No
one can say that 2020 has been an ordinary year – from the outbreak of COVID-19
in the first quarter of 2020 to the death of Supreme Court Justice Ruth Bader
Ginsburg to the upcoming Presidential election.
Here
are ten estate planning tips worth considering, right here, right now, during
the final three months of 2020:.
1.
. The Federal Reserve’s decision to keep
interest rates historically low, even at the risk of inflation, has created a fertile
environment of estate planning freeze strategies which utilize the IRS’s
published interest rates. The Grantor Retained Annuity Trust (or “GRAT”) and
the Charitable Lead Annuity Trust (or “CLAT”) are two techniques which, when
most successfully deployed, allow for the transfer of wealth at a reduced gift
tax cost and provide that the future appreciation on the assets transferred
passes without exposure to the individual’s estate tax. The GRAT pays a defined
sum back to the creator for a fixed number of years, and the remainder passes
to family; the CLAT pays a fixed sum to a named charity for a defined number of
years, and then the remainder passes to the creator’s family. The current
applicable Federal interest rate for determining the gift tax value of these
techniques is currently 0.4%, having dropped from 2.2% in February. Normally a
GRAT or CLAT is most successful when a client transfers an asset which has
significant appreciation potential, such as a closely-held entity where the
owner expects a successful sale in the future. However, funding a GRAT with
securities (or swapping them into an existing GRAT, as described below), given
the relatively depressed and volatile capital markets and the low interest
rates, means that more long term growth resulting from the rebounding stock
market will be able to be passed to family.
3.
Checking the Existing Basic Estate
Plan. Now is the time to review your will or your revocable
living trust agreement (or both) to see if they still accurately reflect your
wishes.
Testamentary
Provisions. Reconsider whether
inheritances should be outright or placed in trust for the benefit of children
and more remote descendants. Parents have a unique ability to provide
meaningful asset protection for children by utilizing trusts for their benefit,
to shield children from claims in divorce and other predatory maneuvers. Simple
wills can overlook nuances that perhaps now during this period have become
magnified, particularly in younger families struggling economically and
emotionally with the pandemic. Review and reconsider choices for executors,
trustees and guardians.
Testamentary
Tax Strategies and the 2020 Presidential Election. Tax strategies and language contained
in the will need to be reviewed as the Presidential election approaches and in
its aftermath. Most sophisticated estate plans are framed around optimizing an
individual’s estate tax “applicable exclusion amount” (or “AEA”) using a credit
shelter trust, and his or her generation-skipping transfer (“GST”) tax
exemption amount using a “dynasty” or descendants’ trust. Attorneys draft for
these strategies in wills or living trusts using a formula meant to maximize
the allowance. For many wills, after the Tax Cuts and Jobs Act of 2017 that
formula was impacted by the increase of the AEA and the GST exemption from
$5,000,000 to $10,000,000. (Increased for inflation, that amount is $11,580,000
today.) Barring Congressional action, the AEA and the GST exemption is set to
retreat to $5,000,000 (again indexed for inflation) on January 1, 2026.
Clients and their
advisors should evaluate these formulas on a case-by-case basis, with an eye
towards the 2020 Presidential election. Vice President Biden has spoken of his
intention to repeal the 2017 Tax Cuts and Jobs Act, which, presumably, means
restoring the AEA and the GST exemption to the $5,000,000 level, as indexed. A
long-standing Democratic agenda item has been to restore the AEA to the Clinton-era
$3,500,000. Curiously, the Trump campaign lacks a definitive statement either
to eliminate the Federal estate tax or even take decisive action to make
permanent the exemption increases in the Tax Cuts and Jobs Act. The one secure
tax take-away is that there is no telling what Congress and the President will
do in 2021 and the years following, and so having the flexibility in a will or
living trust to optimize the wealth tax environment, should death occur during
this period of uncertainty, is essential.
How is this
accomplished? Avoid or revisit formula clauses for credit shelter trusts where
a surviving spouse is involved. These clauses might result in an unexpected and
disproportionate benefit passing to a trust which is not exclusively for a spouse’s
benefit. Better planning suggests drafting to set up a marital trust for the
surviving spouse to hold the estate’s financial assets, which, through
elections made during the period of administration and the ability to divide it
into different shares, can provide the same benefits of planning with the AEA
but offer more flexibility to achieve the best tax strategy overall.
4. Check Advance Directives and
Durable Powers of Attorney. Usually an integral part of the basic estate
planning package, advance directives for health care and durable powers of
attorney tend to gather dust as years wane. Unlike wills, which only take
effect at death, these documents state an individual’s wishes regarding
financial decision-making and health care decision-making while he or she is
alive but unable to act or express intentions. These documents should be
reviewed and refreshed at least every ten years, even if there is no change.
Advance
Directive for Health Care.
Different practitioners may use different forms, but at its core, this
documentation sets out wishes about health care decisions and end-of-life views
(end-of-life decisions are sometimes set out in a separate document known as a living will), and the appointment of a health care representative to act as the
agent to make medical decisions including end-of-life decisions (sometimes set
out in a separate document known as a health care proxy or proxy
directive). Are these choices and
wishes still accurate? Is the agent’s information up to date? Have the wishes been discussed with the
agent? If the pandemic has taught many families one thing about estate
planning, it has stressed the importance of having this document prepared,
properly executed, and having the agent informed and ready with decision-making
knowledge and resolve.
Durable
Power of Attorney. A durable
power of attorney as created by most practitioners immediately grants authority
to an agent to conduct business or financial transactions in the name of the
individual who executes it. That being said, these documents can often be the
most difficult to use. Many banks and financial institutions will insist on
their own forms, whenever possible. In view of these hurdles, these documents
should be reviewed and updated, if necessary, to avoid a costly confrontation
with an uncooperative bank representative should the need arise to have them
implemented. Check the names and addresses of the named agent. If there are
co-agents, can they act independently or is unanimity required? Is there a
power in the agent to make gifts? Is there authority to deal with digital
assets? What is the relationship between the agent and the named executor in
the client’s will?
5. Check Existing Estate Planning
Strategies. Individuals
should take stock and review their other irrevocable strategies implemented in
years past which may be impacted by the current economic and political climate.
Existing life insurance trusts, spousal lifetime access trusts (described
below), dynasty trusts, GRATs, qualified personal residence trusts, and
charitable trusts, to name the most common, all may be accomplishing a desired
goal of minimizing a client’s exposure to estate tax, but they need care and
feeding, and a proper audit from time to time is essential. For example:
Insurance
Trusts. Are Crummey
notices being sent faithfully to trust beneficiaries in the case of insurance
trusts where transfers are being made to the trust to pay premiums? Are the
trust provisions still desirable? Are the successor trustees still acceptable?
Are beneficiary designation forms up to date?
GRATs. Is the property in an existing
GRAT subject to volatility such that it might be appropriate to freeze the
fluctuation by having the creator substitute the property for a less volatile
asset class (like cash) having an equivalent value? Have the required GRAT payments
been made faithfully as prescribed in the trust agreement? If a GRAT has
terminated, has the remaining property been transferred to the beneficiary of
the remainder?
Dynasty
Trusts and Spousal Lifetime Access Trusts.
Are the provisions in the governing instruments regarding trust benefits and
distributions and trustees still desirable? How are the assets performing? Is
there an opportunity to do income tax planning for an asset otherwise excluded
from the creator’s estate by swapping it out, as described above with the GRAT?
In many instances, upon
reviewing these existing strategies, clients or their counsel have identified
concerns or issues which need immediate attention, either because the
provisions are no longer desirable or the technique has lost its purpose
relative to size of his or her estate. Many states, including New Jersey, have
adopted in one form or another, the Uniform Trust Code, which can help
practitioners address changes needed to outdated or out-of-touch trusts.
Decanting, combining or merging may also present viable options.
6. Renegotiate Family Loans.
Intra-family loans can often be a pragmatic solution for individuals
looking to transfer wealth using the technique of an estate freeze. The transfer itself is not a gift, but the
value of the transfer is frozen at the time it takes place, meaning that the
expected return of the principal amount is fixed by the value of the loan,
whereas the asset or funds in the hands of the borrower is allowed to
appreciate free of estate tax. For example, assume in 2015 a parent lends
$1,000,000 to a child to purchase a home. If the parent had the child sign a
promissory note and mortgage with a market rate of interest, no gift occurred.
In October 2015, the applicable Federal interest rate (i.e., the minimum rate
the parent must charge to avoid characterizing the loan as a gift) was 2.44%.
In October 2020, the AFR for the same term loan is 1.12%. By refinancing the
indebtedness, the child can lower his/her payments of interest by more than half.
And if the parent is forgiving the interest as part of an annual gifting
program, the annual gift tax cost has dropped from $24,400 to $11,200.
Consideration should be given, however, to determine if refinancing to a lower
rate and the benefit which the child realizes is, itself, a taxable gift. This
may be avoided if the child pays to the parent the points associated with the
adjustment to the lower interest rate at the time of the refinancing.
7. Using (or Losing) Your AEA before
2021 (or 2026). As mentioned above, the AEA is currently
$11,580,000 per person and, absent any legislative overhaul, will continue to
be adjusted for the next five years with inflation and then disappear,
reverting to the base amount of $5,000,000. Neither candidate seems to have
mentioned gift, estate or GST taxes directly in any public discourse, but the
Biden tax platform does include ending the income-tax benefit of the step-up in
basis on appreciated property at death. The step-up at death currently allowed
under the tax laws offers pragmatic and economic benefits for all taxpayers,
regardless of affluence. Although not entirely clear as yet, a Biden
administration agenda item appears to suggest that previously-unrealized gains
are to be taxed at an individuals death, regardless of whether they are sold.
Similarly, if Republicans were to revive their efforts at full-blown estate tax
repeal, it is likely that the measure would follow the pattern of the repeal
which occurred in 2010, namely that outside of an exemption, most of a
decedent’s assets would not be allowed a step-up in basis.
Sunsetting
and “Clawback.” Putting
aside these possibilities, the enhanced AEA will, absent any legislative
action, sunset on January 1, 2026, thereby eliminating a meaningful amount of
tax-free wealth which an individual can pass to family. Individuals planning for this
increasingly-likely situation are being encouraged to make taxable gifts
immediately which use their AEA (i.e., gifts of up to $11,580,000 for
individuals or $23,160,000 for married couples). In addition, the IRS has
confirmed that taxpayers who make such gifts during this period will not be
penalized even if the base amount of the AEA reverts to $5,000,000 as a result
of the sunset in 2026. Prior concerns of
this “clawback” have discouraged gifts in the past, but with this
pronouncement, there is no downside for making the gifts today and,
potentially, no time like the present.
Techniques. While any irrevocable family dynasty
trust can be effective to make a lifetime gift of AEA, the most pragmatic
technique which keeps the assets within the creator’s reach is the spousal
lifetime access trust (or “SLAT”). SLATs are appealing for married individuals
because, when properly set up, SLAT property remains accessible to the creator
of the trust through their spouse as the beneficiary. However, the growth on
the assets in the SLAT not consumed is passed on to the lower generation
without further exposure to estate tax. Obtaining a policy of insurance on the
life of the beneficiary (in an irrevocable trust) can be a way to insure for
the creator that the death of the spouse-beneficiary does not compromise the
access to funds otherwise being enjoyed by the couple prior to the creation of
the trust. Spouses can set up SLATs for each other, but care must be taken to
avoid the IRS’s “reciprocal trust doctrine” and the “step transaction
doctrine,” both of which can cause undesirable consequences. Clients who are considering the technique but
not sure if or when they want to pull the trigger should take steps now to
prepare for the eventual transfer of assets by making a substantial gift to the
spouse who may not have sufficient assets in her or his own name, in order to
enable that spouse to create the gift. In this way, there is a meaningful
amount of time which has passed and allows the gift to “cure” in the hands of
the spouse before being moved into a trust. Just how much should be considered
to be placed in the trust? The answer will vary from client to client and will
likely depend upon resources outside of the SLAT, but ultra-high net worth
couples are advised to take a large bite of their unused exemption, using the
SLAT, while it is still available.
8. Don’t Forget about the GST: Are
Existing Trusts Being Optimized? Many family wealth portfolios already have in
existence trusts which provide benefits in the form of income, savings or
potential future educational funds for children. Such trusts may have been
created by parents or grandparents or even by the clients themselves during the
last “fiscal cliff” estate planning crisis of 2012. Many of these trusts
present challenges and opportunities for multi-generational wealth planning
which, in this dynamic tax environment, require attention. Many individuals are
unaware of the impact of the Federal generation-skipping transfer (or “GST”)
tax, which, when applicable, creates an additional tax of up to 40% on
transfers which land in the laps of beneficiaries who are two or more
generations removed from the creator of the trust. In reviewing these trusts
clients should be aware of the following:
“Grandfathered
Trusts.” Is the trust even
subject to the GST tax? In general, any trust which was already in existence
and irrevocable prior to September 25, 1985, enjoys the status of being a
so-called “grandfathered trust,” meaning it is not subject to the tax at any
point. Trusts of this nature should be carefully administered to avoid
potential unintended exposure to the tax resulting from the exercise of certain
rights or powers by beneficiaries or the modification of the terms (using
certain statutory techniques or judicial actions). Such actions have the
potential to cause the trust to be subject to the tax.
“Non-Exempt”
Trusts Fully Subject to the Tax.
As wealth from “the greatest generation” passes down to baby boomers, many
sophisticated estate plans have irrevocable trusts that are literally GST tax
ticking time bombs. These trusts were created with an individual’s wealth
which, at the time of transfer, exceeded his or her GST exemption amount
available. By definition, these trusts upon termination will suffer the full
blow of the 40% GST tax, thereby depleting the wealth otherwise intended to be
passed to the family. Trustees have a fiduciary duty to minimize all taxes –
including GST taxes – consistent with the intent of the creator. In many cases
there are options available which should be considered at this time,
particularly in the face of potentially shrinking estate tax exemptions. For
example, assume the principal trust beneficiary is a child of the creator who
has personal assets which fall below the AEA. Here, a trustee might do well to
consider making a large principal distribution to the beneficiary to enable him
to create a SLAT or a dynasty trust using the beneficiary’s own AEA so the
trust escapes both the GST tax as well as estate tax when the beneficiary dies.
Another strategy might include granting the beneficiary a testamentary general
power of appointment which changes the impact of the GST tax and causes the
trust to be included in the beneficiary’s estate for estate tax purposes.
Capital
Gain Taxes and GST-Exempt Trusts.
Apart from the GST tax planning opportunities and obligations, trustees should
also consider the fact that many generational trust strategies may be victims
of their own success in another way:
appreciated assets – particularly in GST-exempt trusts such as dynasty
trusts – may be harboring large unrealized gains. Family members may be pleased
to receive appreciated assets free of GST tax, but that good feeling may soon
dissipate if the appreciated asset is sold and the individual is subject to
income tax on a large, long-term capital gain. Such gains by definition are not
stepped up (as they are in the case where the underlying assets are subject to
estate tax) because they bypass the beneficiary’s estate. Trustees, therefore,
need to consider strategies which might be employed to minimize the potential
gain. Unlike the GST strategies above, these income tax-driven techniques are
more complex and need to be vetted against the individual variables of a
client’s tax picture.
9. Strategize about Business
Succession and Long-Range Planning. The national lock-down which began in March
not only locked down the economy, but it created a unique environment for
business owners to stop and reflect about their enterprises and the future. Is
this the time to liquidate a business? A division? Sell certain assets to raise
cash and redeploy in a different line of products or services? Professional
advisors are essential because they can help provide perspective and options.
And if a business owner is looking to stay the course and transition the
business to the next generation, an important consideration will be the fitness
of the family to continue the legacy in the “new normal.” Business succession
experts and consultants are well aware of the expression “shirtsleeves to
shirtsleeves in three generations,” meaning an entrepreneur’s ability to have a
business thrive multi-generationally is a direct function of the ability of the
family members in the next generation to work hard, continue to innovate and
adapt to new challenges.
10. Consider State Estate and Income
Tax Effects on Your Domicile. One of the unintended silver linings of the
past six months has been the surprising ease with which certain businesses can
conduct their operations in a remote capacity. The increased reliance on
web-based video conferencing technology has revolutionized the way employees
can accomplish tasks. The long-range effect of this shift in employment
platforms may be that companies no longer need employees to remain in a
centralized locale. Indeed, many individuals fled their homes and urban
apartments to take refuge in the Berkshires, the Jersey Shore and Florida,
where they continue to work productively. If business in the post-pandemic age
permits migration, individuals now have a unique opportunity to re-evaluate
their domicile in terms of tax and estate planning. Florida, for example,
affords the benefits of no state income or estate tax and a generous homestead
exemption. New Jersey has – for the moment – repealed its estate tax but has
retained its inheritance tax. Residing in other jurisdictions could have other
benefits. This may be the time to consult a tax advisor to determine if
shifting domicile creates an overall tax reduction. In so doing, clients need
to remember that a residence maintained in a former domicile renders them
vulnerable to tax challenges by that jurisdiction. A legal domicile is a
factual consideration made up of a series of intent-driven indicators which go
beyond an individual’s physical presence in a jurisdiction. Factors include the
individual’s driver’s license, voter registration, club and religious
affiliations and the like. If social contacts relating to the former domicile
become more prevalent, that state might be able to prove that the individual
ultimately intended to return to that jurisdiction and negate even a
temporary change in domicile. Here again, a legal advisor can assist in
advising which steps are best to accomplish the desired result.
Conclusion
Neither
the pandemic nor the upcoming Presidential election promises us any certainty
anytime soon. In the midst of this climate, it is important to remember that
certain opportunities for shifting wealth down to lower generations may be
expiring within the next few years. The pandemic and its effect on the economy
continue to keep interest rates at historic lows, which make this an ideal
environment to engage in all aspects of estate planning, from the simple to the
comprehensive. Now is the time to take stock of what is driving your estate
planning, to think through existing choices and options with the help of legal
and financial advisors, and then decide how best to optimize the strategies
going forward.
The information contained herein is
general in nature and based on authorities that are subject to change. It is
not intended and should not be construed as legal, accounting or tax advice or
opinion provided by the author or Sills Cummis & Gross P.C. This is not
written legal or tax advice directed at the particular facts and circumstances
of any person or entity. Persons interested in the subject of this
communication should contact the author or their legal or tax advisor to
discuss the potential application of this subject matter to their particular
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& Gross P.C. for informational purposes only and does not constitute
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