While federal estate tax today effects less than 1% of the U.S. population (since the exemption is a whooping $11.7 million), that will change if the proposed Bill is passed as it will affect millions more people. You see, the Senate’s proposed Bill would SIGNIFICANTLY DECREASE the estate tax exemption to almost 2/3 of what the current exemption level is now. Some of the proposed changes include:
- Reduction of the estate tax exemption amount from the current $11.7 million per person to $3.5 million per person.
- Reduction of the gift tax allowance to only $1,000,000 during your lifetime, which means that if you continue to gift once you have reached the allowance, you will have to pay gift tax on any overage in the year it is gifted, which typically is the same taxation scale as estate tax!
- Increasing the estate tax rate significantly. Once a deceased person’s taxable estate exceeds $3,500,000, it is taxed at 45%, with a sliding scale that increases the taxation to up to 65% when the estate value exceeds $10,000,000.
- Gifting of up to $15,000 per year per person will be limited to $30,000 per donor per year for gifts to irrevocable trusts or of interests in certain “flow through entities.”
The tougher news for many clients is that some of the primary tools and strategies used in the past will not be available in the future, beginning upon the date that President Biden signs the bill into law if this occurs. Once that happens, we will not be able to fund or have assets sold to Irrevocable Trusts that can be disregarded for income tax purposes, and we will also not be able to use valuation discounts or Grantor Retained Annuity Trusts (GRAT’s) in most circumstances (although those arrangements put into place before the new law is passed will be grandfathered if they are not added to or altered after the law is passed, as the Bill is presently written).
Nevertheless, if the proposed Bill is passed, it would take effect January 1, 2022, which does not leave a lot of time for planning! While it is our hope that this proposed law will not be enacted as written, it seems advisable to “plan for the worst and hope for the best,” especially since the “Current Tax Cuts and Jobs Act” will automatically expire anyway at the end of 2025, causing the estate tax exemption levels to revert to the pre-2018 exemption level of $5.6 million per person, even if the proposed Bill is not passed.
What does all of this really mean? Well, if the Bill passes as it is written now and it is signed into law, any person with total assets over $3.5 million in their countable estate when they die will have to pay 40-65% of the overage to federal estate taxes! For a married couple, the estate tax exemption will remain “portable,” which means if you elect to keep any unused exemption when one spouse dies, in effect, it increases the total exemption for a married couple to $7 million.
The key is to ACT NOW AND PLAN AHEAD! Once the proposed law passes, (or the current one sunsets and expires in 2025), it is TOO LATE, as the inevitable is on its way and it will leave little time to prepare! Here a few types of things that you should consider to help avoid an estate tax problem:
START GIVING AWAY YOUR
ASSETS TO REDUCE YOUR ESTATE
This has long been a way for people to try to reduce their estate, but the Government figured it out a long time ago, so thus the “gift tax” was born. Today, you can give away up to $15,000 in an asset to as many people as you want, and there is no reporting requirement. However, if you give away more than $15,000 to a single person, in a single year, you must report the gift to the government. There is also a lifetime total gift tax exemption, which currently is $11.7 million. However, as noted above, that is set t0 drop significantly, so the goal may be to gift $15,000 to as many people as you want every year after reaching the limit.
ELECT PORTABILITY TO INCREASE YOUR OWN
ESTATE TAX EXEMPTION IF YOUR SPOUSE DIED IN 2021
If your spouse has died in the last 8 months, you need to elect the portability of the remaining estate tax exemption within 9 months of the date of death. While this will not change the estate tax amount that your estate is exempted from when you die, it will certainly be a huge benefit because it will significantly increase your applicable estate tax exemption. Here's how it works:
John died on February 1, 2021. The estate tax exemption for his estate is $11.7 million. He only had $3 million in assets, which all went to his wife Mary. His wife has $2 million in assets of her own. So now the total amount of assets in Mary’s estate is $5 million since she inherited all of John's assets. When Mary dies, if the estate tax exemption is $3.5 million, then her estate will have to pay at 40%+ tax on $1.5 million, since that is the amount that her estate exceeds the exemption.
However, if she filed the election for portability of her husband’s unused portion of his exemption, which is $8.7 million, her estate tax exemption when she dies will be the amount in effect at the time of her death PLUS her husband’s unused $8.7 million! So now, if the estate tax exemption in effect when Mary dies is $3.5 million, the total estate tax exemption for her estate is $12.2 million and there will be no estate tax owed.
REMOVE LIFE INSURANCE FROM
YOUR TAXABLE ESTATE WITH AN “ILIT”
The main reason that most people have life insurance is to replace income that would be lost if they die prematurely. In general, a named beneficiary receives the life insurance death benefit payment free of any federal income tax (and usually free of any state income tax, too). But for the life insurance policy owner, it is a countable part of their estate for federal estate tax purposes!
Here is how it works: When you own a policy on your own life, the death benefit is included in your taxable estate — unless the money goes to your surviving spouse and he or she is a U.S. citizen. Also, you are considered “the owner” of a life insurance policy if you are the one with control over the policy, like where you retain the power to change policy beneficiaries, change coverage amounts, and cancel the policy, even if the policy is not on your life.
If having life insurance death benefits included in your taxable estate would cause an estate tax hit, the solution to avoid this is an Irrevocable Life Insurance Trust (also known as an “ILIT”). The Trust becomes the owner of the policy. The Trust then pays the premiums, while the death benefits go to the beneficiaries you name in the Trust. Therefore, there is no federal estate tax on the death benefit, and there is no federal income tax either to the beneficiary or the Trust. However, there are a few caveats to make this approach successful:
- If you die within three years of transferring a life insurance policy to the trust, the death benefits are still included in your taxable estate.
- If that is a concern and you want to ensure the life insurance is not part of your taxable estate, the trust must purchase a new policy on your life.
- If it is not possible to obtain a new policy, maybe because underlying health conditions would preclude issuance of a new policy, you really have nothing to lose by transferring an existing policy to an ILIT.
- Be wary of possible gift tax consequences. This can occur when transferring existing policies with a cash value in the policy in excess of the current gift tax exemption amount, which is currently $15,000.
PRESERVE THE CURRENT $23.4 MILLION
ESTATE TAX EXEMPTION BY CREATING A
SPOUSAL LIFETIME ALLOWANCE TRUST (“SLAT”)
We will not get into the minute details of this more sophisticated Trust, but here are a few of the basics:
- A Spousal Lifetime Access Trust (SLAT) is a type of irrevocable trust utilized for transferring wealth outside of a person’s estate in order to avoid estate tax.
- SLATs allow you to preserve the current federal exclusion of 11.7 million person before the new laws are enacted or before they expire in 2025.
- A properly structured SLAT still provides the donor spouse limited, indirect access to the Trust asset while receiving income directly from the assets.
Essentially, A SLAT is utilized by a gift of assets from one spouse (the donor spouse) to an irrevocable trust for the benefit of the other spouse (the beneficiary spouse) while both spouses are alive. The entire goal of the SLAT is to exclude those gifted assets from the beneficiary spouse’s gross estate, which means those assets in the SLAT are not subject to estate tax when the beneficiary spouse dies. The terms of a SLAT can be flexible, even though it is an irrevocable Trust. For example, the SLAT can be drafted to require the beneficiary spouse receive the Trust’s income for life, but it is not required. Therefore, the SLAT could have multiple current beneficiaries, such as the beneficiary spouse and the couple’s children, grandchildren, etc. Usually, there is a SLAT for the husband and a SLAT for the wife. The main requirement for a SLAT is that the couple is married.
THE KEY TO AVOIDING ESTATE TAX:
PLAN NOW TO RELIEVE YOUR WORRIES
Planning AHEAD is the key, as this change will affect millions of people, and you do not want to be caught-up in a rush to beat the clock. So, time is of the essence as any fabulous estate planning attorney would tell you! So now what do you do? You can contact our office for a no-obligation evaluation of your estate and a complimentary consultation to review strategies specific to your situation. Or if you want more information about planning with an ILIT or a SLAT, just contact us for a free brochure. You can reach us anytime at 888-787-1913 or by email at legalteam@twestateplanning.law.
