At the time this article is being written, the Biden campaign has yet to release a comprehensive tax proposal and has not proposed any changes to the estate tax. That said, if next year the Democratic Party controls the Senate, the House of Representatives, and the White House, we are certain to see new tax legislation. Now is the time to develop a contingency plan that can be implemented this fall depending on the outcome of the November election.
During the current 116th Congress, prominent Democratic senators introduced several bills relating to the gift and estate tax regimes. The bills are not only consistent, they have the exact same wording on a number of key points. It’s reasonable to expect many of those elements will be included in future legislation. If that happens, estate planning as we know it will change dramatically.
Senate Bill 309, the “For the 99.8 Percent Act,” was introduced by Senator Bernie Sanders (the “Sanders Bill”). Senate Bill 787, the “American Housing and Economic Mobility Act of 2019,” was introduced by Senator Elizabeth Warren (the “Warren Bill”). Senate Bill 2231, the “American Opportunity Account Act,” was introduced by Senator Cory Booker (the “Booker Bill”). Finally, Senator Chris Van Hollen introduced Senate Bill 1950, the “Strengthen Social Security by Taxing Dynastic Wealth Act” (the “Van Hollen Bill”).
Exemption Amounts. All four of these bills decrease the estate tax exemption to $3.5 million and eliminate any inflation adjustment going forward. The Sanders Bill and the Van Hollen Bill further reduce the gift tax exemption to only $1 million. The Van Hollen Bill is unique in that it also limits portability, by restricting the Deceased Spouse Unused Exclusion Amount (DSUEA) to $1 million for gift tax purposes. This represents a dramatic decrease from the current inflation adjusted $10 million exemption, as well as the inflation adjusted $5 million exemption we will revert to in 2026 under current law.
GRATs. The Sanders, Warren, and Booker Bills all require Grantor Retained Annuity Trusts (GRATs) to have a minimum term of 10 years, instead of the current two. All three bills eliminate the concept of a “zeroed out” GRAT, with the Sanders and Booker Bills mandating the value of the remainder equal at least the greater of 25% of the value of the contributed property or $500,000, while the Warren Bill only requires a remainder equal to 10% of the value of the contributed property. Note that if the gift tax exemption decreases to $1 million and the minimum remainder value on a GRAT is $500,000, a taxpayer could create no more than two GRATs before paying gift tax.
Grantor Trusts. The Sanders, Warren, and Booker Bills all provide that the assets of any grantor trust created after the law is enacted would be included in the taxable estate of the grantor upon her death, and any distributions from such a trust would be treated as a gift by the grantor. This would require rethinking many common planning techniques, including GRATs, insurance trusts, SLATs, and sales for low interest rate loans.
Annual Gifts. The Sanders and Warren Bills would limit total annual exclusion gifting by an individual to $20,000, while the Booker Bill allows a more generous $50,000 limit.
GST. Under the Sanders and Warren Bills, any trust created after the law is enacted with a duration of more than 50 years would have a GST inclusion ratio of 1, meaning it would not be GST exempt even if GST exemption was allocated to the trust. Distributions from trusts that were GST exempt when the law is enacted would operate under the existing rules for 50 years, but thereafter would also be subject to the GST because they would be taxed as if they had a GST inclusion ratio of 1.
Discounts. Finally, the Sanders Bill is unique among the four in that it eliminates valuation discounts for lack of control and lack of marketability for assets that are not actively used in a trade or business.
These bills are intended to disrupt most of the key tax concepts underlying modern estate planning. Given the risk posed by this legislation, it is only prudent to begin working with clients to develop a comprehensive plan that can be implemented if needed after the November election.
The current situation is not dissimilar to what happened in 2012. At that time the gift tax exemption was $5.12 million, but was scheduled to drop to $1 million on Jan. 1, 2013. It was widely expected the exemption amount would be extended, but as the year stretched on that didn’t happen. Many clients were caught flat footed and there was a mad dash of planning in December as clients hastily created trusts and made large gifts.
Under pressure, many did not have time to carefully consider how such gifts would impact their personal financial situation, and the resulting trusts could not be customized to the needs of each family. I have encountered many families over the last eight years with donor regret stemming from planning done in December 2012.
Now is the time to help clients understand the many strategies that can be deployed to preserve family wealth for future generations based on current law. A partial list includes:
• Taxable Gifts. Making a large gift in 2020, whether in trust or directly to a beneficiary, eliminates the risk that subsequent legislation will reduce the gift tax exemption. The “anti-claw back” regulations issued last year under Section 2010 will also prevent any estate tax from being imposed on this gift, even if the estate tax exemption in the future is less than the amount of the gift.
• Pre-Fund Life Insurance Trusts. Many clients have life insurance trusts that rely on annual exclusion gifts to fund the insurance premiums. If those premiums are more than $20,000 a year a client may wish to make a large gift to the trust now to provide funds that can be used to pay premiums in future years. This would take advantage of the existing high gift tax exemption, which may not exist next year.
• Spousal Access Trusts. While the math may be compelling, many clients will still be hesitant to make large gifts in trust for fear they will need some of those resources in the future. A grantor can create a trust for the benefit of the grantor’s spouse, thereby retaining the possibility of benefiting from those assets through the spouse. If two such trusts are being created, it’s important to draft them in a way that avoids the reciprocal trust doctrine. It’s also important to recognize that if a spouse passes away prematurely, or if the couple divorce, access to these trust assets may be lost.
• Intra-Family Loan. Clients who are not ready to make large gifts may still be able to lend money to a grantor trust to take advantage of the current low interest rates. This planning effectively moves future appreciation to the next generation estate tax free. Since the Sanders, Warren, and Booker Bills all subject new grantor trusts to estate tax on the death of the grantor, this may be the last chance many clients have to establish and fund this highly favorable structure. For clients who have previously created an intra-family loan, forgiving that loan could be a way of making a large gift in 2020 and capturing the existing exemption amount.
• Dynasty Trusts. Both the Sanders and Warren Bills have proposed a 50-year limit on GST exempt trusts. If a large gift is being made in trust consider creating a dynasty trust and allocating GST exemption to that gift. This may be the last opportunity to create a true dynasty trust that can pass through multiple generations without triggering a death tax.
• GRAT Planning. Given that three of the Senate bills discussed above limit GRAT planning by mandating a ten year term and a significant remainder, consider funding one or more zeroed out GRATs with durations of less than ten years.
This is the time to help clients think through what they will do if the November elections makes it likely there will be unfavorable tax changes. Careful planning now will allow sufficient time after the election to properly implement a plan that is optimal for each client. There are still many planning opportunities available, but time is not on our side.