Preparing for Falling Federal Estate Tax Exemptions

At the end of the year, please watch this space for our 2021 outlook letter, which will report on adjustments and changes in federal estate tax exemptions, among other estate and tax planning strategies. However, as a lead up to that, we would be remiss in not addressing and preparing for what will likely be a reduction in those tax exemptions over the course of the next months and years.

Right now, the Federal estate tax exemption is set at $11.58MM per married person (married couples have a combined exemption of $23.4MM), with the portability of spouses’ exemptions between them. Next year, that number is set to index upward to $11.7MM. What these numbers mean is that a person can gift or devise up to these amounts during their life or at their death without having to pay a 40% Federal tax on the amount of the transfer. The numbers are historically high, and the time may be ripe to take advantage of today rather than tomorrow. Even though the exemptions have been set at such a high rate, it was never intended to be permanent. The higher exemption is set to sunset at the end of the year in 2025, and, if nothing is otherwise done, would come down to a number reminiscent of pre-2018 amounts, indexed for inflation – think $6MM range.

Could our newly elected officials accelerate that rollback sooner? Yes, it is certainly possible, and many legal observers believe it is probable, given the high price tag the 2020 year has charged. Additionally, not only could the exemptions reduce to lower amounts, but the tax rate could increase to higher rates at certain thresholds.

With all this in mind, the immediacy of the higher exemption amounts existing today, and perhaps not tomorrow, present a unique “use it or lose it” planning strategy. The IRS has stated unequivocally that should the exemption amounts reduce, there will be no claw-back of exemption used while the amounts were at higher peaks. This means that gifts made under today’s rules will not be subject to estate taxes in the future if the exemptions are reduced. For that reason, we are encouraging clients to consider using myriad estate planning strategies today to preserve the higher amounts while they still apply.

Keep in mind that when you gift those assets (a completed gift under IRS rules), you relinquish ownership in order to remove the asset from your estate. That loss of control can be troubling to many of our clients. However, for our married clients, we may be able to establish Spousal Lifetime Access Trusts (SLATs), using both spouses’ exemption amounts, and still indirectly enjoying the benefit of assets gifted through a trust for the use by the other spouse. For our single clients, the use of a Beneficiary Defective Inheritor’s Trust (BDIT) may be an avenue to gift assets to a trust set up by a parent, but ultimately managed by and benefiting the gift maker, who is named as Trustee and Beneficiary of a creditor protected trust holding that asset.

For assets that are set to appreciate in the near future upward and beyond prospective exemption amounts, our clients might consider various “freeze” techniques, such as installment sales to an Intentionally Defective Grantor Trust (IDGT), or engage in a series of Grantor Retained Annuity Trusts (GRATs). The effect of these strategies is to move low basis assets out of the estate today, under higher exemptions, taking into account any discounting strategies for lack of marketability of assets as well as asset substitution powers, effectively “freezing” their value for estate tax purposes, and allowing them to grow unfettered outside of the estate, in a protected trust for you and your beneficiaries.

These strategies are complex, and the clock is ticking. We need time to strategize, value, and analyze the tax effects. Given the impending sunset on our higher exemptions, the time is now to call our team and begin preparing for the reductions. We will carefully analyze with you the best strategies and put the most effective plan in place, carefully tailored to your particular scenario.