Wealth Transfer Strategies to Consider Ahead of the 2020 Election

Written by: Bennie A. Wall

Posted on: October 30, 2020

wealth strategies for estate and gift tax exemption

Written by: Bennie A. Wall

With the 2020 Presidential election drawing near, many clients are wondering how the ensuing chaos may affect the bottom line.

From an estate planner’s perspective, regardless of who takes the White House, there is no better time than right now to take advantage of our current tax landscape in your own estate planning.

Current Landscape: Low Interest Rates, Historically High Exemptions, and IRS’s Anti-Clawback Regulations.

Under current law, the estate and gift tax exemption (a.k.a. the basic exclusion amount) is set at $10 million (indexed for inflation to a total of $11.58 million in 2020). Any wealth over the exemption amount is taxed at a rate of 40% before it passes to beneficiaries. The generation skipping transfer (“GST”) tax exemption is a matching $10 million (again indexed for inflation to a total of $11.58 million in 2020).

In addition to these historically high exemptions, we have recently experienced historically low federal interest rates. These low interest rates are making this an opportune time to consider wealth transfer strategies like intrafamily loans or sales, installment sales to intentionally defective grantor trusts, or grantor retained annuity trusts to transfer large amounts of wealth with limited or no gift tax liability. Add into the mix these high exemptions and the IRS’s recent regulation regarding “clawbacks” and you have set up a recipe for fantastic estate planning opportunities between now and year’s end. BUT TIME IS LIMITED! Scheduled reductions to the current exemptions, an upcoming election, and continued government stimulus spending, mean these opportunities will likely be clamped down on in the years to come.

Future Landscape: Scheduled Reductions, Proposed Changes, Easy Targets.

Scheduled Reduction to Exemptions

The currently high exemptions (i.e. $11.58 million) for gift, estate, and GST taxes are scheduled to be cut in half to $5 million (also to be indexed for inflation) on January 1, 2026, unless new legislation is passed before then.

Proposed Changes from Biden Administration

Much of what we know about the potential tax landscape under a Democratic majority has been pieced together from reviewing campaign speeches and debates, observing interviews with candidates, and pouring over drafted legislation that is waiting to be introduced into Congress for passage.
Presidential candidate Biden has suggested that he supports legislation to reduce both the estate and GST tax exemptions to $3.5 million per individual and would lower the lifetime gift tax exemption to $1 million.

In addition to reduced transfer tax exemptions, a number of Democratic tax reform proposals have discussed returning estate tax rates to “historic norms.” What does that mean? It is hard to say until more plans are made public. Looking back in time, the top estate tax rate was 77% in the 1940s and rates were has high as 45%-55% in the early 2000s. In any event, we may see a sharp increase from today’s 40% flat rate.

Easy Targets to Fill Coffers

It is important to note that the chances of these changes being implemented in the near future are not limited to what happens in the November elections. It is very likely, even if President Trump remains in the White House, that Congress will rein in some of the more favorable gift and estate tax provisions. After all, funds will need to be raised somewhere to offset the pandemic related spending and stimulus packages. Since wealth transfer taxes have always been an easy target when Congress needs to raise funds, changes to our current tax landscape could be implemented even by a Republican-controlled Congress as the nation grapples with the economic pressures stemming from the coronavirus pandemic.

What can you do to prepare?

With so much uncertainty, you need to consider how lower tax exemptions, increased tax rates, and the potential end of adjusted (stepped-up) tax basis on inherited assets will affect your estate planning.

No matter what plan you put in place, you will want to move swiftly with implementing any of these strategies. The process to plan, draft, obtain valuations, and transfer assets can take months. Any changes Congress makes to the current rules in 2021 can be made retroactive to January 1st, so ideally you will have your plan in place and funded before December 31, 2020.

Below, I’ve outlined what I find to be five of the most popular wealth transfer strategies used by clients interested in taking advantage of today’s tax landscape to protect their family’s wealth.

#5 – Lifetime Gifts to Children

Making lifetime gifts to children is often viewed as the simplest strategy. Since the estate and gift tax exemption is a unified credit, meaning you can either give away $11.58 million during your lifetime, or when you pass away, but not both, many people see it as an easy solution to go ahead and make gifts to their children (and maybe grandchildren) up to their current exemption amount.

Not a bad strategy if you have the money to spare and your beneficiaries are responsible; however, few families are so lucky. With the money involved, you should consider the consequences of lifetime gifts to children outright vs. gifts to trust for the benefit of children. Utilizing trusts for gifting to your children will allow you greater control over the disposition of your wealth and will help to ensure: (1) that the gift you make is protected from the beneficiary’s creditors, (2) that your gift does not leave your child in a divorce, and (3) that there are no estate taxes paid when any remaining wealth or appreciation passes from your children to future generations.

Consider, for example, the following:

Kevin and Anne are married, and they are concerned about a potential decrease in the estate and gift tax exemption amount in the coming years. Their estate is valued at $30 million, they are comfortable living the rest of their lives on $6 million and decide that they would like to go ahead and make a substantial gift to their daughters.

While they have full confidence in their three girls to be good stewards of the funds, they want to ensure that the funds are protected and stay in their family. They establish three gifting trusts, one for the benefit of each daughter, and fund them utilizing their combined exclusion amount of $23.16 million (Kevin’s $11.58 million and Anne’s $11.58 million).

They pass away in the same year when the estate and gift tax exemption has been reduced to $3.5 million per person. Even though they have gifted more than the $7 million allowed between the respective exemptions in effect at their deaths, they will not need to worry because they took advantage of the opportunity when the exemption was at a historic high and the IRS has taken the position that it will not punish taxpayers with a clawback provision. See Treasury Regulation Section 20.2010-1. As a result, Kevin and Anne have saved over $6 million in estate taxes assuming a 40% estate tax rate at the time of their deaths. If you think that is impressive savings, also consider that any appreciation of the assets gifted are also out of their estates and, therefore, are not subjected to the 40% tax at their death.

The remaining four strategies, outlined below, can be used as part of your overall gifting strategy to achieve similar results.

#4 – Irrevocable Life Insurance Trust

The irrevocable life insurance trust, or “ILIT” for short, is a common tool in wealth transfer planning. You can transfer an existing insurance policy into an ILIT, or the trustee of the ILIT can purchase an insurance policy with funds you gift to the trust.

The donor—i.e., you—can make gifts to the ILIT that qualify for the annual gift tax exclusion (currently $15,000), and the trustee will use those gifts to pay the policy premiums. Since the insurance policy is held by the life insurance trust, the premium payments and the full death benefit are not included in the donor’s taxable estate. Furthermore, the insurance proceeds at the donor’s death will be exempt from income taxes.

#3 – Grantor Retained Annuity Trust

A grantor retained annuity trust, or “GRAT”, is an efficient way for a donor to transfer asset appreciation to beneficiaries without using any (or only using a minimal amount) of the donor’s gift tax exemption. After the donor transfers property to the GRAT and until the expiration of the GRAT term, the trustee of the GRAT will pay the donor an annual annuity amount. This provides the donor with a stream of income for the term. The annuity amount paid to the donor is calculated using the applicable federal rate as a specified percentage of the initial fair market value of the property transferred to the GRAT.

There are many strategies that can be used with GRATs. A Walton or zeroed-out GRAT is one of the most common used in wealth transfer planning. The Walton GRAT, named after the Walmart heiress Audrey J. Walton, is intended to result in a remainder interest (i.e., the part that is considered a gift) that is valued at zero or as close to zero as possible. This allows for any appreciation above the applicable federal rate (which has recently been at historic lows) to pass to the beneficiaries after the annuity term ends. In other words, not only were you successful in transferring an asset out of your estate with no or minimal transfer tax liability, you’ve also managed to transfer the appreciation gained over the term.

In short, if your goal is to transfer an appreciating asset without having to cut deeply into your gift tax exclusion, then you can seize the moment to take advantage of these historically low federal rates and consider a GRAT as part of your overall wealth transfer planning.

#2 – Spousal Lifetime Access Trust

A spousal lifetime access trust, or “SLAT”, allows a spouse to gift assets to an irrevocable trust for the benefit of the other spouse and possibly the children and grandchildren. The SLAT is set up to ensure that the donor spouse’s exemption is utilized—thus shielding any appreciation on the assets transferred to the trust from future estate taxes.

The spousal lifetime access trust solves one of the greatest concerns individuals have with wealth transfer planning: i.e., giving up control and wealth. With the spousal lifetime access trust, an independent trustee can make discretionary distributions to the spouse. While funds that are distributed from the trust lose the tax advantages provided by the trust, knowing that your spouse may benefit from the assets held in the SLAT allows you both to rest assured that even if life takes a turn for the worse at least you have not given all your money to your children.

In short, a SLAT allows one spouse to lock in the current, historically high exemption and allows the other spouse access to those funds through an independent trustee—potentially saving millions in estate taxes in the future.

#1 – Qualified Self Settled Spendthrift Trust

The qualified self-settled spendthrift trust, or QSSST, is a type of Domestic Asset Protection Trust outlined in the Code of Virginia. Very few states have statutes allowing for the creation of a self-settled asset protection trust, so many are surprised to learn about this unique planning opportunity.

The QSSST, pronounced as Quist, is an irrevocable trust that, unlike any of the other trusts outlined above, allows the donor to remain a beneficiary of the assets. In fact, the Code of Virginia explicitly provides for this.

Drafted properly, the QSSST will not only provide you excellent creditor protection but can also be used to lock in the current high estate and gift tax exemption.

A transfer to a QSSST will count as a completed gift for gift tax purposes so long as the assets transferred are not reachable by creditors of the donor. Under the applicable Virginia statute, a “qualified interest” in a QSSST cannot be attached by a judgment creditor. There are other factors at play, but with careful drafting you can have your exemption frozen at these great rates and have the peace of mind knowing that should you ever need to live off assets in the trust, you can. Just think of it as a super secure rainy day fund capable, if untouched, to pass on massive wealth for generations.

When Should You Talk to an Estate Planner?

If you are ready to take advantage of this limited opportunity to transfer massive wealth with minimal taxation, time is running out as 2020 is coming to a close!

If any of the strategies discussed above interest you, or you feel that potential legislation will negatively impact your wealth, we strongly encourage you to schedule a meeting with us at your earliest convenience. We can review your estate plan and recommend improvements to protect you from future changes.

If you would like to set up a meeting (virtual or in person) to discuss this valuable information or anything else on your mind, please contact us today and mention that you have read this post.

Further Reading: For more information on the current tax laws, check out our post on the Tax Cuts and Jobs Act of 2017.

Upcoming Articles: Over the next couple of weeks I will be posting more in-depth articles on each of the Trusts outlined above, so be sure to subscribe to our blog so you do not miss out.

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