Year-End Estate Planning Techniques in Times of Political Uncertainty

Miller & Martin PLLC Alerts | October 20, 2020

Based on the uncertainty of our current political climate, the current transfer tax structure related to estate and gift taxes could be dramatically revised. Everyone currently has an estate tax exemption of $11,580,000 (adjusted for inflation each year).  This exemption can be used either to protect lifetime taxable gifts from gift tax or to protect assets you leave in your estate from estate tax at your death.  This exemption is currently scheduled to go down to approximately $6,000,000 in 2026.  Democratic proposals would reduce the exemption next year to between $3,500,000 and $6,000,000, with the tax rate on assets exceeding the exemption rising as well from the current 39% to potentially as high as 70%.  The basic assumptions underlying current estate plans could be adversely impacted in additional ways:

  • Increased transfer tax rates
  • Elimination of the step-up in income tax basis at death
  • Adverse modification of rules governing current popular estate planning techniques, such as changing the terms of years allowed in certain trusts, eliminating valuation discounts, etc.

Before the end of 2020, some clients may want to utilize currently available estate planning techniques to reduce the size of their estates and take advantage of the present IRS rules allowing them to use all or a portion of the current high estate tax exemption of $11,580,000 before it might be reduced.  If the exemption is reduced and you have not used it, the portion reduced is lost.  Some of these techniques include:

 Spousal Limited Access Trusts (“SLATs”)

A SLAT is an irrevocable trust that one spouse sets up for the benefit of the other spouse using his or her own assets.  The assets are removed from the grantor-spouse’s estate, and the beneficiary spouse may receive income and/or principal distributions from the trust during his or her lifetime.  The grantor spouse indirectly benefits from such distributions.  Assets in a properly structured SLAT are not taxable in either spouse’s estate and are not reachable by either spouse’s creditors.

 Sale to an Intentionally Defective Grantor Trust (“IDGT”)

This technique would allow you to sell an asset to a trust (the IDGT) and then receive an installment note in return. At least 10% of the value of the asset should also be contributed to the trust as seed money; this contribution is a taxable gift, but it keeps the entire asset from being considered a taxable gift to the trust. You would then receive either payments on the note for a specified period of time or annual payments of interest with a final payment of the principal at the end of the term.  Any remaining income and appreciation on the trust assets in excess of the principal will pass to the trust beneficiaries free of gift, estate, and GST tax if the rate of return exceeds the applicable federal rate.  This technique is most effective in an environment of low interest rates.

 Charitable Lead Annuity Trusts (“CLATs”)

A CLAT is an irrevocable trust into which you transfer an asset, removing it from your estate, so no estate taxes will be owed on it at the time of your death, and you also take a charitable tax deduction at the time of the transfer.  The trustee may sell the asset at full market value but pays no capital gains tax.  The trustee may (and usually does) re-invest the sales proceeds in income-producing assets. The CLAT then pays the income to a charity (or charities) that you have chosen for a term of years.  After that term of years expires, the remaining assets are distributed to the remainder beneficiaries that you have named.  The taxable gift at the creation of the trust is the fair market value of the assets reduced by the present value of the annuity created. 

 Charitable Remainder Trust (“CRTs”)

A CRT is similar to a CLAT in that it is also an irrevocable trust into which you transfer an appreciated asset with the same benefits of removing the asset from your estate (thus avoiding estate tax at your death) and taking the charitable deuction.  The trustee may also sell the asset with no capital gains tax and reinvest the proceeds in income-producing assets.  The difference between a CLAT and a CRT, though, is that the CRT first pays income to you for your lifetime, then at your death the remaining trust assets are distributed to a charity (or charities) that you have chosen.

Grantor-Retained Annuity Trust (“GRATs”)

A GRAT is a trust into which you transfer assets for a term of years, during which time you receive an annual annuity payment.  When the term expires, any remaining principal is distributed to the beneficiaries that you named in the trust.  Like a CLAT, the transfer is a taxable gift equal to the fair market value of the assets reduced by the present value of the annuity created.  However, GRATs are often structured with the goal of “zeroing out” the trust, meaning that the present value of the retained annuity interest equals the value of the asset you transferred to the trust.  The result is that the taxable gift would be zero.

 Qualified Personal Residence Trust (QPRT)

With a QPRT, you would transfer your home to this special trust but you would retain the right to continue living in it for a specified term of years.  If you outlive the term of the trust, you will have successfully removed the value of the house from your estate.  At the end of the term, the house is transferred to the beneficiaries of the trust that the person has named, and there is a reduced gift-tax cost. You can continue to occupy the home after the term of the trust expires, but you will pay rent to the trust, which further reduces your estate. Basically, the longer the term of the trust, the greater the reduction of the gift-tax.  One must outlive the term of the trust, though, to avoid having the fair market value of the trust included in your estate.  You can also transfer a vacation home into a separate QPRT (a QPRT can only hold one property).

Disclaimer Gift

Making gifts in trust to beneficiaries with a right to disclaim the gift may provide an additional window of opportunity to wait and see what might happen to the exemption amount. A gift can be “undone” within 9 months if the beneficiary disclaims the gift within that time period. This strategy can be used alone or in connection with other strategies.

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These planning ideas are provided for your consideration. Selection and implementation of these concepts should only be undertaken within the context of your overall planning objectives with the advice of counsel. We would be pleased to advise you on these and other ideas that might be appropriate for you and your family in these changing times. These concepts require careful planning and require a balancing of tax risks and potential rewards.

Please contact attorneys Donald Morton, James TramonteJennifer Smith, or any of our Trusts, Estates & Wealth Management attorneys to schedule an appointment.