Senator Bernie Sanders released his proposed tax reform legislation on March 25th which outlined major changes to the estate and gift tax rules. This bill, co-sponsored by Senators Gillibrand (D-NY), Whitehouse (D-RI), Reed (D-RI) and Van Hollen (D-MD), will have a similar version in the House sponsored by Representative Gonzales (D-CA).
This bill is impactful and complex from a financial aspect but is straightforward in how it would achieve its goals – by reducing the current estate tax exemption from its present $11.7 million down to $3.5 million, and the lifetime gift tax exemption down to $1 million, beginning in 2022. It will also eliminate or curtail many important planning techniques used by estate planners upon enactment.
The exemption decreases mean that they will be reduced $7 million per person, which is a 70% reduction! Moreover, the exemption will no longer be indexed for inflation. Many individuals, for good reason, will likely seek advanced estate planning strategies to gift their existing exemption (up to $11.7 million) prior to year-end 2021. If the gift exemption is not used, then it will be wasted.
This is best illustrated by example: Bob has made $2 million of taxable gifts and has $9.7 million of his exemption remaining. If Bob uses another $1.5 million of his exemption, then he will have nothing left for 2022 and beyond if the legislation becomes law, since his total gifts would now be $3.5 million.
Bob may be encouraged to use at least $6.2 million of his exemption prior to year-end so that he does not lose that amount and should consider using the full $9.7 million of exemption remaining. Bob would have to give more than $3.5 million to take advantage of the current exemption amount.
The amount in the example may be transferred to an irrevocable trust for the benefit of Bob’s spouse and descendants. That trust may also benefit Bob in the event Bob were to suffer any financial hardship, so long as the trust is properly formed and operated in a creditor-protected jurisdiction.
It’s likely that many married couples, in response to this rule, have one of the spouses establish a trust for the other and the couple’s descendants, while the other spouse establish a trust that may solely benefit the couple’s descendants. The IRS challenges spouse’s trusts that are too similar under something known as the “Reciprocal Trust Doctrine.” There are many strategies to mitigate the possibility of an IRS challenge. Each family should seek competent counsel to guide through the strategies that makes sense relative to the family’s goals.
Perhaps some of the most problematic features of this legislation can be found in the gifting limitations. Currently individuals enjoy an $11.7 million gift tax exemption, reduced by any taxable gifts made during life. If you’ve made more than $1 million of transfers outside of annual exclusion gifts to your loved ones (or others), and don’t take advantage of your current exemption prior to this legislation becoming law, you won’t have the opportunity to make transfers outside of the annual exclusion gifts without paying gift tax.
As I mentioned earlier, the bill does away with several common planning techniques as well. These include Intentionally Defective Grantor Trusts (IDGTs), Grantor Retained Annuity Trusts (GRATs) that are less than 10 years in duration, Irrevocable Trusts that last more than 50 years in duration, and family partnership valuation discounts.
Annual exclusion gifting techniques will also be curtailed if the legislation becomes law. Crummey transfers for insurance is one such technique, as would be other transfers where the donee doesn’t have the ability to liquidate the gift.
No one is certain whether this legislation will pass, or whether aspects of it will change before becoming law. Nevertheless, the clock is ticking, leaving taxpayers with less than eight months to decide whether to use the current law to their advantage.
It promises to be a busy year for estate planning. I published a whitepaper covering this bill in greater detail, that you can download for free. Go to floridaestateplanning.com/thank-you-scoop-of-unfavorable-tax-legislation/ to download your copy.
Stay tuned to this column for further developments or join my firm’s Facebook group to get the news as it happens.
© 2021 Craig R. Hersch learn more at floridaestateplanning.com