Gulf coast residents are always relieved when hurricane season passes at the end of summer. The political winds, however, are another story. Those are often just heating up as fall emerges, when Congress looks to pass new legislation and corresponding tax increases to “pay for it.”
In mid-September this year, the tax storm came within view, as the House Ways & Means Committee offered its proposed tax bill. A multitude of far-reaching income tax changes is getting most of the press. But the bill would also make sweeping changes to the estate and gift tax landscape if it becomes law. The most fundamental of those changes would be to reduce by 50% the gift/estate and generation-skipping tax exemptions, effective January 1, 2022. This would bring the exemptions down to approximately $6 million (with an inflation adjustment to be determined).
As a result, the focus of many taxpayers is to use the current “Trump” generous exemptions if gifts of such magnitude are financially feasible. A single taxpayer who has never made a taxable gift can give up to $11.7 million in 2021, free of gift tax; a married couple could give up to $23.4 million before year-end. Though not a particularly popular tax strategy, if a person dies in 2021, his or her estate passes free of Federal estate tax up to $11.7 million in value.
Generally, gifts in trusts are recommended for a number of tax and non-tax reasons. The most important tax reason is to utilize one’s “generation-skipping tax exemption,” referred to as the GST exemption, at the same time as using the gift tax exemption; these exemptions are the same (but can be “de-coupled” if used on separate transfers). The GST exemption allows a gift in trust not only to be removed from the donor’s taxable estate but also from the taxable estate of the donee (often the donor’s child). In this manner, a taxpayer can shelter assets from two generations of transfer taxation, regardless of future tax law changes. The non-tax reasons for gifts in trust include protection from the beneficiary’s possible divorce or creditors, and for the donor to exert control over where the remaining trust assets flow at the donee’s death.
It is always important to keep potential estate tax savings in perspective. Gifted assets receive a “carry over” income tax basis from the donor, so could be exposed to greater capital gains tax than a bequest at death. Assets received at death enjoy a “step up” in basis, meaning the appreciation up to date of death is eliminated. This makes high basis assets ideal for lifetime gifts. In addition, any gift is irrevocable and therefore should be thoughtfully considered. If a single person wishes to make no more than a $6 million dollar gift, then he or she may well wait until 2022 to ponder that decision. The only reasons to expedite such a gift to 2021 are to get the future growth on the gift out of the estate sooner, and possibly to make the gift in favor of a “grantor” trust (discussed in separate article below). By contrast, if that same person wishes to make a larger gift (in excess of the 2022 threshold), then time is of the essence in 2021.
The winds are swirling around us currently, and the proposed tax bill has prompted us to anticipate what structures might topple. Now may be the time to board up those windows and reinforce your structures before the storm comes ashore.