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Timely Estate Strategies For An Opportune Moment

Few Americans are currently subject to the federal gift and estate tax. But today, those Americans face a clearer picture of that tax’s future than they did a year ago.

While some of these taxpayers braced themselves for major changes to the federal gift and estate tax after the 2020 election, they can now begin to relax. On the campaign trail, President Joe Biden proposed a variety of changes to the estate tax regime. Yet as my colleague Paul Jacobs observed back in 2020, lowering the unified credit to subject more estates to federal taxation was likely a nonstarter from the beginning with the Democrats holding a razor-thin Senate majority.

The most likely vehicle for major change would have been an omnibus bill. Tax experts kept a careful eye on both the the Infrastructure Investment and Jobs Act, which became law in late 2021, and the Build Back Better bill, which at this writing remains under debate in the Senate. Even if the latter becomes law, it is now clear that it is an unlikely vehicle for Biden’s proposed estate tax changes. Nor did the former make any significant estate tax changes. With midterm elections in the near future, taxpayers have a reprieve from the potential of a lowered unified credit, an increased federal estate tax rate, or the elimination of the step-up in basis at death, all of which had been discussed earlier.

That said, the uncertainty of 2021 is a reminder that federal estate tax law is not set in stone. Many of the provisions of the Tax Cuts and Jobs Act of 2017, including the current level of the gift and estate tax’s lifetime exemption, will sunset at the end of 2025 unless lawmakers take action.

For now, the total personal exemption remains high by historical standards. For tax year 2022, the unified credit amount is set at $12.06 million per individual taxpayer. Married couples who take advantage of portability have joint access to an exemption of $24.12 million. If Congress does not act, the unified credit will drop to $5 million per taxpayer, indexed for inflation, as of Jan. 1, 2026.

The future always includes an element of uncertainty, even if the legislative landscape feels relatively stable for now. Taxpayers may want to take advantage of various strategies to make the most of the current rules while they remain in effect. The Internal Revenue Service has confirmed that there will be no clawback for the use of the increased exclusion amount if a taxpayer dies after the credit reverts to its lower level. While this article cannot offer a comprehensive list of potential strategies or determine which of them are right for you, I can suggest a few common approaches you may want to consider.

Intrafamily Loans

With inflation in the United States higher than it has been for many years, the Federal Reserve is primed to raise interest rates. But at this writing, rates are still historically low. Some families may want to take advantage of these circumstances to make an intrafamily loan. As the name suggests, this technique involves making a loan, in contrast to an outright gift, to a family member, often an adult child or grandchild.

Bear in mind that, to qualify as a loan, the arrangement must involve interest. The lowest rate the IRS will recognize is the Applicable Federal Rate, or AFR, which varies depending on the loan’s term. If you do not charge interest, or charge less than the AFR, the IRS will count any forgone interest as a taxable gift that will count against your unified credit (to the extent it exceeds the annual exclusion amount). Forgiving debt payments greater than the annual exclusion amount may also count as a gift for federal tax purposes.

As an estate planning technique, intrafamily loans can allow assets to grow outside the lender’s estate. Say you lend your son $1 million at 1% interest compounded annually over five years. To keep this example simple, assume this rate meets or exceeds the AFR in force at the time of the loan. Your son invests that entire amount in a diversified stock portfolio. Over the course of the loan term, his portfolio grows to $1.5 million. With interest, he will have repaid you $1,051,010 by the end of the five-year term. You will have then effectively transferred the remaining $448,990 to your son with no effect on your personal exemption.

Intrafamily loans can have other applications, too. They may allow heirs to purchase a family business when passing the entire business outright would trigger significant tax liability. Some individuals may also choose to make a loan to an irrevocable family trust. The trust would then invest the money and repay the loan according to the agreed upon terms. After repayment, the remaining assets would remain in the trust, outside of the lender’s estate as in the previous example, but subject to the terms of the trust.

Spousal Lifetime Access Trusts

As its name implies, a spousal lifetime access trust, or SLAT, is a strategy designed for a married couple. At its most basic, a SLAT represents a gift from one spouse to an irrevocable trust for the benefit of the other spouse. Depending on how the trust is structured, it may also have secondary beneficiaries, often the couple’s children. While gifts to the trust are irrevocable, the donor spouse may indirectly benefit from property owned by the trust as long as he or she remains married to the trust’s primary beneficiary.

SLATs are generally set up as grantor trusts, which means the spouse that funded the trust will pay any associated income taxes. This arrangement can further reduce the grantor’s estate and allows trust assets to grow unencumbered by income taxes. Since both lifetime gifts and bequests to a spouse are tax-free in any amount, as long as the recipient spouse is a U.S. citizen, the trust can optionally be structured to give the beneficiary a “present interest” in the gift, potentially making the transfer to the trust free of gift tax. However, it is critical to consult with a knowledgeable professional to ensure that the trust fulfills the requirements of this strategy. Note, too, that contributions to the trust exceeding the donor spouse’s annual exclusion normally will be subject to federal gift tax once the unified credit exemption amount is exhausted. However, if assets grow within the trust, any appreciation remains outside the grantor’s estate.

SLATs, and all the trusts I will mention in this article, can be complicated and costly to administer. It is essential to rely on estate planning professionals to ensure you have structured your trust correctly to act as you intend.

Grantor Retained Annuity Trusts

A grantor retained annuity trust, commonly called a GRAT, allows a grantor to remove assets from his or her estate while ensuring a stream of income for some set amount of time. The grantor places assets in an irrevocable trust and receives an annuity back on a predetermined schedule. Any assets that remain in the trust when it ends pass to designated beneficiaries.

GRATs are especially useful when interest rates are low because of the way the IRS values transfers to the trust. The gift to the trust’s beneficiaries is valued based on both the annuity payments and the expected rate of return on the trust assets. These expectations are pegged to a monthly figure called the Internal Revenue Code Section 7520 rate. In a “zeroed out” GRAT, the grantor makes the present value of the annuity payments, discounted with the Section 7520 rate, equal to the assets transferred to the GRAT. The IRS does not recognize this as a taxable gift. But if the assets earn more than the 7520 rate over the trust’s term, those earnings pass to the beneficiaries free of tax.

Note that GRATs are useful for lifetime transfers, but are designed to end before the grantor’s death. If the grantor dies prior to the end of the GRAT’s term, any remaining trust assets are included in the grantor’s estate. For more on GRATs, see my colleague Paul Jacobs’ article “GRAT Planning Strategies.”

Charitable Remainder Trusts

If philanthropy is part of your estate plan, you may want to consider a charitable remainder trust. These trusts, often abbreviated as CRTs, let assets grow income tax-free as long as the trusts meet particular requirements. Like both SLATs and GRATs, CRTs are irrevocable trusts.

CRTs pay individual beneficiaries annually, quarterly or monthly. This payment can be a fixed dollar amount or a fixed percentage of the trust’s value; the former is a charitable remainder annuity trust or CRAT, and the latter is a charitable remainder unitrust or CRUT. Depending on your needs, you can also structure the trust with yourself as the lifetime beneficiary. At the end of the trust’s term, which can be the beneficiary’s lifetime or a fixed number of years up to 20, any remaining assets go to a designated charitable beneficiary. The donor receives an income tax deduction for the charitable remainder portion of the transfer to the trust on his or her income tax return.

Since CRTs are income-tax free, donating appreciated assets directly to the trust can be an especially powerful strategy. While the annual distributions to a noncharitable beneficiary are taxable, the recipient only owes income or capital gains tax on as much as he or she receives. This means that, even if you are the beneficiary, you may ultimately owe less in capital gains taxes on an appreciated asset that you transfer to the trust than you would if you sold the asset outright. Any assets remaining in the trust at the time of your death pass directly to the designated charity outside of your taxable estate.

Charitable Lead Trusts

Charitable lead trusts are something of a mirror image to charitable remainder trusts. Over a set term – unlike a CRT, not limited to 20 years – the trust pays an annuity to one or more designated charitable beneficiaries. When the term ends, any remaining assets go to noncharitable beneficiaries, often the grantor’s family. Like CRTs, CLTs may be structured as annuity trusts or unitrusts. Note that, unlike CRTs, charitable lead trusts are not exempt from income tax, which means they do not offer the chance to defer or avoid capital gains tax. You may, however, take an immediate partial income tax deduction for cash contributions.

Annual Exclusion Gifts

Don’t overlook the power of your annual gift tax exclusion. The annual gift tax exclusion for tax year 2022 is $16,000 for individuals and $32,000 for married couples. This annual exclusion amount applies per recipient, and if you are married, you and your spouse can pool your gifts to a single recipient. For married individuals with a lot of potential recipients, annual gifts can really add up. For example, say you have one adult daughter who is married. You and your spouse can give your daughter and her spouse $32,000 each in 2022 with no effect on your lifetime exemption. That represents a $64,000 reduction in your taxable estate.

You can also pay someone else’s tuition or medical bills in any amount without triggering gift tax, as long as you pay the institution or provider directly. Gifts to political organizations (subject to campaign finance rules) and to certain qualifying charities are also tax-free in any amount.

The ideas above are just a selection of the strategies available, and none of them will be appropriate in every case. Consulting an estate planning attorney and a tax professional with experience in estate planning can help you to have confidence that you are crafting a plan that fits your needs and that will remain flexible enough to weather future legal changes. As my colleagues and I know from experience, no tax regime is truly permanent.

Estate planning can be an emotional exercise for many people, and political uncertainty doesn’t make it less so. But with a reasonably clear path for the next three to four years, individuals and families should make the most of their current opportunities.

Vice President Eric Meeermann, who is based in our Stamford, Connecticut office, is the author of several chapters in our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 11, "Social Security And Medicare"; Chapter 18, "Philanthropy"; and Chapter 19, "A Second Act: Starting A New Venture." He was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.
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