How might the coming election affect you?
I think we can all agree, we have never experienced a year like 2020 with the difficulties presented by COVID-19 and the resulting volatility in the financial and employment markets. As the 2020 presidential and congressional elections approach, the potential for change in the White House and in Congress raises additional uncertainty as to how estate, gift, and income taxation laws will change in the coming years.
Wealth Transfer Taxation
In 2011, Congress set the estate, gift, and generation-skipping transfer (GST) tax exemption amount at $5 million per individual ($10 million per married couple), adjusted each year for inflation. In 2017, in response to President Trump’s call to repeal the estate and gift tax, Congress compromised and passed legislation temporarily doubling the exemption amounts until the end of 2025, when the legislation is scheduled to sunset (expire). In 2020, an individual may make $11.58 million, and a married couple may make $23.16 million, in lifetime or testamentary (at death) transfers without being subject to the 40 percent wealth transfer tax.
With the upcoming election and potential Democratic reform, these all-time high exemption amounts may be decreased sooner than the scheduled sunset in 2026. Presidential candidate Joe Biden has indicated support for policy to raise estate taxes back to the historical norm, which may be achieved by lowering the exemption amounts to a base of $3.5 million (last seen in 2009), $5 million (last seen in 2011), or some other reduced amount determined by Congress, and by increasing the wealth transfer tax rate from the current 40 percent to possibly 65 percent or higher.
Income Taxation
Following the election, taxpayers may also lose the major benefit of full step-up in basis adjustment at death, which effectively reduces or eliminates capital gains upon the sale of appreciated inherited assets, including but not limited to real estate, stock, and other property, if the assets were includible in the deceased taxpayer’s estate at the taxpayer’s death. Unlike property or other assets gifted during the taxpayer’s lifetime, which retain the taxpayer’s carryover basis (the basis at the time of the lifetime transfer), an asset transferred at death to a deceased taxpayer’s beneficiaries receives an adjustment to make the basis equal to the fair market value of the asset at the taxpayer’s death. Presidential candidate Biden has proposed limiting or eliminating stepped-up basis, a longtime taxpayer benefit.
Planning Opportunities
It may be prudent to act now to take advantage of the current wealth transfer and income tax laws. The Internal Revenue Service has taken the position in a revenue ruling that, if the exemptions are reduced after 2026, it will not penalize taxpayers who took advantage of the existing estate, gift, and GST tax exemptions before the reduction by clawing back transferred assets into the taxpayer’s taxable estate. Taxpayers must now use it or lose it to avoid missing out on millions of dollars worth of wealth transfer tax savings.
Specifically, you may wish to consider the following wealth transfer strategies to discuss with your estate planning attorney:
- Intrafamily Sale: The near-historic low federal interest rates provide an excellent opportunity to transfer appreciating or income-producing assets, such as rental real estate or an interest in a family business, to your family members. In return for the assets, your family members execute a note paying you both principal and interest. If your family can generate a return on the assets greater than the interest on the note, you have successfully transferred wealth to them without using any of your estate and gift tax exemption.
- Swap Power for Basis Management: Assets gifted or transferred to an irrevocable trust do not receive a step-up in income tax basis at the donor’s death. Gifted assets instead retain the donor’s carryover basis, potentially resulting in significant capital gains realization upon the subsequent sale of any appreciated assets. Swap powers allow you to remove one or more low-basis assets from an existing irrevocable trust in exchange for one or more high-basis assets currently owned by and includible in your estate for estate tax purposes. In this way, low-basis assets are positioned to receive a basis adjustment upon your death, and the capital gains realized upon the sale of any high-basis assets, whether by the trustee of the irrevocable trust or any trust beneficiary who received an asset-in-kind, may be reduced or eliminated.
- Grantor Retained Annuity Trust: A grantor retained annuity trust (GRAT) is an efficient way to transfer asset appreciation to beneficiaries using a minimal amount of gift tax exemption. After assets are transferred to the GRAT and until the expiration of the initial term, the trustee of the GRAT will pay you, the donor, an annual annuity amount. The annuity amount is calculated using the applicable federal rate as a specified percentage of the initial fair market value of the property transferred to the GRAT. A Walton or zeroed-out GRAT is intended to result in a remainder interest (the interest that is considered a gift) valued at zero or as close to zero as possible. Your retained interest terminates after the initial term, and any appreciation on the assets in excess of the annuity amounts will pass to your beneficiaries. In other words, if the transferred assets appreciate at a rate greater than the historic low applicable federal rate, the GRAT will have succeeded in transferring wealth.
- Installment Sale to an Intentionally Defective Grantor Trust: This strategy is similar to the intrafamily sale described above. However, the income-producing assets are sold to an existing irrevocable trust instead of directly to a family member. In addition to selling the asset, the donor also seeds the irrevocable trust with assets worth at least 10 percent of the assets being sold to the trust. This strategy gives you the opportunity to efficiently use your remaining gift and GST tax exemptions if the assets sold to the trust warrant a valuation discount.
- Spousal Lifetime Access Trust: A spousal lifetime access trust (SLAT) allows you to lock in the current, historic high exemption amounts. You transfer an amount up to your available gift tax exemption into the SLAT. Because the gift tax exemption is used, the value of the SLAT’s assets is excluded from both your and your spouse’s gross estates. Your spouse may also execute a similar but not identical SLAT for your benefit. The SLAT allows the appreciation of the assets to escape federal estate taxation and, in most cases, the assets in the SLAT are generally protected from creditor claims. Because the SLAT provides protection against both federal estate taxation and creditor claims, it is a powerful wealth transfer vehicle that can be used to transfer wealth to multiple generations of beneficiaries.
- Irrevocable Life Insurance Trust: An existing insurance policy can be transferred into an irrevocable life insurance trust (ILIT), or the trustee of the ILIT can purchase an insurance policy in the name of the trust. You can make gifts to the ILIT that qualify for the annual gift tax exclusion, and the trustee will use those gifts to pay the policy premiums. Since the insurance policy is held by the ILIT, the premium payments and the full death benefit are not included in your taxable estate. Furthermore, the insurance proceeds at your death will be exempt from income taxes.
If you wish to minimize the taxes due at your death and would like to discuss these strategies in more detail, or if you have not updated your estate planning documents recently, it is crucial that we schedule a meeting to review your Estate Plan. We will not only ensure that the documents are appropriate under current laws, but also take steps to protect you from future changes in legislation that may negatively impact your estate. Some wealth transfer strategies require a considerable amount of preparation, so time is of the essence.
At Kerlin Walsh Law, we are here to answer questions, address your concerns, and ensure that your Estate Planning needs are met. Simply call our offices today at 708.448.5169 and you will be assured Estate Planning with warmth and competence.
