- Exemption: The $3.5 million exemption would greatly reduce the ability of wealthy people to shift wealth out of their estates, or into protective structures that may limit the reach of divorcing spouses or claimants. This might mean that there is a great advantage to using the current $11.4 million exemption now or as much of it as possible before a change is enacted. If you’re of moderate wealth (“moderate” relative to the current exemption amount) you might be able to make a simple gift to a trust to accomplish much of the asset protection, estate tax planning, succession planning, and other goals. If you wait, much more costly and complex planningmight be required, and some of those techniques are on Bernie’s tax chopping block.
- Example: Doctor Jane has $6 million in savings, $1 million in a house and $2 million in a retirement plan. As a surgeon, she is worried about malpractice risks. She is also concerned about what might change with the estate tax rules if the political winds blow in another direction. She would like to remove $5 million from the reach of claimants and the estate tax. If she created a self-settled domestic asset protection trust (“DAPT”) today she can gift $5 million to the trust by simply ACAT’ing securities to her new trust. If the exemption drops to $3.5 million that would limit what she could transfer to that amount, and the excess would be more difficult to transfer given the other changes proposed. It might no longer be practical to do so. So why wait?
- Gift Exemption: Bernie’s Act also would drop the gift tax exemption (how much you can gift without a current gift tax) to a mere $1 million. That would inhibit a lot of the commonplanning. In case that was not enough, if you make gifts this year to use your current high $11.4 million exemption there will be a penalty for that with the gifts “clawed” back into your tax calculation. If that were to be enacted it might already be too late to plan. Again, while few if any people seem to believe that Bernie’s Act will be passed with a Republican Senate, the changes, like these gift tax changes would radically restrict planning.
- Grantor Trusts: The heart of many estate plans for years has been to create grantor trusts. The 99.8% Act would include in your taxable estate all assets held by trusts that are grantor trusts. These are trusts whose income is taxed to you, the settlor creating the trust. This income tax characterization for a trust permits you to pay the income tax on trust income, permitting greater growth of wealth inside the trusts. It also permits you to sell assets to the trust and shift growth outside your estate. These sales, often done for a note issued by the trust have been a mainstay of planning in the estate planners arsenal. What if you added to new trusts (or old trusts that you decant into new trusts) a provision that says if the assets of the trust will be included in your estate then effective one-day before your death the trust shall convert to non-grantor and all power holders holding powers that could taint or characterize the trust as a grantor trust agree that those powers or rights will be extinguished. Might that work just in case you don’t affirmatively turn off grantor trust status just before death?
- GST Tax: Another foundation of planning has been to shift value to an irrevocable trust and allocate generation-skipping transfer (“GST”) tax exemption to the trust. Properly done the value of assets in that trust, no matter how much they appreciate, should never be subject to transfer taxation. The compounding of wealth outside the estate tax system can provide incredible wealth shifting opportunities. When this is coupled with a long-term trust (dynasty trust) wealth can compound outside your estate forever. Bernie’s plan appears to limit the application of the GST exemption to 50 years. That would emasculate this type of planning and might result in a costly tax after 50 years of a trust. If something like this is enacted but if it “grandfather’s” existing trusts (i.e., the new restrictions only apply to trusts formed after the new law) many people, even those of moderate wealth, might benefit from creating long-term dynastic trusts now.
- GRATs: Grantor Retained Annuity Trusts (“GRATs”) are a long-favored planning tool. A key benefit of GRATs is that you can create these trusts to shift wealth out of your estate without using any (or any material) part of your gift tax exemption. Many, perhaps most, GRATs were structured as so-called zeroed-out GRATs. This meant that the annuity payment the trust made to you as the grantor creating the trust equaled the value of assets gifted to the trust. Upside appreciation (above the rate of return the IRS required to be used in the technique) would inure to the beneficiaries of the GRAT with no gift tax cost. Bernie’s proposal would perhaps eliminate the viability of this technique in many cases by requiring a minimum 10-year term. If you don’t outlive the term of the GRAT all the assets (generally) are included in your estate. That would dramatically increase the risk of a GRAT succeeding. There is also a minimum required gift amount. These two changes could make GRATs impractical for very wealthy taxpayers that have used GRATs when they no longer had the exemption. It would also seem to eliminate the common technique of “rolling-GRATs” where you create a 2-year GRAT and re- GRAT each annuity you receive to a new GRAT and keep on rollin’.
- Discounts: Valuation discounts would be severely restricted, e.g. not permissible in a family planning context. Example: Mom wants to gift $18 million of interests in real estate LLCs that own neighborhood shopping centers. Because these are non-controlling interests under current law the interests might be valued at perhaps $11 million. She might be able to simply gift all these interests to a trust for descendants. The discount in value is because the interests mom owns do not control the LLCs and cannot dictate when a distribution is made or when the LLC might be liquidated. If mom waited until after a Bernie-like proposal is enacted the elimination of discounts might reduce the percentage she can gift. If the exemption is lowered as well, even less can be transferred. This is all potentially even worse still. Based on some recent case law developments (e.g. Estate of Powell v. Commr., 148 T.C. (slip op. at 16) (May 18, 2017) and Estate of Cahill v. Commissioner, T.C. Memo. 2018-84 (June 18, 2018)) the IRS might argue that if she retains any interests in the LLCs that mom “in conjunction with” others control the LLC and therefore even the interests which mom thought she transferred, are included in her taxable estate.
- Crummey Powers: Another common planning tool has been to make gifts to trusts from which a class of beneficiaries can withdraw up to the annual gift exclusion amount. This facilitated making large gifts to trust, e.g. used to buy and hold life insurance, and not incurring any gifttax cost. Bernie has proposed eliminating this technique. If this applied to all trusts after enactment, the results could eliminate the common Irrevocable Life Insurance Trust (“ILIT”) which has been ubiquitous in estate plans. You might discuss with your advisers getting that ILIT you’ve always wanted (it is on your bucket list, right?) in place in case existing trusts are grandfathered (i.e., exempted from the new change). You might also consider making a large gift now (using that exemption that might disappear) so that you won’t have to rely on annual gifts to fund your life insurance trust.
Sanders Estate Tax Proposal: Estate Planning Steps to Take Now
Martin Shenkman Contributor Forbes.com
Bernie Sanders estate tax proposal may foreshadow what Dems may propose if they can. What steps should you take now?
Get off the planning couch and take action! Bernie Sanders’ proposed tax act “For the 99.8% Act” should concern everyone with wealth.
While few if any believe the estate tax bill proposed by Bernie Sanders could be enacted with a Trump White House and a Republican Congress, take heed. While you might dismiss this as electioneering by Sanders, be careful. This proposal might be a glimpse as to what might occur if the so-called Blue Wave continues through the 2020 election.
Sanders proposed a tremendous increase in the estate tax, reducing the exemption from $11.4 million currently to the $3.5 million level that existed in 2009. For those in the moderate wealth range, say $3 million + this could be significant and a dramatic change from the current environment. For the merely wealthy the dollar value of the exemption is critical. Too many wealthy folks, however, have been sitting back relying on the high current $11.4 million per person exemption as making the estate tax irrelevant to them. Well, folks, Sanders’ announcement should be a wakeup call for you. It should be a call to act and use your exemption and use it wisely (we’ll explain that below) before it disappears if there is a sufficient Democratic shift in Washington.
Bernie also proposed raising the estate tax rates with a maximum rate of an astounding 77% for estates over $1 billion. For uber-wealthy, the marginal rate is the biggest fear as at stratospheric wealth levels the exemption becomes rather insignificant. For the very wealthy estate planning has not ever really been only about the exemption as even the current high amounts are kind of insignificant to the very wealthy. The marginal estate tax rate is really critical in terms of the estate tax pinch.
But the proposed changes are much tougher than just the exemption and the rate. Bernie’s changes include restrictions on the use of valuation discounts, GRATs, and more that have been the grease for many estate plans. The proposed restrictions on planning techniques may have an incredibly negative impact on the ability of very wealthy taxpayers to shift wealth to future generations. So, the mega-wealthy should really be planning with vigor and not waiting to see what might occur. If you opt to wait, you might face a scenario similar to the end of 2012. In case you don’t recall there was a considerable worry at the end of 2012 that the estate tax exemption would drop from $5 million to $1 million in 2013. Taxpayers lined up outside their planners’ offices hoping to get work done in time. Apart from taking a number (like at the bakery on Sunday morning) some taxpayers had too little time to consider the implications of planning Also, compressed 2012 planning schedules increased the risk of causing step-transaction doctrine issues because there often could not be much time between different actions or transfers. The 2012 rush resulting in some cases in planning that really didn’t serve the client’s needs as they might have hoped, as there just wasn’t enough time for clients to absorb ideas or planners to compete forecasts or other steps a calmer planning schedule would have permitted. Also, if you wait to the last minute, what if there is a Democratic victory and the effective date of new tax legislation is so soon after the election that it precludes you from doing the planning you wish? Consider the effective dates of Bernie’s proposed changes to the estate tax rules! Waiting might feel right, but it could also be a costly mistake.
With modern trust drafting techniques you can have the ability to access your assets (in non-reciprocal spousal lifetime access trusts), control investments (as the investment advisor of a directed trust), and other steps that traditional trust drafting which was less flexible did not afford. So why wait?
Here are some of the changes and what they might mean to planning if some variation of them is enacted:
If you think that Bernie’s proposal is just a flash, think again. Many aspects of Bernie’s proposal discussed above are not new and should not be a surprise. Democratic candidates have long called for restrictions that would make the estate tax harsher. President Obama’s Greenbook would have reduced the estate tax exemption to $3.5 million but what many did not understand that was only a small part of the get-tough-estate tax plan he had proposed. Many of the commonly used estate planning strategies like grantor retained annuity trusts (“GRATs”) that can shift value out of your estate to the extent that the growth in those assets exceed a mandated federal interest rates, note sale transactions to grantor trusts (you sell a non-controlling interest in an asset whose value is discounted because of the lack of control and marketability of that asset to lock in not only the discounts but future post-sale growth), and much more. Whoever helped craft those proposals understood many of the tax planning strategies the uber-wealthy use to shift assets outside their estates. These and other changes from the Obama White House appear to be part of the playbook for Bernie and other Democratic nominees.
Following are a list of planning steps the wealthy and mega-wealthy might all consider, along with some of the reasons why planning should be pursued sooner rather than later. But keep in mind if Bernie’s Act was made law tomorrow (unlikely) you could already be out of luck. So, while there is certainly no means of predicting what might, or might not happen, should you at least review with your planning team whether you should accelerate your planning and get it in place now?
QTIPs – Marital trusts such as Qualified Terminable Interest Property trusts are taxed in the estate of the surviving spouse. Planners love this and have made this the default plan for many clients (one-fund QTIP with a disclaimer or Clayton) but hey if we end up with a much lower exemption those with QTIPs could be exposed to lots of tax. Consider making a disclaimer of part of the income interest in the QTIP now. That could trigger a deemed gift of all of the QTIP assets (principal) under Code Sec. 2519. That would use up part of theexemption the surviving spouse has before the law might reduce her exemption. It is not clear whether a change in the law might affect the unused exemption of the first spouse to die (called the Deceased Spouse Unused Exemption, or “DSUE”). Another approach might be to distribute out the QTIP assets to the surviving spouse if the QTIP trust terms permit that, and have the surviving spouse gift the assets to say a self-settled domestic asset protection trust (“DAPT”) of which she can be a beneficiary. If a QTIP is not GST exempt, consider creating a grantor 678 trust and shifting value via a note sale to that new trust. Lots of options but you may have to get ‘em while you can.
Crummey Trusts – lots of trusts including the typical life insurance trust are based on the premise of making annual gifts. What a hassle. Gifts, writing checks, issuing annual demand notices (Crummey powers). That’s as much fun as getting a root canal. Make a big gift to the trust (file a gift tax return) that will cover gifts for along time and dispense with future annual hassles. If future laws lower the exemption or reduce annual gift exclusions this won’t be possible. If Bernie’s plan nixes Crummey powers you won’t be able to fund this type of trust the way you had in the past. Get simplicity while you can. You might want to consider decanting (merging) the existing old Crummey trust into a new trust that provides more flexibility.
Split-Dollar/Note Sales – Many wealthy taxpayers, who are barely wealthy now relative to the high temporary exemptions, engaged in split-dollar life insurance plans, and note sale transactions, and other techniques to shift wealth out of their estates. The result is an existing trust that owes money to you for the purchase of assets (e.g. an interest in a family business), or on a note secured by life insurance. A simple gift to the trust within the parameters of the current high exemption might be used to unwind that old plan and simplify ongoing plan administration. But keep in mind that Bernie’s plan might clawback these 2019 transfers if enacted. While no one can guess at what future legislation might do, it may well prove advantageous to have made these transfers and unwound the planning by using exemption while you have it.
DAPTs/SLATs – Domestic asset protection trusts (“DAPTs”) are trusts you create that you are a beneficiary of. Spousal lifetime access trusts (“SLATs”) are trusts you create that your spouse is a beneficiary of. The key of these trusts for planning now is that you may still benefit from assets you shift out of your estate. There are risks
and lots of options with either of these techniques, but the key is that for most folks access is critical to have the ability to gift away sufficient assets to use most/all of their exemption. Both of these types of trusts, if they succeed, might provide you with access to the assets transferred. If that flies, you get your tax cake and can eat it too. Assets might be moved outside your estate, out of the reach of your creditors, but you can benefit if you need to.
In formulating your planning, evaluate some of the following concepts with your planning team:
Step-Transaction Doctrine – If there are a sequence of steps in a plan that are not independent the IRS might disregard them.
Example: wife gives $5 million of assets to her husband who the next day gifts those assets to a trust that benefits the donor/wife (e.g. a SLAT) the IRS might disregard the intervening steps of the gift to the husband, and the husband’s gift to the trust. The IRS might just treat the transaction as if the wife gave the assets directly to the trust. If she has already used her exemption that could trigger a gift tax.
Remember the old adage “The early tax bird gets the worm?” If instead of waiting to the last minute, consider if the wife gave the gift to husband now in early 2019. Those funds are then commingled with the husband’s assets and invested perhaps even using different asset allocation. Then, more than a year from now in 2020, the husband makes a gift to the trust. The intervening time, the fact that the transfers occurred in different tax years, and the investment with other funds, might all serve to reduce the risk that a step-transaction challenge might be reduced. Waiting might harm your planning.
Asset Protection – Every doctor, and really every professional, a board of director member, real estate developer, etc. should be concerned about liability exposure. Society seems to be getting meaner and more litigious. Big exemptions make it easy to transfer assets into protective irrevocable trust structures (whichever trust flavor you choose). Live the Nike slogan “Just do it!” if not the opportunity might be lost and only more complex, costly and riskier options may remain.
Bad Trusts – Lots of old trusts are not optimally drafted, some have mistakes, many were created when planning styles were different (e.g. distribute assets at say age 30 outright instead of keeping in long term trusts), they may not have allocated GST exemption, and so on. Do your housekeeping now while there’s lots of gift and GST exemption in case you need them in the cleanup. For example, if you decant (merge) and old not- so-great trust into a better drafted more modern trust you might want to make a late allocation of GST exemption to that trust. That means allocating some of your $11.4 million GST exemption to the trust now (rather than when a gift was first made years ago to the trust). That might enhance the overall benefits of the trust in that it may then be outside the transfer tax system for as long as the trust lasts.
While Bernie’s plan is unlikely to get enacted for a while, or ever, it is a clear indication where Bernie and perhaps others in the Democratic party might wish to see estate tax rules change. You can wait and see or act and hope. The latter certainly may prove more prudent.
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