With the 2020 presidential election looming, many people are curious about how the results might affect their tax liabilities. One area that deserves particular—and immediate—attention is how potential changes to wealth transfer laws could affect your estate planning.
Right now, the federal estate and gift tax exemption is at an all-time high. This means that taxpayers interested in minimizing their estate tax liability should act as soon as possible in case a post-election push returns these taxes to their historic norms. While any changes to tax law would be put in place after the new year, attorneys expect to be overwhelmed by requests in the days following the election—so it’s a good idea to get a jump on planning now.
Luckily, there are many strategies available to make sure that taxpayers are protected, no matter what the outcome of the election is.
Understanding the Estate Tax
Currently, the federal estate and gift tax exemption is set at $11.58 million per taxpayer, and assets included in an estate that exceed the remaining exemption are taxed at a federal rate of 40 percent. Right now, each asset included in an estate also receives an income tax basis adjustment to reflect that asset’s value on the date of the grantor’s death. This means that beneficiaries realize capital gains on inherited assets only to the extent of the asset’s appreciation since that date of inheritance.
If the election results in a political party change, it could mean not only lower estate and gift tax exemption amounts, but also the end of the longtime taxpayer benefit of stepped-up basis at death.
To avoid the negative impact of these potential changes, here are a few wealth transfer strategies it would be prudent to consider before the year-end.
Sell Within the Family
Federal interest rates are currently extremely low. This allows donors to loan funds or sell income-producing assets to family members in exchange for a note charging interest at the federal rate. By doing this, donors provide a financial resource to a family member on more flexible terms than a commercial loan. Additionally, because interest rates are so low, the loaned funds can produce a return rate that exceeds the interest rate, allowing the donor to transfer wealth without using the estate or gift tax exemption.
Use the Swap Power
Assets gifted to an irrevocable trust do not receive a step-up in income tax basis at the donor’s death. Instead, they retain the donor’s carryover basis, potentially resulting in significant capital gains upon the subsequent sale of any appreciated assets—that’s bad news for whoever ends up paying the tax!
Exercising the swap power allows the donor to make sure that low-basis assets receive a basis adjustment on the donor’s death and that capital gains realized on the sale of high-basis assets are reduced or eliminated.
Learn to Love the GRAT
A grantor retained annuity trust (GRAT) allows the transfer of assets without using the gift tax exemption. A donor transfers property to the GRAT, and the trustee of the GRAT pays the donor an annual annuity amount.
The donor’s retained interest terminates after the initial term, and any appreciation on the assets in excess of the annuity amounts passes to the beneficiaries. In other words, if the transferred assets appreciate at a rate greater than the historically low applicable federal rate, the GRAT will have succeeded in transferring wealth at no cost.
Sell to an Irrevocable Trust
This strategy is similar to the intrafamily sale. The difference is that income-producing assets are sold to an irrevocable trust instead of directly to a family member. This strategy not only allows donors to pass appreciation to their beneficiaries with limited estate and gift tax implications, but also gives donors the opportunity to maximize their remaining gift and generation-skipping transfer tax exemptions.
Use the SLAT
A spousal lifetime access trust (SLAT) allows donors to lock in the current, historic high exemption amounts and avoid adverse estate tax consequences at death.
The donor transfers an amount up to the donor’s available gift tax exemption into the SLAT. Because the gift tax exemption is used, the value of the SLAT’s assets is excluded from the gross estates of both the donor and the donor’s spouse. The donor’s spouse may also execute a similar but not identical SLAT for the donor’s benefit.
Because the SLAT provides protection against both federal estate taxation and creditor claims, it is a powerful wealth transfer vehicle that can be used to transfer wealth to multiple generations of beneficiaries.
Establish an ILIT
Another way to minimize tax liability is to transfer an existing insurance policy into an irrevocable life insurance trust (ILIT). The donor can make gifts to the ILIT that qualify for the annual gift tax exclusion, and the trustee uses those gifts to pay the policy premiums. Since the insurance policy is held by the ILIT, the premium payments and the full death benefit are not included in the donor’s taxable estate. Furthermore, the insurance proceeds at the donor’s death will be exempt from income taxes.
Consult an Estate Planning Attorney
Estate planning is complex. Setting up and executing the strategies described above requires the advice of an experienced estate planning attorney. Additionally, the strategies that make sense for one person won’t always be as useful for another—your estate plan should be developed based on your specific goals and situation. This is why working with an estate planning attorney is always a critical part of planning for the future.
And, as has been the case with all things 2020, circumstances are even more complex this year. Potential upcoming legislation could change which actions are legal and adjust the rate at which the taxable portion of an estate is taxed.
To learn more how the election results could affect your plans (as well as what you should do now), contact us. Our experienced attorneys can help.