The big question in the estate planning world today is whether, when, and to what extent Congress will pass changes to gift, inheritance and income tax laws. With many challenges facing the new Biden administration and the Strictly Democratic Senate, major tax legislation may not even be considered in 2021. Nonetheless, the tax proposals approved by the Biden administration provide clear signals for actions that customers should consider this year.

KEY POINTS TO REMEMBER

• Donation time is 2021 – change is on the horizon.

• The timing and extent of potential changes to gift tax and inheritance laws is unclear.

• Some potential changes include: reducing the exemption, increasing the inheritance tax rate, increasing the capital gains tax rate, and eliminating the base adjustment.

• Consider “locking in” the $ 11.7 million exemption by donating to irrevocable trusts and continuing to take advantage of low interest rates to deflect your estate appreciation through techniques such as FREEs. and intra-family loans.

• Retroactive changes are unlikely; expect the changes to take effect on January 1, 2022 at the earliest.

Potential tax changes having the greatest impact on the transfer of wealth

During his campaign, President Joseph Biden proposed to lower the current exemption amount from $ 11.7 million to $ 3.5 million per person and to increase the inheritance tax rate from 40% to 45% on amounts exceeding the exemption. Reducing the exemption to $ 3.5 million is ambitious in itself, given the need for support from moderate Democrats with large Republican bases. Instead, Congress can simply revert to $ 5 million, adjusted for inflation, which was the amount of the exemption before the substantial increase enacted under the Reductions Act of 2017. tax and employment (TCJA).

For what it’s worth, the exemption has never been lowered. Despite this, the doubling of the exemption under the TCJA was a radical departure from previous policies. Thus, reducing the exemption to $ 5 million, adjusted for inflation, seems easier to agree. In other words, Congress can choose to treat the past four years as a fluke and go back to “normal”.

The Biden team also signaled during the campaign that they would call for the repeal of the base increase on death and tax the capital gains as ordinary income. While base elevation is a concept in tax planning, it is also an important consideration in transfer tax planning. Under current law, donations of low base assets can be detrimental because the donee receives the base from the donor. Taxpayers often decide to keep some low base assets, rather than selling or offering them, to get the base markup on death. The family members or trusts that receive these assets can then sell those assets with little or no capital gains tax.

The Biden campaign had proposed eliminating this basic adjustment. Another proposal is to treat the transfer of property appreciated on death or by donation as a taxable event leading to recognition of the gain, but commentators believe this is unlikely.

Biden’s campaign proposal to tax long-term capital gains and qualifying dividends as ordinary income on all income over $ 1 million would further worsen the impact of repealing the base increase . It is also possible that Congress will increase the current highest ordinary income tax rate from 37% to 39.6%.

Planning for the coming year

This year is a good time to make the most of your inheritance and gift tax exemption and the low interest rate environment.

“Immobilization” of the exemption from inheritance and gift tax

Many very wealthy people have used most, if not all, of their exemption. Under current tax laws, in 2021, individuals can donate up to $ 11.7 million over their lifetime ($ 23.4 million for married couples). If the exemption goes from $ 11.7 million to $ 3.5 million and the inheritance tax rate goes from 40% to 45%, the cost of inaction is almost $ 3, $ 7 million (if an individual donates $ 11.7 million while the exemption is $ 3.5 million and donations in excess of the exemption are taxed at a rate of 45 percent , the resulting gift tax is approximately $ 3.7 million; $ 7.4 million for married couples). If individuals and married couples have not used their exemption (s) and can afford it, they should seriously consider completing giveaways equal to their remaining exemption (s) in 2021. , ideally to a generation leap trust for the benefit of their descendants. .

Depending on your goals and family, situation, remaining exemption, and cash flow requirements, it may not be possible to give up to $ 23.4 million, or even $ 11.7 million, to a trust for your beneficiaries. One long-accepted way to address this concern is to create a trust that benefits both the spouse and the descendants of the grantor. These are commonly referred to as Spousal Life Trusts (SLATs). A SLAT is a simple and effective way to meet the possible need of the older generation to access transferred property – it provides direct access for the beneficiary spouse and indirect access for a grantor spouse. Arrangements of the transferor trust, such as those allowing the transferor of the trust to exchange assets or take out loans from the trust, provide tax flexibility and access to funds by borrowing.

SLATs have become so popular that couples have created trusts. This is not without risk and should only be done with different trust arrangements and with the creation of separate trusts over time. Finally, it’s important to remember that potential estate tax savings should never be the sole determinant of your financial planning decisions. People who have made an effort to give important gifts sometimes have deep “donor remorse”. So, give gifts if you can, but, more importantly, do them if you are comfortable doing so.

Freeze domain size

Perhaps you and your spouse have already used your exemptions and are looking for ways to further reduce the tax burden on your estate, or you are not ready to make large transfers of your property. Either way, a great alternative is to freeze the growth of your estate with strategies such as Preserved Annuity Trusts (FREEs) and installment sales with family trusts or loans. FREEs and installment sales thrived in a low interest rate environment (as we wrote previously) because assets have often appreciated in value at a rate higher than the annuity rate, in the case of FREEs, or the interest rate on a note. Thus, these strategies essentially “freeze” the size of his estate and transfer a significant appreciation, which otherwise would have remained in the client’s estate, out of his estate.

Uncertainty does not prevent planning

It is absolutely within the power of Congress to enact retroactive tax legislation if it is rationally linked to a legislative objective, but on a practical level Congress generally avoids doing so. It is almost always unpopular and only adds nominal additional income for budgeting purposes. Biden administration officials have previously said they don’t want retroactive tax changes.

Given the low probability, the threat of retroactive changes in tax law should not prevent clients from implementing new estate planning strategies. For those who remain concerned, a number of strategies can be structured to limit the potential liability of gift tax in the unlikely event that legislative changes are adopted retroactively. In 2021, customers should consider reviewing their existing plan to determine if they can use certain strategies to maximize the use of their exemption and meet their planning goals.