business. This provision would be effective on the date it is enacted.

In addition to the House proposal, three other proposals were released earlier this year. Some of the concepts included in those proposals were incorporated into the House bill but others were not. Notable absent provisions include increasing estate tax rates, capping annual exclusion gifts, limiting the duration of dynastic trusts and eliminating the step-up in basis rule. However, clients should keep these in mind, as they may be revived in the Senate’s version of a budget bill.

Importantly, the House bill is a mere proposal at this point. The situation continues to be fluid, and changes are expected as the bill moves through the legislative process. As a result, the final timing and content of the bill is unknown. The Senate Finance Committee will likely advance its own version of a bill, and both the Senate and the House will need to combine their respective bills to form one comprehensive package.

Techniques to consider for using your remaining gift tax exemption

Despite not knowing what legislation will eventually come to pass, all signs seem to point to significant changes coming. And before they do, taxpayers should immediately look to (1) use their remaining gift and GST tax exemptions, (2) create new grantor trusts, if necessary, and (3) take advantage of valuation discounts for passive assets. Failing to utilize your full gift and GST tax exemptions this year could increase your estate tax bill by approximately $2.3 million ($5.7 million expiring exemption multiplied by 40% estate tax rate).

Ideas for using exemption include:

SLATs

For married couples reluctant to give away substantial wealth without being able to later access that wealth or the income generated by it, spousal lifetime access trusts (SLATs) can offer a welcome solution. A SLAT is an irrevocable trust created by one spouse for the benefit of the other. The spouse who creates the trust (the “donor spouse”) makes a gift to the trust, using some or all of his or her gift tax exemption, and names his or her spouse (the “beneficiary spouse”) as the initial beneficiary. (Children and grandchildren can also be named as initial beneficiaries, and the beneficiary spouse can alternatively be named as a beneficiary at some time after the trust is created.) Despite the beneficiary spouse’s ability to receive trust distributions, the trust is designed to be excluded from both the donor spouse’s and the beneficiary spouse’s estates.

  • Importantly, SLATs are generally grantor trusts. This feature allows the trust’s assets to compound unabated by income taxes (because the donor spouse is responsible for the tax), and it allows the donor spouse to sell appreciated assets to the trust without realizing gain. However, taxpayers wanting to take full advantage of SLATs should act immediately to create them before any new law passes that would cause estate tax inclusion of grantor trusts. SLATs would no longer be as valuable after such a change.
  • SLAT assets are generally protected from the donor spouse’s, the beneficiary spouse’s and other beneficiary’s creditors.
  • SLATs can be structured to be multigenerational. The duration may be limited by the proposed tax law changes.
Gift of business interests

Current law allows the value of a minority interest in a closely held business to be discounted for gift (and estate) tax purposes. These discounts can be substantial and have the effect of allowing the true gift value to be much higher than the gift tax cost. However, these discounts are in jeopardy of being eliminated under the House proposal. Consider taking advantage of discounts before they go away.

Forgiving existing installment notes

Clients who have outstanding installment notes from prior sales to defective grantor trusts or intra-family loans may consider forgiving some or all of those notes before year-end to use their remaining gift exemptions.

Gift to trusts for heirs

Clients looking to shift wealth to trusts for descendants should create those trusts this year. Not only will this allow clients to use their remaining exemptions, but also it can afford asset protection to the trust beneficiaries for amounts held in trust.

Fully fund irrevocable life insurance trust (ILIT) premiums

Although not part of the House bill, Sen. Bernie Sanders, I-Vt., proposed to limit the amount of annual exclusion gifts that can be made to trusts to $30,000 annually. Therefore, clients who have existing ILITs with policy premiums exceeding that amount should consider pre-funding those premiums in full this year. In this way, clients can use some or all of their remaining gift tax exemption to fully fund those premiums and avoid future gift tax consequences that may result if Sen. Sanders’ proposal is incorporated into a combined House and Senate package. In addition, since ILITs are grantor trusts, fully funding ILIT premiums in advance would help to avoid estate tax inclusion of ILITs under the proposed House provisions that would include the portion of grantor trusts attributable to contributions made on or after the date the bill is enacted.

Other year-end considerations

  • Annual exclusion gifts: Utilize annual exclusion gifts up to the limit of $15,000 per donee in 2021.
  • Pay medical bills for family members: Payments made directly to medical providers do not count against gift tax limits.
  • Pay tuition costs for family members: Tuition payments made directly to educational organizations do not count against gift tax limits.
  • Consider GRATs: The hurdle rate for GRATs, though not at its lowest point, continues to be low. The rate (that is the 7520 rate) for September 2021 is 1%. Asset growth above this hurdle rate passes to beneficiaries free of gift tax; thus, GRATs tend to perform best when rates are low, as they are now. In addition, the House proposal may effectively eliminate GRATs, so consider taking advantage of them while you can.
  • Intra-family loans: Interest rates for intra-family loans also remain low. Consider loaning funds to family members and allowing them to earn a return likely higher than the repayment rate. The repayment rates (or AFRs) in September 2021 sit at 0.13% (for short-term notes, 0-3 years), 0.65% (for mid-term notes, 4-9 years) and 1.31% (for long-term notes, 10 or more years).

Some of these planning opportunities may only be available for a couple more months. Anticipating that, many have rushed to take advantage of the favorable tax laws while they can. As a result, fewer planning professionals have capacity to take on new cases. Time is of the essence.

For more information on this topic, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

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