Estate Planning 2021: Estate Planning in 2021–The Time is Ripe
Under the Tax Cuts and Jobs Act (“TCJA”), passed by Congress in 2017, federal gift, estate and Generation Skipping Tax (“GST”) exemptions have increased to $11,700,000 (or $23,400,000 for a married couple) as of January 1, 2021. These historically high exemptions have created unique opportunities for high net worth individuals to shift considerable amounts of wealth to their children and subsequent generations. This year may be the optimum time to take advantage of one or more gifting techniques described below.
Because the TCJA was passed through the Reconciliation process, it expires by its terms as of January 1, 2026, and the exemptions revert to their pre-TCJA levels of $5,490,000 per individual, $10,980,000 per couple, adjusted for inflation. There is also the possibility that the exemption rates will be pared back by Congress to their pre-TCJA levels or even lower (as well as an increase in the maximum estate, gift and GST tax rates) as part of legislation that may be passed through the Reconciliation process this fall. If such legislation is passed, while there is the risk of retroactive application of changes to the federal estate, gift and GST tax structure, the likelihood is greater that any changes made would be prospective to January 1, 2022 or, at worst, upon the date of enactment of the legislation.
Apart from the possibility of new legislation negatively affecting estate planning, a positive reason for high net worth individuals to act soon to use their federal gift and GST exemptions is that the current values of many assets, particularly real estate, have been greatly diminished by the effects of the COVID-19 pandemic, making it a great time to transfer such assets, or interests in the entities owning such assets to vehicles for the benefit of younger generations. Even if exemptions are not pared back and rates are not increased, transferring such assets now, when they will have a lower valuation, will keep future appreciation and income out the older generation’s estates.
New York residents also need to bear in mind that its current estate tax exemption is $5,930,000, or $11,860,000 per couple, indexed for inflation. New York currently does not have a gift tax, but gifts made within three years of death are added back into the decedent’s estate. The New York estate tax structure is particularly harsh on estates which are valued at more than 105% of the applicable exemption amount. In such cases, no exemption is allowed (the “cliff”), and New York estate tax is levied starting from dollar one (after funeral, administration and other allowable deductions). Lifetime gifting will also have the effect of insulating gifted assets from New York estate tax and, if the donor survives for three years, in some cases it will also reduce the donor’s remaining estate below the applicable exemption amount.
Strategies to Maximize Use of Current Federal Gift and GST Exemptions
A number of strategies provide attractive opportunities to maximize wealth transfer using the current Federal Gift and GST exemptions. While a detailed discussion of such strategies is beyond the scope of this article, I have listed a number of the strategies with brief explanations below.
Dynasty Trusts, SLATS, IDGTs
One of the most effective wealth transfer techniques is the use of a generation skipping or “dynasty” trust. The trust is funded with assets that have maximum growth potential. The trust is structured so that the grantor’s children, grandchildren and possibly subsequent generations may access income and some principal from the trust. The grantor uses his/her lifetime gift and GST tax exemptions to remove the value of the assets from the grantor’s estate. The value of the trust will not be included in the estate of the grantor’s children or grandchildren as well. If structured as an Intentionally Defective Grantor Trust (“IDGT”), discussed below, then during the grantor’s life, the grantor would pay income taxes on the trust’s income. After the grantor’s death, the trust, or beneficiaries receiving the income would be liable for the income taxes. The grantor would allocate his GST tax exemption to the trust. If a grantor does not want to pay the income taxes on the trust’s income, the trust may be structured as a non-grantor trust, in which case, the trust, or the beneficiaries receiving the income, would be liable for the income taxes.
A Spousal Lifetime Access Trust (“SLAT”) is a variation on a dynasty trust. The grantor spouse funds the SLAT with assets that have maximum growth potential. The SLAT is structured so that the non-grantor spouse is a beneficiary of the trust during his/her lifetime so in the event the assets or the income from the assets is needed by the couple, they are accessible. However, if not accessed, the assets and growth in value are removed from both the grantor’s and non-grantor spouse’s estates, and if also structured as a dynasty trust, will not be taxed in the estates of the grantor’s children or grandchildren. Two caveats regarding the SLAT: First, on the death of the beneficiary spouse, the grantor spouse will no longer have access to the income or principal of the trust, but it will remain in trust for the grantor’s children and subsequent generations. Second, in the event of a divorce or other strife in the marriage, the grantor spouse may lose access to the trust assets depending on the beneficiary spouse’s actions. A SLAT is also an IDGT for income tax purposes.
An IDGT is a grantor trust in which the assets transferred to the trust are considered gifts and removed from the grantor’s estate for estate tax purposes, but income, credits and deductions attributable to the trust assets are taxable to the grantor, not to the trust or beneficiary who receives such income. If the grantor can afford it, this has the advantages of not only removing the value of the transferred assets and the future growth of such assets from the grantor’s estate, but because the grantor continues to pay income tax derived from income earned on the transferred assets, the trust and/or beneficiary receives additional wealth while the grantor bears the tax.
Additional Planning Techniques
The following techniques also continue to be attractive:
Gifting partial interests in closely held entities holding real estate, business interests, stocks and securities can qualify for substantial discounting from the net value of the underlying assets based on minority interest, lack of control and marketability. Gifting such interests to one of the trusts discussed above is a powerful tool for maximizing wealth transfer.
An installment sale of assets by a grantor to an IDGT can provide a method of selling low basis property without recognizing a gain due to its grantor status. The grantor takes back an installment note from the trust equal to the fair market value of the property sold. Ideally, low basis property with good appreciation prospects and features that permit its qualification for valuation discounts would be used. This would not be a gift transaction and would lock in the transfer of assets at a discounted valuation plus future growth.
The use of Grantor Retained Annuity Trusts (“GRATs”) and loans to younger generation family members (or trusts for their benefit) with interest charged at the minimum rate allowed by the IRS both take advantage of low interest rates to allow the funds used in these vehicles to invest with a greater return for the younger generation than the interest which will be paid to the older generation creating the GRAT or making the loan.
The techniques above are only a sampling of strategies that may be used to transfer wealth. There are many nuances in the techniques described above, and not every technique is suited to a particular family’s needs and circumstances. However, while the gift, estate and GST tax exemptions remain high, and closely held business assets remain depressed in value, the time is ripe to consider transferring wealth to younger generations. Members of Rosenberg & Estis’s newly added Trusts and Estates Department would be happy to assist in devising a plan suited to your particular situation.
The above is only a summary and should not be viewed as a complete analysis of the rules in the areas discussed. The information provided may not be applicable in all situations, and legal guidance regarding your particular situation should be obtained prior to implementing any of the strategies described in this article.