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Estate Tax Strategies in the Shadow of the Election

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Estate Tax Strategies – Looking at the Impact of the Election on Estate Tax Law
Oct 30, 2020

After the Tax and Jobs Act of 2017 was passed, the federal estate tax exclusion was raised to over $11 million per person (over $22 million for a married couple).  For the vast majority of people, federal estate taxes therefore faded away as a major concern for a while.  Recently, however, estate taxes have been a hot topic again in financial planning circles, and estate tax attorneys have seen their schedules filling up with appointments.

The concern is this: with a Biden presidency becoming increasingly likely – and maybe even a Democratic sweep of Congress, experts believe that the federal estate tax exclusion may sunset earlier than originally planned (the current levels are scheduled to sunset in 2025).  Many think the exclusion could be reduced in 2021 or 2022 (a $5.5 million exclusion – the level back in 2017 – seems to be the odds-on favorite right now, but it could be lower).  The following chart shows what the federal exclusion has been for the past 20 years:

Large Gift Strategy

For families with wealth well exceeding the expected new limits, there has been a rush to their estate attorneys to give away part of the estate to the children now – before the exclusion goes back down.  The bet is that the current exclusion will continue to at least apply for the 2020 tax year, and that the government is unlikely to impose taxes later for gifts already completed (a reasonable assumption).  And, of course by removing the assets from the estate, future growth will avoid any estate tax.

If you think you might have a taxable estate exceeding $5.5 million per person (or $11 million for a couple), should you get in line at your estate attorney’s office to set up an irrevocable trust?  Not necessarily.  We want to highlight some offsetting considerations that aren’t being discussed nearly as often:

  • You lose the step-up in basis. The downside of gifting assets during your lifetime is that the securities do not get a “step up” in their basis like they would if you passed them on as part of your estate.  So assets with a lot of unrealized gains will carry that tax liability along with them in a gift, while that would have been forgiven if you passed it in the estate (at least under current law – this could be changed also).  The important thing is that it’s not a one-for-one trade of estate tax vs. capital gains tax because the capital gains “step up” is lost on all the assets, while the estate tax is saved only on the amount over the exclusion.  (Assets with few unrealized gains, like cash and bonds, therefore make the best gifts).
  • You have to give away more than the expected new limits. Any large gift you make in 2020 will need to be accompanied by an IRS filing and will count against your eventual exclusion.  The reason for making a gift in 2020 is based on the idea that if you give away an amount that is greater than the new exclusion, but that didn’t require a tax payment under the current rules, the government won’t seek to “claw back” those taxes later.  But if you don’t exceed the estimated future exclusion amount, you’ve used up some of your future gifting allowance without expanding it in any way.
  • It’s hard to predict future estate tax policy. Even if exclusions do come down under the next administration, in the long run it is difficult to predict what estate tax policy will be.  Still, if you plan to make a significant gift of well over $5.5 million per person, it likely makes sense to consider doing it now.  (One strategy is to have just one person in the couple make a large gift, using their current allowance and retaining the allowance of the other spouse).

In summary, gifting a substantial part of your estate before the end of 2020 may be a viable strategy for people who currently have significantly more assets than the new exclusion might encompass, who are far enough into their retirement to be confident that they do not need the assets for themselves, and/or who do not have significant unrealized gains embedded in their holdings.

Initial steps in gifting

Current tax law allows you several opportunities for simple and “free” gifts that do not count toward any exclusion and do not require the filing of any forms with the IRS.

First, there is the annual $15,000 per person exclusion.  A couple with two married children can gift up to $120,000 every year with no estate tax implications and with no required filings ($15,000 from each spouse, to each child and spouse).  You can gift even more than that if you have grandchildren, or if you want to gift to anyone else.  You’ll still give up the step-up in basis, but if you gift from just the cash or bond part of your portfolio that impact will be minimized.  (Also, look out for our upcoming article about gifting EE bonds – an ultra-safe investment that still pays over 3.5% interest over 20 years!)

Another great gifting opportunity is that you can make direct payment for a child or grandchild’s medical or educational expenses.  As long as the payment goes directly to the provider (i.e. tuition payments), these are not considered taxable gifts at all.  You can actually make such gifts on almost anybody’s behalf – other family members or even for friends.

Conclusion

For very large estates, the current interest in making a significant gift to children may make sense, but there are offsetting considerations that should be considered carefully.  For those with estates of a size that might not suggest making a big move this year, you may still want to consider a gifting strategy. Many estates could still eventually grow to exceed the expected new limits, and an annual gifting strategy could make a lot of sense to reduce the size of the estate, to give children income they can use earlier in their lives, and to do so in a way that does not use up any exclusions or require any filings.