If itâ€™s true that the future depends on what you do today, there couldnâ€™t be a better time than now to consider succession and wealth planning. IRS interest rates are at an all-time low and federal estate and the total lifetime gift tax exemptions are at a record high â€“ making this an especially opportune moment to take advantage of lifetime gifting options.
The federal estate and gift tax exemption is currently $11,580,000. For couples, itâ€™s double that amount if portability is elected on a federal tax return. The exemption amount is due to expire at the end of 2025, but in light of the recent presidential election results, the exemption could fall sooner. In fact, some estate and wealth advisors are predicting it could happen as soon as sometime in 2022.
Another reason for acting soon is that IRS interest rates are at a record low. This makes certain estate and gifting options very appealing to higher net-worth individuals.
Together, these two historic financial factors should have you reviewing your goals and deciding how much of your wealth you are prepared to part with now.
Here are some valuable strategies for taking advantage of lifetime gifting options while they are still available:
Spousal Lifetime Access Trusts
In late 2018, the IRS finalized regulations in the Tax Cuts and Jobs Act (TCJA) of 2017 about increasing the basic exclusion amount (BEA) for estate and gift tax. For gifts made and estates of individuals dying before January 1, 2026, the TCJA increased the amount to $10 million, with allowances for inflation. Thus, the amount for 2017 was $5.49 million and, for 2018, it more than doubled to $11,180,000. The BEA rose to $11.4 million in 2019 and is at $11.58 million for 2020.
The statutory sunset, or conclusion, of a higher BEA that applies at the time of a personâ€™s death and reversion to the lower amount could, in fact, retroactively deny taxpayers who die after 2025 the full benefit of the higher exclusion amount applied to previous gifts. This possible situation has sometimes been called a â€œclawbackâ€ of the applicable exclusion amount.
To help avoid such scenarios, the IRS adopted a special rule known as an anti-clawback regulationâ€¦
In calculating a personâ€™s estate tax, when the portion of the credit as of the decedentâ€™s date of death that is based on the exclusion amount is less than the total of the credit amounts that can be ascribed to the exclusion amount allowable in computing gift tax payable on post-1976 gifts, the portion of the credit against the net tentative estate tax that is attributable to the exclusion amount is based upon the greater of those two credit amounts.
For example, if an individual made post-1976 taxable gifts of $9 million, all of which were sheltered from the gift tax by the cumulative $10 million in BEA allowed on the dates of the gifts, and the person dies after 2025 when the BEA reverts to $5 million, the IRS special rule allows the credit amount against estate tax to be based on the BEA of $9 million.
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Spousal Lifetime Access Trusts
Benjamin Franklin rightly observed that nothing is certain except death and taxes. That said, todayâ€™s Spousal Lifetime Access Trusts can help to ensure that high-wealth individuals can reduce their estate tax liability while making certain the maximum amount of assets passes to their heirs.
If youâ€™re someone who wants to pass as much of your financial legacy as possible to family and other beneficiaries, you will find that establishing one or more trusts can help. Many kinds of trusts are available and function in specific ways, but marital trusts can be the best way to ensure a spouse is financially secure after you die.
While thereâ€™s a wide variety of marital trusts, itâ€™s important to remember that the larger your estate, the larger your federal estate tax liability will be. Individuals with a federal estate worth more than $12 million can take advantage of higher estate tax exemptions and also enjoy the benefits of their marital trust while still alive with a Spousal Lifetime Access Trust (SLAT).
A SLAT is an irrevocable trust that one spouse establishes for the other during his or her lifetime. The donor spouse does not need to pass away to utilize this trustâ€”in fact, this is the major difference between SLATs and other types of marital trusts that only commence upon death. The donor spouseâ€™s gift to the trust is irrevocable, and he or she gives up any right to the funds, but the beneficiary spouse and potentially other beneficiaries such as children and grandchildren have immediate use of the money.
The major advantage of a SLAT is that you benefit from the large estate tax exemption currently available. If the exemption amount is reduced during your lifetime, youâ€™ve lawfully helped to boost what you can pass on and it will be free of estate taxes. Another advantage of a SLAT is that they protect current assets; since the money is in an irrevocable trust for someone elseâ€™s benefit, itâ€™s no longer considered yours in case of a bankruptcy or litigation.
Before establishing a SLAT, itâ€™s critical to have your trusted financial advisor provide forecasts that demonstrate you can afford transferring assets to the trust. Your spouse will keep access to the funds but you will still want to use assets remaining in your own names for customary expenses. In addition, you will need to determine what you want to happen if you lose access to the funds in case of divorce or the spouseâ€™s death.
A few more considerations in setting up a SLAT:
- The donor spouse gives up all control over the assets, so an independent trustee must be appointed in case distributions need to be made for any reason. If the beneficiary spouse acts as the trustee, distributions must be limited to an â€œascertainable standard,â€ specifically health, education, maintenance or support.
- While the beneficiary spouse is usually the primary beneficiary of the SLAT, children, grandchildren or other family members can also be named as current or remainder beneficiaries. This helps to keep the funds in the family.
- All income generated by the trust is taxed on the tax returns of the donor spouse, thus allowing you to make additional non-taxable â€œgiftsâ€ to the trust for the amount of the owed taxes. However, a SLAT also can be set up as a non-grantor trust so that all income is taxed to the trust itself. Depending on the state in which the trust is located, this may enable you to avoid state income taxes.
- If the beneficiary spouse dies prematurely, or if you divorce, youâ€™ll lose the indirect access to the funds you had through your spouse. An attorney can advise about ways to potentially replace the funds, such as giving your spouse a power of appointment to be able to direct the funds back to you, or purchasing life insurance to be paid to you upon the spouseâ€™s death.
Finally, itâ€™s important to recognize that every couple has different considerations: For example, LGBTQ couples and those couples on their second marriage each have their own unique concerns. The amount of wealth, as well as age and children/beneficiaries are all factors when youâ€™re creating a trust. Your trusted financial advisor and an estate planning attorney should be able to provide objective guidance that fits your needs.
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With the annual gift tax exclusion, which is currently $15,000 per person, married couples can double the total amount of gifts that can be made tax-free to a trust or other beneficiary by combining individual gift tax exclusions. As an added bonus, this frequently used estate planning technique wonâ€™t affect your lifetime gift and estate tax exemption.
For example, John and Mary Jones want to help out their son, who is building a costly addition to his home. John transfers $30,000 to their son, and the donor couple then file a gift tax return. Mary signifies her consent by checking a box on the return and signing it.
This sounds easy enough, but itâ€™s important to understand the possible snags with gift splitting because the potential consequences can be very costly. Here are a few common pitfalls to keep in mind:
- One spouse must be a U.S. citizen for a couple to use gift splitting.
- A couple must be married at the time of giving the gift. If a couple divorces and one person remarries within the calendar year in which the gift was made, it is ineligible for gift splitting.
- Gift splitting can only be used for present interests. A gift in trust qualifies only if the beneficiary receives a present interest.
- Gift splitting may not be used to benefit a spouse. For example, making a gift to a trust of which the spouse is a beneficiary is prohibited unless the chances the spouse will benefit are very remote.
- If the donor dies within three years of splitting a gift, some of the tax benefits may be lost.
Despite these caveats, gift splitting can be an effective estate-planning technique. First, however, itâ€™s critical to consult your trusted financial advisor and an estate planning attorney for guidance and assistance.
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Annual Exclusion Gifts
High net-worth individuals usually enjoy giving gifts. But to avoid surprise tax bills, itâ€™s important to keep in mind the laws concerning the gift tax and the lifetime gift tax exemption.
This is especially important when giving substantial gifts. Starting in 2020, the lifetime gift tax exemptionâ€”as noted early in this article, is $11.58 million. This means that you can give up to $11.58 million in gifts over your lifetime without ever having to pay gift tax on it. For married couples, each spouse gets the $11.58 million exemption; so, they can give away a total of $23.16 million before paying the gift tax.
Remember that even if you donâ€™t come close to exceeding the exemption, you may still need to file gift tax returns. Keep a record of any gifts you give; your trusted financial advisor can inform on what the requirements are for your situation.
The lifetime gift tax exemption is directly tied to the federal estate tax, which applies when an estate is worth more than $11.58 million. Moreover, the federal estate tax exemption can be transferred between spouses; when one spouse dies, the remaining spouse can effectively have a $23.16 million exemption.
Gifts made each year in excess of the $15,000 annual limit per recipient reduce your federal estate tax exemption when you die. For example, if you give your grandchild a gift of $25,000 in a year, the first $15,000 isnâ€™t taxable because of the annual exclusion. After that, however, the remaining $10,000 counts against both your lifetime gift tax exemption and your federal estate tax exemption. Now, when you die, your federal estate tax exemption will be $11.57 million. All money exceeding that will be subject to estate taxes.
Certain kinds of gifts are always exempt from the federal gift tax and do not have to be reported to the IRS. These include IRS-approved charities, a gift to your spouse (as long as he or she is a U.S. citizen), a gift to cover someoneâ€™s education tuition if paid directly to the educational institution, and gifts that cover someoneâ€™s medical expenses if paid directly to the medical facility.
In 2020, Connecticut is the only state that still levies a gift taxâ€”it matches the federal exemption level of $11.58 million.
Finally, keep in mind that besides the lifetime gift tax exemption, thereâ€™s also an annual gift tax exclusion; for 2020, it is $15,000. This means you can give up to $15,000 to as many individuals as you want in a given year without affecting your lifetime gift tax exemption. You donâ€™t need to report gifts below the annual gift tax exclusion, but if they exceed $15,000 you must file a gift tax return. Estate tax rates currently range from 18% to 40%, and the amount by which you exceed the annual gift tax will also be deducted from your lifetime gift tax exemption and your federal estate tax exemption.
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REDW Wealth Can Help
With interest rates at a record low and federal estate and lifetime gift tax exemptions at an all-time high, this is an ideal time to review your gifting plans. The experienced team at REDW Wealth is ready to answer your questions or help you develop a plan that aligns with your lifetime gifting options and concerns.
Please contact Paul Madrid, Principal and REDW Wealth Practice Leader.