By Brian J. Fernandez, JD, CPA
Partner, Managing Member, Matter Family Office
Planning anything in 2020 has been quite challenging – so it should be no surprise that we may have to spend a lot of time planning soon for something that may not be clear until after the election and possibly well into 2021 or beyond: potential Federal estate and gift tax changes.
Anticipating a year-end Federal estate planning tax crunch is not new – it seems to happen every few years. Here’s just a short summary of the past decade:
- 2009: We were awaiting clarity on the potential estate tax repeal in 2010 or significant estate tax law reform.
- 2010: There was no estate tax and the estate tax laws were unsettled until late in the year.
- 2012: We were planning for a potential reduction of the estate tax exemption from $5M to $1M.
- 2017: We were anticipating tax reform and the exemption was increased to its current level ($11.58M per taxpayer through 2025) via the Tax Cuts and Jobs Act of 2017.
No matter the year, the potential for significant tax changes in the following year causes a rush of planning, decision-making, and activity by year-end. The potential for increases in Federal income tax rates causes additional complexity at year-end, as it may accelerate mergers and acquisitions and the sale of other assets to take advantage of the current tax rates.
The irony for taxpayers and advisors is that each of the scenarios above resulted in the Federal gift, estate, and generation-skipping transfer (GST) exemption being increased so the year-end planning crunch was, with the benefit of hindsight, unnecessary.
Why is this a possible emergency?
The current estate tax laws are currently legislated to be in place through 2025 but a potential transition to a Democrat-controlled government is expected to lead to a revision of the Federal estate and gift tax laws (in addition to many Federal income tax laws). The supposition is that any change will increase the amount of Federal taxes due for taxpayers at higher income or wealth levels.
We are already in a favorable technical environment for estate planning based on the historically high gift, estate, and GST exemption ($11.58M per taxpayer and $23.16M for a married couple), potentially depressed asset values due to the global pandemic, and utilization of low interest rates that can enhance some estate strategies. However, if you are like most people, you may not see now as an ideal time to give away significant wealth, and many people do not have the energy to plan for something that is uncertain.
We do not use the word “emergency” very often as we are intentional planners. Nonetheless, the potential volume of activity for estate planners suggests we should start planning now, so we are in position to implement our strategy after the November election (if necessary), and not just getting started.
What strategies are recommended?
There is not a simple answer on which strategy is best to use because each situation is unique. The following are some of the factors for consideration:
Gift Your Exemption Amount Now
If the current estate tax exemption ($11.58M per taxpayer) is utilized under current law, the Internal Revenue Service (IRS) has indicated it will not be challenged in the future – so it is “use it or lose it” if the exemption amount is reduced in the future. There are many strategies and structures to utilize the exemption. Intentionally Defective Irrevocable Trusts (IDITs) and Spousal Limited Access Trusts (SLATs) are effective ways to make a transfer of assets to a trust that can consume your remaining exemption.
Example: The A Family used $10M of exemption in 2012 to maximize their planning under 2012 laws. They recently made $13.16M of gifts to the same trusts in order to use the remaining balance of their gift, estate, and generation-skipping transfer (GST) exemption.
Transfer Assets at Low Values
Depressed asset levels could mean greater wealth transfer now, as any rebound in the asset values will benefit the new owner. IDITs, SLATs, and Grantor Retained Annuity Trusts (GRATs), can capitalize on low asset values as these trusts transfer assets at their current value and all future appreciation is retained by the new owner.
Example: The B Family has used nearly all of their exemption already, but they created GRATs for each child using a 6/30/2020 stock value of their private company that is experiencing a 20% decline in business in 2020. The company is expected to recover by the end of 2020, and the GRATs should hold stock that will be valued 20% higher early in 2021.
Utilizing Low Interest Rates
Low interest rates are beneficial for intra-family loans, GRATs, and other transactions. The IRS requires that certain transactions use approved interest rates – either the AFR (Applicable Federal Rate) or the Section 7520 Rate (this is 120% of the mid-term AFR). These rates are historically low which allows for more transfer of wealth. Grantor Retained Annuity Trusts (GRATs) depend on the appreciation of the value above the Section 7520 interest rate to transfer wealth – if the interest rate is low, then the GRAT is more likely to have appreciation that passes to the beneficiary.
Example: The B Family completed their 2-year GRAT in August 2020 when the Section 7520 Rate was .40% (less than half of 1 percent) – if their company stocks grows above .40%, the excess will be transferred in trust for their daughters.
Some of the proposed tax plans may lower the exemption amount to $3.5M, increase the gift and estate tax rate from 40% to 55% (levels we have seen before), and eliminate some of the estate minimizing techniques altogether. The urgency is present now, because the process of creating new trusts or other entities, setting up new accounts, completing transfers, and completing other action items by December 31 is challenging in most years and the potential volume of activity will make this even more complicated this year.
We appreciate that added complexity in 2020 is not what people are seeking to end the year. Nonetheless, one our primary goals is to help families sustain their wealth for the rising generation, and the potential tax changes are too significant to dismiss given the current opportunities. Even if this is another “false alarm” and the tax laws do not change in 2021, this will give you a head start on the planning necessary for the 2026 changes and any other surprises that may be ahead.
This report is the confidential work product of Matter Family Office. Unauthorized distribution of this material is strictly prohibited. The information in this report is deemed to be reliable but has not been independently verified. Some of the conclusions in this report are intended to be generalizations. The specific circumstances of an individual’s situation may require advice that is different from that reflected in this report. Furthermore, the advice reflected in this report is based on our opinion, and our opinion may change as new information becomes available. Nothing in this presentation should be construed as an offer to sell or a solicitation of an offer to buy any securities. You should read the prospectus or offering memo before making any investment. You are solely responsible for any decision to invest in a private offering. The investment recommendations contained in this document may not prove to be profitable, and the actual performance of any investment may not be as favorable as the expectations that are expressed in this document. There is no guarantee that the past performance of any investment will continue in the future.