The Estate Tax Exemption: How Much Was It and How Much Will It Be?

We all know the adage: there is nothing certain in life except death and taxes. But while taxes are for certain, they are far from being consistent. Over the past 20 years, Congress has enacted tax legislation that sometimes defies logic. These fluctuations present a number of challenges for estate planning, which makes it imperative to review estate plans annually.

Once such tax law provision is the approaching “sunset” of the estate and gift tax exemption. When Congress passed the 2017 Tax Cut and Jobs Act (TCJA), the lifetime gift and estate tax exemption was doubled. For 2020, the exemption is $11,580,000 per person. For the next five years, the exemption will be indexed for inflation before sunsetting at the end of 2025. In 2026, the estate and gift tax exemption will revert to its pre-TCJA level of $5 million.

Because the increase was temporary, many high net worth individuals considered that there was a limited window to reduce taxable estates by making gifts that utilize all or most of the lifetime exemptions during this period. Some high net worth individuals were concerned that for a death occurring after 2026, any gifts made in years where the exemption was higher could be “clawed back” into the estate. Fortunately, the IRS alleviated these concerns and subsequently issued a ruling indicating no “clawback.” This provides a unique opportunity to potentially accomplish significant wealth transfer utilizing the current higher exemption.

However, because of the sunset provision, this opportunity is limited. It is critical for high net worth individuals to implement a plan that not only takes advantage of the current tax laws, but with a perspective to adapt to any future changes that could impact an estate. With proper planning, there are ways to accomplish this that are not only tax-efficient, but incorporate greater flexibility and control, such as by gifting to a trust with appropriate spousal access language. Another alternative is gifting to Section 529 plans (tuition saving plans) for grandchildren, that could enable a high net worth individual to also reduce a potential tax liability.

In order for a transfer to qualify as a taxable gift and be removed from an individual’s estate, the gift or must surrender sufficient control of, and any beneficial interest in, the assets being gifted. An individual contemplating a gift that will use most or all of the increased exemption will, therefore, lose the ability to financially benefit from the asset being transferred. For some, the prospective loss of this financial benefit may be too costly because of the need for the income generated by the gifted assets to maintain a certain standard of living, or a fear that the gifted asset will be needed later.

For married individuals interested in using the increased exemption but concerned about losing the financial benefit of the assets being transferred, a Spousal Limited Access Trust (SLAT) may provide a solution. Under the terms of a SLAT, the primary beneficiary is the spouse of the grantor of the trust. Since the spouse is a beneficiary of the SLAT, the grantor of the trust indirectly benefits from distributions made by the trust. Additionally, the assets that the grantor transfers to the SLAT are gifts that reduce the grantor’s estate for estate tax purposes. Future appreciation of the transferred assets will be excluded from the grantor’s estate.

If the concern is for assets being available only in the event of need, then an individual can plan on a sprinkling of principal and income, in the trustee’s discretion, for the spouse for his or her health, education, maintenance and support. These limited dispositive provisions will preserve the trust’s principal, thereby maximizing the efficiency of the gift.

Planning Considerations

• Determine and constantly update your net worth: The best plan is to expect the unexpected and plan for the inevitable changes in estate and gift tax laws. The pandemic has had an enormous impact on the economy. While Congress will be considering various stimulus packages, any changes to current tax laws is unknown at this time. When Congress considers a variety of sources to pay for the stimulus, it is likely they will consider changes or tweak existing regulations. Consider life insurance to ensure appropriate protection and the likelihood of an estate value exceeding the exemption limits.
• Ramp up Gifting: High net worth individuals, who can afford to and/or would like to make large gifts may consider using their exemption limits and avoid any potential clawback after the sunset period.
• Trusts, ILIT’s, SLAT’s and pre-funding: A common estate planning tool is to create trusts that fulfills the wishes of the grantor to ensure benefits accrue as intended by the grantor.
• Be flexible: Since, gifting inherently involves parting or control of the assets, there are considerable options available to keep planning flexible as laws evolve and change. In certain circumstances, adapting, changing or decanting from an older trust into a new trust may be an ideal solution.