2020 has been a year of unprecedented uncertainty for many individuals and businesses, with the coronavirus pandemic wreaking havoc on the economy, financial markets, industry segments, financial prospects for individual companies and the valuations of asset holdings. More change could be coming this fall, with an election, the prospect of a new administration on the horizon and the uncertainty of future economic conditions. If Democrats gain control of both Congress and the White House, many expect that significant tax increases will be enacted. This confluence of events has created a sense of urgency for estate planners who wish to take advantage of the current favorable estate tax regime, which may only be in effect through the end of the year, and potentially reduced company and asset valuations. While the election outcome will not be known until November, estate planning strategies can often take weeks or months to carry out and should be put into motion as soon as possible.
Gift and Estate Tax Exemption
The gift and estate tax exemption is the maximum amount of wealth that can be passed on from one generation to the next without incurring the federal gift or estate tax. The current exemption is $11.58 million for each individual ($23.16 million for a married couple), meaning that an individual can make lifetime gifts or bequeath to descendants up to $11.58 million tax-free. Prior to 2018, the exemption amount was $5 million (indexed for inflation) for several years but was doubled by the Tax Cuts and Jobs Act passed at the end of 2017. The exemption at its current level is scheduled to sunset at the end of 2025, at which point it will revert back to half of the inflation-adjusted amount at that time.
Proposed Tax Increases
Many commentators have suggested that one of the first policy goals for a Democratic administration, if elected, would be to overhaul the tax code. Joe Biden’s recently published tax plan proposes several tax increases on the wealthy, including an elimination of the step-up in basis of assets that occurs upon an individual’s death. While not specifically addressing the gift and estate tax exemption, Biden has previously indicated that he would aim to restore the exemption amount to “historical norms” (likely in the $3.5 to $5 million range, adjusted for inflation, although historically the exemption has been as low as $1 million). If a decrease to the exemption amount is enacted in 2021, it could potentially be made retroactive to January 1, 2021, meaning that any estate planning strategies utilizing the current amount would need to be completed by then.
Potential Planning Strategies
To mitigate the risks posed by an unfavorable change to the federal gift and estate tax rules, an individual can make a gift of assets prior to December 31, 2020 and lock in the current, generous exemption amount as well as generally reduced business and asset valuations. By making such a gift, the assets would be removed from the present owner’s estate and any future appreciation would also avoid any gift or estate taxes. While such a gift can be made outright to an individual, many donors would prefer to place the gifts in trust or into an entity such as an LLC or family partnership. Below are just a few of the techniques that can be used to implement a gifting strategy without providing the recipient immediate access to and control over the assets:
- Family Limited Partnership: This technique involves placing assets in a partnership (or LLC, or other similar business entity) prior to gifting them. By gifting units in the partnership rather than the assets themselves, a marketability discount may be applied to reduce the value of the gift.
- Intentionally Defective Grantor Trust (“IDGT”): In this structure, the owner of the assets can either gift the assets to the IDGT or sell them in exchange for a promissory note. Since the grantor is still deemed to own the assets for income tax purposes, the transferor’s estate can be further reduced by the income taxes due on the trust’s future income.
- Spousal Lifetime Access Trust (“SLAT”): For individuals with spouses, a SLAT can be used to provide for future generations while allowing the beneficiary spouse access to funds if he or she needs them. Such trusts can be funded by both spouses for the benefit of the other.
There is no guarantee that estate and gift tax laws, as well as generally reduced business and asset valuations, will change in the near future, even with a Democratic victory in the November elections. However, individuals with substantial assets and unused gift and estate tax exemption amounts should consider contacting an estate planning professional to discuss potential strategies that can be implemented before the end of the year.
If you would like more information on estate planning opportunities, please contact your Bennett Thrasher advisor by calling 770.396.2200.