Solving for uncertainty created by biden’s proposed gift tax law changes What you can do now and why you shouldn’t waitFebruary 2021
Presently, the law allows a historically high amount of assets to transfer estate and gift tax free. The fear and expectation that this amount will decrease drove many to make tax free gifts at the end of 2020. With Biden’s election and the Georgia senate races, many are afraid it is already too late to make tax free gifts this year but this article discusses what options are still available for 2021.
Federal law imposes a tax on the gratuitous transfer of assets. Gift tax applies to transfers that occur during life and estate tax applies to transfers that occur following death. The highest tax rate is the same for both—presently 40%. For example, if Jane, a widow, dies with $15MM in assets and gives the whole of it to her son, the first $11.7MM is tax-free and the remaining $3.3MM is subject to estate tax, resulting in approximately $1.3MM in tax.
Biden and other democrats propose reducing the estate and gift tax exemption, which will increase the tax owed on the transfer of wealth. Some propose decreasing the exemption as low as $1MM for gifts and $3.5MM for inheritance and increasing the highest gift and estate tax rate to 45%. The House of Representatives is controlled by democrats and the Senate is now an even tie. Vice President Harris serves as the tie breaker, giving democrats a slight edge. The fear that Biden will succeed in reducing the exemption motivated many to perform last-minute planning at the end of 2020.
Present circumstances make unclear what type of tax change will pass and take effect in 2021. The coronavirus pandemic rages on in the United States, which provides Biden with both a more pressing issue as well as the opportunity to cultivate bi-partisan activity. In addition, high jobless rates and fears of a potential stock market bubble and real estate bubble demand his attention. With such a narrow margin in the Senate, it is impossible to predict which niche matters, like the estate tax exemption, survive political negotiations.
If tax reform did pass, it is foreseeable (though not necessarily probable) that it takes effect retroactively. Both President Obama and President Clinton executed retroactive tax changes. President Obama orchestrated tax reform not signed until the end of 2010 that altered the estate and gift tax exemption as of January 1, 2010. President Clinton increased tax rates with a law executed in August of 1993 that took effect January 1, 1993. Both President Obama and President Clinton benefit from a more agreeable Congress possessing much more voting control than Biden’s Congress, which makes it more difficult to predict what Biden can accomplish.
Returning to the prior example involving Jane, if the exemption will lower, Jane’s son benefits if she gifts before the exemption lowers. For example, if the estate tax exemption is lowered to $1MM and Jane dies after that change takes effect, her estate tax bill increases by $4.3MM. Alternatively, if Jane gifts assets to a properly structured trust before the exemption lowers, she eliminates this tax increase. Furthermore, if the assets appreciate in value between her gift and her death that appreciation also passes to her son estate tax free. This explains why so many rushed, at the end of 2020, to make taxable gifts.
Most gift planning last year used trusts for the benefit of children or a spouse. For example, Jane could establish a trust for her son’s benefit and transfer $11.7MM to the trust. If Jane was married, instead of transferring to her son she could transfer to a trust for the benefit of her spouse. This trust, called a Spousal Lifetime Access Trust, or SLAT for short, usually provides the spouse with discretionary income and principal payments for life. Accordingly, Jane would indirectly benefit from the trust, as long as she remains with her spouse, and still transfer the assets to her son tax free.
A retroactive change to the gift tax exemption adds an element of risk to this planning. If, today, Jane gives $11.7MM to the trust for her son, or the SLAT for a spouse, and then in December Biden signs a law reducing the exemption to $1MM as of January 1st, Jane will owe approximately $4.2MM in tax on something she thought would be tax free. For this reason many hesitate to plan, adopting a wait-and-see approach, which could be a costly mistake. Suppose a tax bill is in the works but doesn’t pass by December 31st. You waited and waited and for nothing.
Fortunately, there is a better solution. If you are concerned with the risk of a retroactive change, make your trust a Qualified Terminable Interest Property (“QTIP”) SLAT because this grants you extra time to make a decision. A QTIP SLAT is a present gift in trust that isn’t taxed until the death of your spouse, if you choose. The trust provides mandatory income to your spouse for his or her lifetime and the remainder to heirs of your choosing. With a QTIP SLAT you wait until next year to decide if the gift is taxable (1) at the time of the transfer or (2) at the death of your spouse. By the time you make that decision you will know if tax reform changes occurred and, if so, if they were retroactive. Therefore, a QTIP SLAT allows you to transfer assets now but resolve the tax consequences later.
This year provides a significant opportunity to engage in gift tax planning. If the gift tax exemption is not lowered this year then the same options remain with an increased motivation. If the exemption is lowered, you can still give tax free to the extent of the exemption and those assets will appreciate tax free. Using a QTIP SLAT buys time to make that decision without losing the opportunity to harvest the benefit of the exemption.
About wealthgate trust
Wealthgate Trust is a client-founded, Nevada-based, multi-family boutique trust company. Born from the founder’s own experiences searching for an ideal trustee solution for his family, Wealthgate Trust partners with ultra high net worth families and their advisory team to create, implement, and administer bespoke trust strategies.
Wealthgate Trust is licensed and regulated by the Nevada Financial Insurance Division (NFID), and audited separately by the NFID and two national CPA firms.
About the author
Aaron is a Wealth Strategist assisting Wealthgate Trust families and their advisors in developing and implementing bespoke estate planning strategies. He’s an attorney licensed to practice in California and Nevada, with over a decade of trust and tax planning experience, and presents on a variety of topics including wealth preservation and private trust companies.
Aaron previously served as the primary tax planning counsel for Lobb & Plewe LLP. He has represented several major trust companies and sits on the board of the Coalition for American Retirement. Aaron earned his JD from the University of Nevada, Las Vegas.