Should you be in a hurry to make gifts before the end of the year?

Stephanie Sieffert, BridgeTower Media Newswires

Certainty, like toilet paper and disinfectant wipes, has been hard to come by this year. As we begin the month of December, not much has changed. However, the presidential election has given all of us something else to discuss for a few weeks. Whether you are cheering or jeering the result, it is important to consider what could happen, from an estate and gift tax perspective, now that Joe Biden is set to become president.

First, a quick review. For federal purposes, each person has an estate and gift tax exemption amount of $11,580,000. For 2021, the IRS has announced that the new federal estate tax exemption amount is $11,700,000 per person or $23,400,000 per couple. The top tax rate is currently 40%. If no new legislation is passed, these figures are set to sunset at the end of 2025.

So how do things potentially change under a Biden administration? One proposal is to decouple the estate and gift tax exemption amounts, meaning the exemptions would not be the same for lifetime gifts and those assets that pass after death. Rather, the federal estate tax exemption could return to the 2009 level of $3,500,000. The gift tax exemption amount could be reduced to $1,000,000.

Another important change could involve the capital gains tax. The top capital gains tax rate is currently 20%. A capital gains tax is paid on the difference in the basis of an asset when it is sold. For instance, if you have a stock with a $10 cost basis and a fair market value of $50, when you sell the stock, there could be up to a 20% tax on $40 ($8). The Biden plan would almost double the current top capital gains tax rate to 39.6% for those individuals with income over $1 million. Because of this change, it may be worth talking to your investment advisor to consider recognizing gain now, rather than taking the risk that the tax could double.

But, we know Biden cannot act alone. The Senate race is still very much up in the air. It is hard to think that while this country is still in the throes of a pandemic there will be a rush for immediate tax reform. However, tax reform may be more likely if the Democrats take the Senate and perhaps there are more roadblocks to tax reform if the Republicans maintain control. Again, no certainty.
Practically speaking, I do not like to push the panic button, nor do I think it’s a good idea to pay, for instance, a capital gains tax now without evidence that the tax will, in fact, increase in the near future.
However, it cannot be ignored that estate and gift tax exemptions are at a historic high. Consequently, it would not be a shock to see a reduction in the federal exemption amount or a rise in the capital gains tax rate. The difficulty is really the time line. And, it cannot be ruled out, even if tax reform does not happen until later in 2021, that such a change could be retroactive to January 1, 2021. This is an argument to make your gifts now.

There is one thing we do know. The IRS has announced that it will not attempt to claw-back lifetime gifts that are made now using the current exemption amounts. In other words, if an individual fully utilizes the federal gift tax exemption amount of $11,580,000 this year and the exemption amount is lowered to $3,500,000 for 2021, there will be no attempt to tax any gifted amounts over the new exemption.

Gifts made during a lifetime not only remove assets from the donor’s estate, but has the added benefit of removing the future appreciation on those assets from the donor’s estate. Therefore, given that there is no guarantee that the exemption amounts are going to stick around, on its face there seems be little downside to utilizing the gift tax exemption now. There are however, a couple of pitfalls to consider.

One downside is that any assets gifted during a lifetime lose a step up in basis. Therefore, you will want to look carefully at the assets you are gifting with an eye toward making gifts with a higher cost basis, if they are available.

Another drawback is that once you give a gift, you don’t have use of it. Most folks are not entirely comfortable giving away a significant amount of assets to save a potential estate tax. In my estimation, it is entirely natural for there to be concerns about a reversal of fortune and the need to recoup the gifted assets. For many families, the goal is to gift the assets for estate tax purposes but figure out a way to have a safety net in the event the assets are needed.

While it seems too good to be true, there are some estate planning techniques that can be used. One popular idea now is to use a Spousal Limited Access Trust (SLAT). This trust technique was common in 2012, the last time there was a concern about the reduction in the estate tax exemption. The purpose of this type of trust is for one spouse to fund a trust for the benefit of the other spouse.
There are some technicalities that must be followed, but by and large this is an ideal solution for a couple that wants to take advantage of the high estate and gift tax exemptions without completely parting with the assets. A major drawback to the plan would be that in the event of a divorce, many benefits would be lost.

If loss of the use of assets is not a driving concern, think about funding a Dynasty Trust. This type of irrevocable trust removes assets from your estate now and can benefit members of your family for several generations to come. As an added benefit, it is possible to establish the trust in Delaware or South Dakota to avoid state income tax and, in some cases, provide a significant amount of asset protection.

Even if you are not overly concerned about utilizing all of your exemption amount, there are straightforward ways to reduce your estate now. For instance, you can simply make an outright gift. Keep in mind that the annual gift tax exclusion amount is $15,000 per person per year. Making annual gifts under the $15,000 threshold per person does not use up any exemption amount. Of course, you can also make charitable donations or fund 529 accounts.

Ultimately, the choice to make significant year-end gifts depends on your facts and circumstances. Now would be a good time to speak to your accountant and/or estate planning attorney to determine what type of gifting strategy will work best for you. While you are at it, there are some other important estate planning questions to review.

Check your wills and revocable trusts for appropriate tax planning provisions. Given all the potential tax changes, is your will and/or revocable trust flexible enough? Do the fiduciary nominations still make sense? Do you agree with the trusts that are established for your children? Should lifetime trusts be eliminated? Should age attainment trusts be extended?

How about Powers of Attorney and Health Care Proxies? Do the present documents reflect your intentions? Is it time to name new agents? Do the agents know what your funeral arrangements should be and what your thoughts on anatomical gifts are?

What about any business-related provisions in estate planning documents? Does your buy/sell agreement adequately outline what would happen in the event of your death? If not, is the subject addressed in your will or trust?

Just as important, everyone should be checking the beneficiary designations on their retirement benefits and life insurance policies. Has it been 20 years since they have been updated? Take the time now to confirm they are correct.

The end of the year is often a time of celebration for many. This year it seems like the celebration may be the very fact that 2020 is coming to an end. One bright spot is that there is still time to clean up your estate and take advantage of opportunities that may shortly expire. Even with all of the estate planning uncertainty, now is a very good time to talk to your advisors and execute the plan you have been contemplating.

—————

Stephanie Seiffert is a partner in Nixon Peabody LLP’s Private Clients group. She focuses her practice on trusts and estates law, developing sophisticated estate plans for high-net worth individuals and their families, and providing fiduciary counsel to financial institutions.