By Daphne Stern, Esq.
The federal deficit now exceeds $3 trillion due to the COVID-19 pandemic and the large federal bailouts. It is expected that the government will attempt to raise much-needed revenue by increasing taxes. With the upcoming presidential election and the necessity for the incoming administration to have a fiscal plan, a tax increase is practically assured.
In particular, there are various proposals calling for the revision of the estate and gift tax laws. These changes may be effective as early as January 1 of the coming year. If enacted, the new laws will result in the imposition of estate and gift taxes on many middle-income individuals who had not previously been subject to taxes, thereby reducing the amounts passing to their heirs. There are planning opportunities available to avoid the impact of such taxes, but the plans must be implemented before year’s end in order to avoid the reach of the new laws.
Federal Estate and Gift Tax Exemption
Currently, the federal estate and gift tax exemption is at a historic high — $11.58 million. This means that if a person has assets under $11.58 million, or makes gifts up to that amount during his or her lifetime, there will be no federal estate or gift taxes.
Unfortunately, this high level of exemption is under attack. There are proposals to reduce the federal estate and gift tax exemption to $5 million, $3.5 million, or even $1 million. That means that if a person owns assets above this exemption amount at death, his or her estate will be subject to estate taxes. It must be understood that one’s taxable assets are not limited to cash and securities. They include the value of one’s home, life insurance, retirement accounts, and vacation property. It will not take much to have a taxable estate if such an exemption amount will apply. While the estate and gift tax system has long been viewed as a means of taxing the wealthy, the new laws clearly will result in an additional tax burden for the middle class.
Even if no new tax law is enacted, under current law the estate tax exemption will return to $5 million (adjusted for inflation) in 2026. This is the so-called “sunset provision” — the Tax Cuts and Jobs Act, which significantly increased the exemption amount in 2018, “sunsets” at the end of 2025 and the exemption reverts to its previous lower amount of $5 million.
Another proposal that has been made is to increase the estate and gift tax rates. The maximum rate is currently 40 percent and it is proposed to increase this to 45 percent. In all likelihood, if the top rate is increased, there will also be similar increases of the tax rates applying to smaller estates.
Given the possible significant reduction of the federal estate and gift exemption, it is imperative that you review your estate plan. Whether you own $1 million of assets or $50 million, you may be impacted by the impending changes in the law. Your wills, trusts, and any other planning documents may need to be modified in light of these changes. Various planning techniques may be used to reduce the value of your estate so that your assets will fall below the threshold of estate taxation, and to remove potential appreciation from your estate. I will briefly discuss one of these techniques: Making gifts in 2020.
One important estate-planning strategy involves current lifetime gifting in order to utilize the $11.58 million exemption before it is reduced to a lower amount. Obviously, if your assets are less than that amount, you will make gifts appropriate to your situation. By making gifts during 2020, you will not only take advantage of the large exemption amount and remove the value of the gift from your estate, but all future appreciation of the gift will also be removed from your estate and passed to your heirs. Gifting as soon as possible is also advisable since any gifts made within three years of death are brought back into a person’s estate and are included in its value.
The Internal Revenue Service has indicated that taxpayers who make gifts currently while the exemption is at its high level will not be penalized even when the exemption sunsets back to $5 million, as discussed above. It appears that there will be no “claw back” of these larger gifts even when the exemption is reduced.
The lifetime gifts may be made to family members and other desired recipients. However, many individuals do not wish to give large sums outright to family members. Concerns arise regarding the recipient’s ability to manage financial matters, creditor issues, or potential divorce problems. A good solution to these issues would be the use of a trust as a recipient of the gift. The trust would be created for the benefit of the particular family member and would be designed in light of the goals of the donor and needs of the beneficiary. It could last for the lifetime of the beneficiary or until a certain age, could benefit such beneficiary and his or her family, and could provide for education and medical needs, or be left to the discretion of the named trustees.
For those who are reluctant to part with access to their assets, there is a solution to that concern as well. One technique that could be implemented for a married couple is the creation of the Spousal Lifetime Access Trust (“SLAT”). In a SLAT, the trust is initially set up to benefit the creator’s spouse, so in essence the assets are accessible to the creator through his or her spouse. At the spouse’s death, the assets will then pass to the children. The larger exemption amount will have been allocated at the time the gift is made so that the assets held in the trust and the appreciation thereon pass to children without the imposition of additional estate taxes.
Given the impact of the pandemic on the deficit and the U.S. economy, it is fairly certain that taxes will be increased. Estate and gift taxes are a likely target. It is important for each person to review his or her estate plan and consider techniques that would take advantage of the current high federal estate and gift tax exemption and other tax benefits that exist currently but may disappear with the year 2020.
Disclaimer: The author’s articles are provided for informational and educational purposes only and do not constitute legal advice. Publication of this information is not intended to create, and receipt or review does not constitute, an attorney–client relationship between the reader and the author. The information contained therein may be changed or rendered incorrect by future legislation or judicial developments. Readers should not rely on it in structuring or analyzing individual matters, and no action should be taken based on the ideas presented in these articles. Legal advice should be sought in connection with any such matter.
Daphne Stern, Esq., is an attorney practicing in Woodmere. She specializes in the area of wills, trusts, estate planning, and estate administration. For more information, call 516-295-0962 or email email@example.com.