Tag: estate tax

2024 Estate Planning Outlook: Transfer Tax Changes are on the Horizon

The Tax Cuts and Jobs Act of 2017 (TCJA) significantly increased the lifetime estate and gift tax exemption from $5.6 million to $11.18 million for individuals, with adjustments for inflation starting in 2018. For 2023, the lifetime estate and gift tax exemption is $12.92 million (or $25.84 million for married couples). For 2024, the lifetime estate and gift tax exemption will be $13.61 million (or $27.22 million for married couples). This relatively high exemption level has offered substantial relief to many taxpayers in recent years.

However, absent Congressional action, the lifetime estate and gift tax exemption is scheduled to sunset after 2025 to its pre-2018 amount (adjusted for inflation). If this sunset does in fact occur, we anticipate that the lifetime estate and gift tax exemption will revert to around $7 million ($14 million for couples) for 2026, effectively reducing the exemption by about one-half. This substantial reduction in the lifetime estate and gift tax exemption will cause many more people to be potentially subject to federal estate tax at death.

The potential substantial reduction in the lifetime estate and gift tax exemption could have several significant impacts on estate planning:

  1. Increased Number of Estates Subject to Estate Tax. A much higher number of individuals could be subject to estate tax at death due to the new lower estate tax exemption threshold. Proper planning is crucial to minimize this impact.
  2. Increased Estate Tax Liability. Individuals with estates valued in excess of the new lower estate tax exemption threshold could be subject to higher estate taxes at death. Proper planning is crucial to minimize this impact.
  3. Gifting Strategies. If the lifetime gift tax exemption is reduced, then individuals will have a diminished ability to make significant gifts during their lifetime and greater care will need to be given to maximizing the tax benefits of the lower exemption.
  4. Reviewing Existing Plans. Individuals who designed their estate plans based on the current lifetime estate and gift tax exemption should consider revisiting their plans to ensure those plans remain aligned with their goals and objectives.

The big question in the estate planning world today is whether, when, and to what extent Congress will enact changes to gift, estate, and income tax laws. With many challenges facing the current Biden Administration and a heavily divided Congress, it is not certain that major tax legislation even will be considered in 2024. Nevertheless, the tax proposals endorsed by the Biden Administration provide signals for actions clients should consider during the current year.

Executive Summary

  • The time to gift is 2024 — change is potentially on the horizon.
  • The timing and extent of potential changes to gift and estate tax laws are unclear.
  • Some potential changes could include reducing the exemption, increasing the estate tax rate, increasing the capital gains tax rate, and eliminating the basis adjustment.
  • Consider “locking in” the 2024 exemption amount by gifting to irrevocable trusts and continuing to take advantage of planning opportunities to shift appreciation out of your estate with techniques such as GRATs and intra-family loans.

Potential Legislative Tax Changes[1]

Potential Transfer Tax Changes – Lowered Transfer Tax Exemptions & Increased Transfer Tax Rate

The Biden Administration has proposed lowering the current lifetime estate and gift tax exemption amount to around $3.5 million per individual and increasing the estate tax rate from 40% to 45% on amounts exceeding the exemption. Instead, we may see Congress simply let the exemption sunset back to around $7 million (adjusted for inflation), which was the exemption amount before the substantial increase enacted under the TCJA.

For what it’s worth, the exemption has never been lowered. Despite this, the doubling of the exemption under the TCJA was a dramatic departure from past policies. Thus, reducing the exemption to $7 million (adjusted for inflation) may seem like an easier path, particularly since Congress is so heavily divided. In other words, Congress may opt to treat the last seven years as a fluke and return to “normal.”

Potential Income Tax Changes – Repeal Basis Adjustment & Capital Gains Taxed as Ordinary Income

The Biden Administration also signaled that it might seek repeal of the basis step-up at death and tax capital gains as ordinary income. Although the basis step-up is an income tax planning concept, it is also an important consideration in transfer tax planning. Under current law, gifts of low basis assets can be detrimental because the donee receives the donor’s basis. Taxpayers often decide to retain certain low basis assets, rather than sell them or gift them, to obtain the basis step-up at death. The family members or trusts receiving those assets then can sell those assets with little or no capital gains tax.

The Biden Administration has proposed to eliminate this basis adjustment. An alternative proposal involves treating the transfer of appreciated property at death or by gift as a taxable event causing the gain to be recognized, but many commentators think this is unlikely.

The Biden Administration proposal to tax long-term capital gains and qualified dividends as ordinary income on all income over $1 million would further exacerbate the impact of a repeal of the basis step-up.

Planning Ahead

2024 is an opportune time to make the most of your estate and gift tax exemption.

“Locking In” the Estate and Gift Tax Exemption

Many ultra-high net worth individuals have used most, if not all, of their exemption. Under current tax laws, in 2024, individuals may gift up to $13.61 million during their lives ($27.22 million for married couples). If the exemption decreases from $13.61 million to $3.5 million and the estate tax rate is raised from 40% to 45% percent, the cost of inaction is more than $4.5 million (if an individual makes a gift of $13.61 million while the exemption is $3.5 million and gifts beyond the exemption are taxed at a rate of 45%, the resulting gift tax amounts to roughly $4.5 million; $9 million for married couples). If individuals and married couples have not used their exemption(s) and can afford to, they should give serious consideration to completing gifts equal to their remaining exemption(s) in 2024, ideally to a generation-skipping trust for the benefit of their descendants, particularly since these exemptions are scheduled to sunset in 2025.

Depending on your and your family’s goals, circumstances, remaining exemption, and cash flow needs, gifting up to $27.22 million, or even $13.61 million, to a trust for your beneficiaries may not be feasible. A long-accepted way to address this concern is to create a trust that benefits both the Grantor’s spouse and descendants. This type of trust is commonly referred to as a Spousal Lifetime Access Trust (SLAT). A SLAT is a simple and effective way to address the possible need of the senior generation to access the property transferred. It provides direct access for the beneficiary spouse and indirect access for a Grantor spouse. Grantor Trust provisions, such as ones allowing the Grantor of the trust to swap assets or take loans from the trust without full and adequate consideration, offer tax flexibility, and access to funds by loan.

SLATs have become so popular that couples have created trusts for each other. This is not without risk and should only be done with different trust provisions and with creation of the trusts separated in time. Finally, it is important to remember that potential estate tax savings should never be the sole determinate of your financial planning decisions. Individuals who have stretched themselves thin to make significant gifts sometimes have profound “gifter’s remorse.” Thus, make gifts if you can, but, more importantly, make them if you’re comfortable doing so.

Freezing the Size of the Estate

Perhaps you and your spouse have already utilized your exemptions and are seeking ways to further reduce the tax burden on your estate, or you are not ready to commit large transfers of your property. In either situation, an excellent alternative is to freeze the growth of your estate with strategies like Grantor Retained Annuity Trusts (GRATs) and installment sales with trusts or family loans. GRATs and installment sales have thrived in the past low interest rate environment because assets have often grown in value at a rate above the rate of the annuity, in the case of GRATs, or the interest rate on a promissory note. However, in today’s current higher rate environment, the tax benefits of these planning opportunities may be more restrictive as the appreciation hurdle for a GRAT is now substantially higher than before, and the interest rate on an installment sale is also substantially higher. However, these strategies will still essentially “freeze” the size of one’s estate and transfer potentially significant appreciation, which would have otherwise remained in the client’s estate, out of his or her estate.

Uncertainty Doesn’t Preclude Planning

It is absolutely within the power of Congress to enact retroactive tax legislation if it is rationally related to a legislative purpose, but on a practical level, Congress usually avoids that option. It is almost always unpopular and adds only nominal additional revenue for budgeting purposes. Biden Administration officials already have stated they are not interested in seeking retroactive tax changes. Given the low probability, the threat of retroactive tax law changes should not prevent clients from implementing new estate planning strategies. For those who remain worried, a number of strategies can be structured in a manner that limits potential gift tax liability in the unlikely event legislative changes are enacted retroactively. In 2024, clients should consider reviewing their existing plan to determine whether they can employ certain strategies to maximize use of their exemption and achieve their planning objectives. If the lifetime estate and gift tax exemption is reduced, clients will lose the ability to give away that excess amount (and all subsequent appreciation on that amount).

[1] The following list of potential legislative changes is not all-inclusive. Instead, it focuses on the transfer tax and income tax proposals that would have the most significant impact on the practice of wealth transfer.

© 2023 ArentFox Schiff LLP
For more news on 2024 Transfer Tax Changes, visit the NLR Tax section.

IRS Announces 2023 Increases to Estate and Gift Tax Exclusions

The Internal Revenue Service recently announced the 2023 cost of living adjustments for the estate and gift tax exclusion amounts.

Gift Tax Exclusion Amount:

The annual gift tax exclusion is the amount (“Gift Tax Exclusion Amount”) an individual may gift to any number of persons without incurring a gift tax or reporting obligation. The Gift Tax Exclusion Amount will increase from $16,000 to $17,000 in 2023 (a combined $34,000 for married couples). The Gift Tax Exclusion Amount renews annually, so an individual who gifted $16,000 to someone in 2022 may gift $17,000 to that same person in 2023, without any reporting obligation. However, for any gift above the $17,000 in 2023, the individual making the gift must report it to the IRS.

Example A: A single person gives her two children $17,000 each in 2023. Each gift falls within the Gift Tax Exclusion Amount so the gifting individual will not have to pay any gift tax or notify the IRS. A married couple could give $34,000 to each child, with the same effect.

Example B: Compare a single person who wants to give her only child $20,000 in 2023. The person who gave the gift must notify the IRS of the $3,000 gift because it exceeds the $17,000 Gift Tax Exclusion Amount.

Estate Tax Exclusion Amount:

The estate tax exclusion is the amount (“Estate Tax Exclusion Amount”) an individual can transfer estate tax-free upon his or her death. The Estate Tax Exclusion Amount will increase from $12,060,000 to $12,920,000 in 2023 (a combined $25,840,000 for married couples).

Example A: A single person with two children passes away in 2023 owning $12,920,000 in assets. The deceased person’s two children will inherit the full $12,920,000 as no estate tax is owed.

Example B:  A single person with two children passes away in 2023 owning $20,000,000 in assets. The decedent’s estate will owe tax on the assets owned that exceeded the $12,920,000 Estate Tax Exclusion Amount ($20,000,000 – $12,920,000 = $7,080,000). The current estate tax rate is approximately 40% which means the decedent’s estate will owe estate taxes in the amount of $2,832,000 ($7,080,000 x 40%).

© 2022 Miller, Canfield, Paddock and Stone PLC
For more Tax Law News, click here to visit the National Law Review.

529 Plans: Estate Planning Magic

The most common way to reduce state and federal estate taxes is to make lifetime gifts to irrevocable trusts. However, in order for an irrevocable trust to escape estate taxation at the grantor’s death, the grantor may not retain the power to “designate the persons who shall possess or enjoy the property or the income therefrom.” (IRC § 2036(a)(2).) In other words, the grantor cannot change the beneficiaries of the trust.

This poses a problem. What if circumstances change? What if a grantor creates a trust for a child, but the child no longer needs the funds? What if the grantor ends up needing the funds themselves? A grantor can build flexibility into irrevocable trusts by granting powers of appointment to the beneficiaries or by appointing a trust protector, but these powers may not be held by the grantor. Thus, reluctance to give up control keeps many clients from making gifts to irrevocable trusts.

The general rule that a grantor must relinquish all control over gifted assets has been seared into the mind of every estate planning professional fearful of accidentally causing estate tax inclusion. But there is one exception: the humble 529 Plan.

Section 529 of the Code contains a shocking statement:

“No amount shall be includible in the gross estate of any individual for purpose of [the estate tax] by reason of an interest in a qualified tuition program.” (IRC § 529(c)(4)(A))

There are, of course, exceptions. 529 plans are (likely) includible in the estate of the beneficiary upon the beneficiary’s death. Also, if the grantor has made the election to “front load” five years of annual exclusion gifts to the 529 Plan (discussed further below) and dies before the five years expires, a portion of the gifted amount will be includible in the grantor’s estate.

Still, 529 Plans offer unparalleled flexibility in estate tax planning. A grantor can remain the “owner” of a 529 Plan and retain the power to change the beneficiary to a qualifying family member (which includes grandchildren, nieces and nephews, and others), while still removing the assets in the 529 Plan from his or her estate. This is in contrast with an irrevocable trust, in which the grantor cannot act as trustee and cannot retain the power to change the beneficiaries.

The other “magic” of 529 Plans is the ability to “front load” annual exclusion gifts. The annual exclusion from gift tax allows a grantor to transfer up to $15,000 per year, per person. But, if a grantor makes the proper election on a gift tax return, he or she can make five years of annual exclusion gifts in a single year and use no transfer tax exemption. If the grantor is married and elects “gift‑splitting,” the couple can transfer $150,000 to a 529 Plan in a single year and use no estate and gift tax exemption.

529 Plans are, of course, designed for education, and are not complete substitutes for irrevocable trusts. The “earnings portion” of non-qualified distributions (i.e., distributions not used for “qualified higher educational expenses”) from a 529 Plan are subject to ordinary income tax at the beneficiary’s tax rate plus a 10% penalty, and for this reason, care should be taken not to “overfund” a 529 Plan. However, 529 Plans can nevertheless serve as effective wealth transfer vehicles because of their income tax benefits and the high probability that a grantor will wish to make significant contributions to the education of at least some members of his or her family. Combined with their unparalleled estate tax features, this makes 529 Plans “estate planning magic.”

© 2020 Much Shelist, P.C.

For more Estate Planning, see the Estates & Trusts section of the National Law Review.

2019 Year-End Estate Planning: The Question Is Not Whether to Gift, But How to Gift

Federal and Illinois tax laws continue to provide opportunities to transfer significant amounts of wealth free of any federal gift, estate and generation-skipping transfer (GST) taxes. However, because certain beneficial provisions “sunset” on January 1, 2026, now is an ideal time to revisit estate plans to ensure you make full use of this opportunity.

Current Exemption Levels

The federal gift, estate and GST exemptions (i.e., the amount an individual can transfer free of any of these taxes) are currently $11,400,000 for each individual, increasing to $11,580,000 in 2020. For married couples, the exemptions are currently $22,800,000, increasing to $23,160,000 in 2020. However, on January 1, 2026, the federal gift, estate and GST exemptions will be cut in half.

Federal and Illinois estate tax laws allow for a marital deduction for assets passing outright to a spouse or to qualifying trusts for the benefit of a surviving spouse. Thereafter, the federal estate tax rate is 40 percent. Illinois imposes a state estate tax based on a $4,000,000 threshold, which is not adjusted for inflation, at effective rates ranging from 8 percent to approximately 29 percent. (The Illinois estate tax paid is allowable as a deduction for federal estate tax purposes.) The only way to take advantage of the increased federal exemptions is to utilize planning strategies such as gifting in advance of the sunset date.

Gifting Options

Lifetime utilization of transfer tax exemption. A simple and effective planning opportunity involves early and full use of the high exemptions. Lifetime gifts utilizing the exemption amounts will almost always result in overall transfer tax savings, unless the assets that have been transferred decline in value. As with any gifting strategy, all income and future appreciation attributable to the gifted assets escapes future gift and estate taxation.

Assuming that assets appreciate, the sooner a planning strategy is implemented, the greater the estate tax savings will be. On November 22, 2019, the IRS issued final “anti-clawback” regulations expressly acknowledging that, when the exemptions are decreased, gifts made using the current high exemption amounts and which are in excess of the future reduced exemption amounts will not be subject to any additional gift or estate taxation. Thus, now is clearly the time for a “use it or lose it” strategy.

Annual exclusion gifts. Making use of annual exclusion gifts remains one of the most powerful estate planning techniques. The “annual exclusion amount” is the amount that any individual may give to any other individual within a tax year without incurring gift tax consequences. This amount, indexed for inflation, is currently $15,000 per donee.

Married couples can combine their annual exclusion amounts when making gifts, meaning that a married couple can give $30,000 per year to a child without using any transfer tax exemption (although filing a gift tax return may be required in some circumstances). When the spouses of children are included in the annual exclusion gifting, the amount that can be gifted is doubled again, meaning that a married couple can give a total of $60,000 per year to a child and the child’s spouse without using any transfer tax exemption.

Annual exclusion gifts can result in substantial transfer tax savings over time, as they allow the donor to remove the gift amount and any income and growth thereon from the donor’s estate without paying any gift tax or using any transfer tax exemption. Annual exclusion gifts also reduce a family’s overall income tax burden when income-producing property is transferred to family members who are in lower income tax brackets and not subject to the “kiddie tax” or the 3.8 percent net investment income tax.

Tuition and medical gifts. Individuals can make unlimited gifts on behalf of others by paying tuition costs directly to the recipient’s school or paying their medical expenses (including the payment of health insurance premiums) directly to a health care provider.

Gifts to spousal lifetime access trusts. Most people consider $11,400,000 to be a very large gift and either cannot, or do not want to, give away that much, as they may need or want it for themselves. A gift to a properly structured “spousal lifetime access trust” lets an individual make a completed gift now, and use the temporarily increased transfer exemption, but allows the individual’s spouse to be a beneficiary of the trust and have access to trust assets if needed. If the spousal lifetime access trust is implemented properly, the assets of trust (and the growth thereon) will not be subject to estate tax at the death of the grantor or at the death of the grantor’s spouse.

Grantor trusts. When planning with trusts, donors have great flexibility in determining who will be responsible for the payment of income taxes attributable to the assets in a trust. As an enhanced planning technique, trusts can be structured as “grantor trusts,” in which the trust is a disregarded income tax entity and the donor—not the trust or the beneficiaries—is responsible for paying tax on the trust’s income. By structuring a trust as a grantor trust, a donor can make tax-free gifts when paying the tax attributable to the trust’s income. This technique promotes appreciation of the trust assets while simultaneously decreasing the size of the donor’s estate, producing additional estate tax savings.

Combining gifting and selling assets to grantor trusts. Additional estate tax benefits can be obtained by combining gifts to grantor trusts with sales to grantor trusts. Because the grantor is treated as the owner of the trust for income tax purposes, no capital gains tax is imposed on the sale of assets to a grantor trust. The trust can finance the sale with a promissory note payable to the grantor, which provides the grantor with cash flow from the trust. The growth on the assets that are sold would then escape estate taxation at the grantor’s death.

Considerations When Making a Gift

Use of trusts when gifting. As with any gifting strategy, assets may be gifted outright so that the recipient directly controls the assets, thereby exposing the assets to the claims of the beneficiary’s creditors. Alternatively, assets may be gifted in trust, which 1) protects the gifted assets from the beneficiary’s creditors, including the spouses of beneficiaries in the event of divorce, 2) determines the future use and control of the gifted assets, and 3) shelters the gifted assets from future gift, estate and GST taxes through the allocation of the GST exemption.

Valuation discounts and leveraging strategies in the family context. “Minority interest,” “lack of marketability,” “lack of control” and “fractional interest” discounts can still be applied under current law to the valuation of interests in family-controlled entities and of real estate and other assets that are transferred to family members. Such discounting provides for estate and gift tax savings by reducing the value of the transferred interests. Leveraging strategies (e.g., family partnerships, sales to grantor trusts and grantor retained annuity trusts) can also be utilized to advantageously pass tremendous amounts of wealth for the benefit of many generations free of federal and Illinois transfer taxes.

State of Illinois estate tax laws. Illinois continues to tax estates in excess of $4,000,000, which is not adjusted for inflation and not allowed to be “ported” to a surviving spouse. Given the disparity between the $11,400,000 federal estate tax exemption and the $4,000,000 Illinois estate tax exemption, married couples domiciled in Illinois should make certain that their estate plans are structured to take advantage of the Illinois estate tax marital deduction. Otherwise, an estate plan that is designed to fully utilize the federal exemption can inadvertently cause an Illinois estate tax in excess of $1,000,000 upon the death of the first spouse.

The obvious and most direct strategy to address the Illinois estate tax is to simply move to one of the many states that do not currently impose an estate tax. In the event that a change of domicile is not possible or is not desired, all of the traditional planning techniques described above (in addition to others) are available to address this state liability. Because Illinois does not impose a gift tax, enacting gifting strategies will reduce future Illinois estate taxes.

Income tax basis changes. We continue to enjoy an income tax basis adjustment for assets received from a decedent upon his or her death (commonly known as the “step-up in basis,” although if values go down it can also be a “step-down” in basis). With the increase in the federal gift, estate and GST exemptions, and even with Illinois’ $4,000,000 exemption, transfer taxes are no longer a concern in many circumstances, and there is increased emphasis on income tax planning (specifically, planning with the goal of obtaining an income tax basis step-up at death). For many clients, it may be advisable, if possible, to “reverse” prior estate planning techniques, including trusts that were established on the death of a first spouse to die, to allow for a step-up in basis.

Traditional Estate Planning Still Matters

There is no time like the present to make certain that estate planning documents accurately reflect current wishes and make beneficial use of the federal and state transfer tax exemptions (to the extent not utilized during lifetime), federal and/or state marital deductions, and federal GST exemptions. Revisions may also be needed if family circumstances have changed since documents were originally executed.

Your estate planning goals may have changed. Many people no longer have taxable estates for federal estate tax purposes and may be able to adjust their estate plans accordingly, while others have existing plans that automatically adjust to the increased exemptions and do not desire more aggressive planning. Still others may want to take prompt action to aggressively utilize the new exemptions.

The above summary is not intended to enumerate all available estate planning techniques. Non-tax reasons to review and implement estate plans include:

  • Planning for probate avoidance
  • Planning for individuals with special needs (or who otherwise require specialized planning)
  • Implementing advance health care directives (such as living wills and health care powers of attorney)
  • Planning for incapacity
  • Planning for business succession
  • Planning for minor children and designating guardians
  • Planning for charitable giving

New Trust Code for 2020

On January 1, 2020, a new Illinois Trust Code will become effective, making many significant changes with regard to the administration of trusts. Of note:

Notice and designated representatives. Under the new law, for trusts that become irrevocable on or after January 1, 2020 (for example, a revocable trust becomes irrevocable upon a settlor’s death), the trustee is required to provide a copy of the trust agreement to all current and presumptive remainder beneficiaries. However, you can name a designated representative to receive such notice on behalf of any current and remainder beneficiaries.

Accountings. Under current law, a trust can be drafted so that accountings only need to be provided annually to current beneficiaries, not presumptive remainder beneficiaries. Under the new Illinois Trust Code, for trusts that become irrevocable on or after January 1, 2020, a trustee will have to provide annual accountings to current and presumptive remainder beneficiaries.

However, a trust agreement can be drafted to forego the requirement of providing the annual accountings to the remainder beneficiaries or potentially to provide that the accountings be provided to a designated representative for a remainder beneficiary rather than the remainder beneficiary himself or herself (although the remainder beneficiaries will be entitled to accountings when the current beneficiary’s interest terminates). This could mean, for example, that children who are remainder beneficiaries of a marital trust created under their father’s estate plan for their mother’s benefit will receive an annual accounting during their mother’s life unless they waive their right to receive it or the trust provides otherwise.

The Secure Act

Finally, pending in Congress is a bill known as the Secure Act. This legislation, if enacted in its current form, would push back the age of required minimum distributions from 70½ to 72 and eliminate the “stretch IRA.” If the Secure Act becomes law, we will send a supplement to this bulletin.

© 2019 Much Shelist, P.C.

More estate planning considerations on the National Law Review Estates & Trusts law page.

California Estate Tax: Gone Today, Here Tomorrow?

California has no estate tax, but that could change in the near future. California State Senator Scott Wiener recently introduced a bill which would impose gift, estate, and generation-skipping transfer tax on transfers during life and at death after December 31, 2020.

California law requires that any law imposing transfer taxes must be approved by the voters. This means that, if the California Legislature approves the California bill, it will be put before the voters at the November 2020 election.

For a time, California imposed a “pick up tax,” which was equal to the credit for state death taxes allowable under federal law; however, federal tax legislation phased this credit out completely in 2005, effectively phasing out any California estate tax. California has not in recent memory, if ever, had a statewide gift or generation-skipping transfer tax.

Under the proposed California bill, like the federal regime, all California transfer taxes will be imposed at a 40% rate. The good news is that the taxpayer will be granted a credit for all transfer taxes paid to the federal government, so there will be no double taxation. The bad news is that, unlike the federal regime where the basic exclusion amount for each type of transfer is $11,400,000 and is adjusted for inflation, the basic exclusion amount for each type of transfer in California will be $3,500,000 and will not be adjusted for inflation. With the federal exclusion rates rising every year, advanced estate planning techniques to minimize such taxes have become something that fewer and fewer people have had to worry about. If the California bill passes, any person who has assets valued in excess of $3,500,000 could be subject to a 40% California transfer tax during life or at death. Moreover, with a full credit for federal transfer taxes, only estates between $3,500,000 and $11,400,000 will be subject to the California tax. Thus, a California resident with an estate of $100,000,000 would pay the same California estate tax as someone with an estate of $11,400,000.

As drafted, the California bill appears to have no marital deduction; however, this is most likely an oversight and should be corrected in future revisions of the California bill. The goal of the California bill is to impose transfer taxes on wealthy Californians equal to what they would have paid prior to the implementation of the increased exemption rates at the end of 2017.  As the marital deduction existed when exemption rates were lower, eliminating the marital deduction at the first death would not be aligned with the purpose of the California bill.

All transfer taxes, interest, and penalties generated by the California bill would fund the proposed Children’s Wealth and Opportunity Building Fund, a separate fund in the State Treasury, which will fund programs to help address socio-economic inequality.

 

© 2019 Mitchell Silberberg & Knupp LLP
This post was written by Joyce Feuille of Mitchell Silberberg & Knupp LLP.
Read more news on the California Estate Tax on our Estate Planning page.

November Election and Estate Planning

estate planning november electionsThe Presidential election is around the corner. What does that mean for estate planning? Probably nothing, particularly if the Executive Branch and Congress remain split among the parties. In the past four years, a Democratic President and Republican Congress has resulted in no significant estate tax legislation. Thus, after 10 years or so of uncertainty and change that preceded 2012, there has been an estate planning calm.

It is unlikely the calm changes in 2017 if there is President Clinton and a Republican Congress. Hillary favors the same provisions as President Obama, which are reducing the estate tax exemption from $5 million per person, indexed for inflation, to $3.5 million, and increasing the estate tax rate from 40% to 45%. But as with President Obama, it is unlikely these proposals will go anywhere, unless Democrats take control of the House and Senate.

Conversely, President Trump wants to eliminate the estate tax, similar to former President Bush. Perhaps a big push to eliminate the estate tax would result if large Republican majorities controlled the House and Senate. But even with a Republican President and Congress it is more likely current law, allowing married couples to protect $10.9 million from estate tax, adjusted annually for inflation, would continue.

Of less concern to most, but significant for the relatively wealthy few, is the Obama Administration’s desire to eliminate or reduce advanced planning techniques, such as GRATS, gift/sales to intentionally defective trusts, dynasty trust planning, and intra-family discounting. A new President and Congress may also address these strategies.

Article By John P. Dedon of Odin, Feldman & Pittleman, P.C.
© 2016 Odin, Feldman & Pittleman, P.C.

The Artist’s Legacy – Gifts of Art to Family and Friends

Sheppard, Mullin, Richter & Hampton LLP

On January 1, 2015, the gift and estate tax exemption increased to $5.43 million per person and to $10.86 for a married couple.  Artists who hope to take advantage of the increased exemption face unique challenges when making gifts to family and friends of visual art they have created.  Although specific situations can differ widely, the general principles to consider when making such gifts are described below.

Generally, the donor’s income tax basis carries over to the gift recipient and is increased by any gift tax paid.   Because visual art is ordinary income property in the hands of the creator, the donee of a gift of a work of visual art from the creator receives the artist’s income tax basis.  The donee will recognize ordinary income if he or she chooses to sell the gifted item, and the proceeds will be subject to tax at the donee’s ordinary income tax rate.

To avoid this result, many artists consider waiting to gift works of visual art they have created until death.  The beneficiary of a testamentary gift of visual art from the creator receives the gift with a “stepped-up” basis to the art work’s fair market value on the date of the artist’s death. Additionally, because the beneficiary is not prohibited from holding the work as a capital asset, the beneficiary’s sale of the work of visual art would receive capital gain or loss treatment.  Whether the long and short capital term gain tax rates are preferential to the taxpayer’s ordinary income rate will vary.  For high income taxpayers, the long-term capital gain tax rate may be lower than the beneficiary’s ordinary income tax rate.  Of course, the donee’s basis is less of a consideration if the donee does not intend to sell the work.

An artist may favor making a lifetime gift of visual art if the gift qualifies for the annual gift exclusion ($14,000 in 2015) and thus, would not be subject to gift tax.  Further, if the artist has an estate that will be subject to estate tax, there may be advantages to gifting art during the artist’s lifetime so that the value of the visual art (and all post-gift appreciation) is not included in the artist’s estate (and subsequently subject to estate tax).

On the other hand, an artist may opt to delay making gifts until his or her death if the artist wishes to use and enjoy the visual art for the remainder of his or her life.  Moreover, there may be limited estate and gift tax advantages to gifting the visual art during the artist’s lifetime if the artist has already used his or her lifetime exemption amount or if the artist’s estate is not expected to be subject to estate tax upon his or her death.

Applicability of the legal principles discussed may differ substantially in individual situations. The information contained herein should not be construed as individual legal advice.

ARTICLE BY

Lauren C. Liebes
Sheppard, Mullin, Richter & Hampton LLP

2014 Year-End Illinois Estate Planning: It’s Time for a Careful Review

Much Shelist law firm logo

As 2014 comes to a close, now is the perfect time for careful planning to address the income, estate, gift and generation-skipping taxes that can directly affect you.  In addition to making sure your estate plan is up to date, making a few important decisions now can reduce your tax liability later.

Transfer Tax Exemption and GST Exemption

The exemption amount that individuals may transfer by gift and/or at death without being subject to federal transfer taxes increased in 2014 to $5,340,000; it will further increase to $5,430,000 in 2015.  The maximum federal estate tax rate remains 40%.  In contrast, Illinois imposes a state estate tax once a decedent’s estate exceeds $4,000,000 (which is not adjusted for inflation). The rates of Illinois estate tax range from 8% to 16% (with the Illinois estate tax paid allowable as a deduction for federal estate tax purposes). Both the federal and Illinois estate tax laws allow for a marital deduction for assets passing outright to a spouse or to qualifying trusts for the benefit of a surviving spouse.  Illinois allows this deduction to be claimed even if a marital deduction is not elected for federal purposes.

In order to impose a death tax at each successive generational level, a generation-skipping transfer (“GST”) tax – equal to the highest estate tax rate – is assessed on transfers to grandchildren or more remote descendants.  However, every taxpayer is also given a separate federal GST exemption equal to the federal transfer tax exemption (i.e., $5,340,000 in 2014 and $5,430,000 in 2015).

Estate planning documents should be reviewed to make certain that beneficial use of the federal and state transfer tax exemptions, federal and/or state marital deductions and federal GST exemption are being utilized.

Annual Exclusion Gifts

Making use of annual exclusion gifts remains one of the most powerful – and simplest – estate planning techniques. For 2014 (and 2015), individuals can make an unlimited number of gifts of up to $14,000 per recipient, per calendar year.  Over a period of time, these gifts can result in substantial transfer tax savings, by removing both the gift itself and any income and growth from the donor’s estate, without paying any gift tax or using any transfer tax exemption.  An individual cannot carry-over unused annual exclusions from one year to the next.  If such exclusions are not utilized by the end of the year, the balance of any annual exclusion gifts that could have been made for that year are lost.  These transfers may also save overall income taxes for a family, when income-producing property is transferred to family members in lower income tax brackets (who are not subject to the “kiddie tax”.)

Tuition and Medical Gifts

Individuals can make unlimited gifts on behalf of others by paying their tuition costs directly to the school or their medical expenses directly to the health care provider (including the payment of health insurance premiums).

Lifetime Utilization of New Transfer Tax Exemption

The ability to transfer $5,430,000 ($10,860,000 per married couple) – after annual exclusion and medical and tuition gifts, and without having to pay gift taxes – paves the way for many planning opportunities.  When combined with valuation discounts and leveraging strategies (e.g., family partnerships, sales to grantor trusts, grantor retained annuity trusts,  etc.), tremendous amounts of wealth may pass for the benefit of many generations free of federal and Illinois transfer taxes. Lifetime gifts utilizing the exemption amounts will almost always result in overall transfer tax savings (unless the assets which have been transferred decline in value). The main reason is the removal of the income and growth on the gifted assets from the taxable estate.

For individuals who fully used their transfer tax exemptions in prior years, consideration should be given to making gifts of the additional inflation adjusted amount (i.e., the $90,000 increase in the transfer tax exemption from 2013 to 2014, and an additional $90,000 increase in the exemption from 2014 to 2015).

Benefits of Acting Early. The main benefit of making gifts that utilize the transfer tax exemption is to remove from the taxable estate the income and appreciation on those assets from the date of the gift to the date of death. The sooner the gifts are made, the more likely that additional income and growth on such assets will escape taxation.

Gifts in Trust. Despite the tax savings, many individuals are uneasy about making outright gifts to their descendants. Such concerns are usually addressed by structuring the gifts in trust, which allows the donor to determine how the assets will be used and when the descendants will receive the funds. The use of gift trusts can also provide the beneficiaries with a level of creditor protection (including protection from a divorcing spouse) and additional transfer tax leverage. This is particularly effective when coupled with applying GST exemption to the trust (discussed above) and making the trust a “grantor trust” for income tax purposes (discussed below).

Many individuals may not be comfortable giving away significant amounts of wealth. However, the gift trust technique is not limited to trusts for descendants, but may also include a spouse as a beneficiary (or as the sole primary beneficiary).  Making the spouse a beneficiary of a gift trust (generally referred to as a spousal lifetime access trust, or “SLAT”) provides indirect access to the trust assets, while allowing the income and growth to accumulate in the trust (if not otherwise needed), and pass free of estate and gift taxes.

One of the most powerful estate planning strategies is the utilization of a “grantor trust.”  Significant additional transfer tax benefits can be obtained by structuring a gift trust as a “grantor trust” for income tax purposes. The creator (or “grantor”) of a “grantor trust” is required to report and pay the tax on the income earned by the trust. This allows the grantor to pass additional funds to the trust beneficiaries free of gift and estate taxes and income taxes, as the grantor’s payment of the trust’s income taxes each year would be considered his or her legal obligation and would not be considered additional gifts.

Taxable Gifts

Although individuals generally dislike paying taxes, making taxable gifts and paying a gift tax may prove to be beneficial.  While the federal government imposes a 40% estate tax on taxable estates and a corresponding 40% gift tax on taxable gifts, Illinois does not impose a gift tax. Thus, taxable gifts result in an overall savings of state estate and gift tax.  Moreover, the differing manner in which the gift and estate taxes are computed and paid results in overall transfer tax savings.

The gift and estate tax, although “unified,” work quite differently. The estate tax is “tax inclusive:” the tax is determined based upon the assets owned at death, and paid from those assets (similar to the income tax, which “after tax” dollars must be used to pay the tax). However, the gift tax is “tax exclusive:” the gift tax is determined based on the assets gifted, and paid from other assets owned by the donor. As an example, if you previously used your transfer tax exemption and then make a $1,000,000 gift you would incur a $400,000 gift tax, $1,400,000 will be removed from your estate, and the donees will receive $1,000,000.  However, if you die without making the $1,000,000 gift, you would have the full $1,400,000 included in your estate, resulting in approximately $676,000 of federal and Illinois estate taxes, leaving only $724,000 rather than $1,000,000 for your descendants. In order to leave $1,000,000 for your descendants at death you would need approximately $1,934,000. The estate tax on such amount would be approximately $934,667, leaving $1,000,000 for your descendants. Stated another way, by gifting assets the IRS gets 40¢ for each $1.00 your beneficiaries receive, but by dying with the assets the IRS gets 93¢ for each $1.00 your beneficiaries receive. However, there are also potential downsides: paying a tax earlier than otherwise may be needed, the possibility that the estate tax may be repealed or the rates reduced, the loss of income/growth on assets used to pay the gift tax, the possibility that the transfer tax exemption may be increased which would have allowed the gifts to pass tax free, etc.

Making Use of Historically Low Interest Rates

Interest rates remain very low (with increases likely on the horizon). The current (and historically low) interest rates continue to create an environment ripe for estate planning and transferring wealth to descendants on a tax-advantaged basis.  Techniques such as grantor retained annuity trusts (“GRATs”), charitable lead trusts (“CLTs”), intra-family loans (bearing the minimal interest in order to avoid a gift of 0.39% for loans of 3 years or less, 1.90% for loans of 3 to 9 years, and 2.91% for loans of 9 years or more as of November 2014), and sales to “grantor trusts” are sensitive to interest rate changes – and are very beneficial in a low interest rate environment.

Illinois QTIP

Given the disparity between the $5,340,000 federal estate tax exemption and the $4,000,000 Illinois estate tax exemption, married couples domiciled in Illinois should make certain that their estate plans are structured to take advantage of the Illinois QTIP marital deduction.  Otherwise, an estate plan that is designed to fully utilize the federal $5,340,000 exemption can inadvertently cause a $382,857 Illinois estate tax upon the death of the first spouse.

Net Investment Income (Medicare) Tax

Higher-income-earners should also plan for the 3.8% surtax on certain unearned income and the additional 0.9% Medicare tax that applies to individuals earning in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately.) While the 0.9% additional tax on wages is only imposed on individuals, the 3.8% tax on net investment income is imposed on individuals, estates and trusts. Individuals are only subject to this new 3.8% Medicare tax if their “modified adjusted gross income” exceeds $250,000 for joint filers ($125,000 for a married individual filing a separate return) and $200,000 for single individuals.  In 2014, trusts and estates are subject to this tax at a $12,150 threshold ($12,300 in 2015). The approach to minimizing or eliminating the 3.8% surtax depends on each taxpayer’s individual situation. Some taxpayers should consider ways to minimize (e.g., through deferral) additional net investment income for the balance of the year, while others should review whether they can reduce modified adjusted gross income other than unearned income. In contrast, others may want to accelerate net investment income and/or modified adjusted gross income that would be received next year so that it is included this year (e.g., to take advantage of deductions this year). Year-end planning (such as timing the receipt of net investment income, the receipt of modified adjusted gross income and the payment of deductible expenses) can save significant taxes.

Retirement Plans and Beneficiary Designations

Contribution limitations for pension plan and other retirement accounts for 2015 were recently released by the IRS.  The following adjustments were triggered by an increase in the cost-of-living index:

  • Elective deferral contribution limits for employees who participate in a 401(k), 403(b) and 457(b) plans increased from $17,500 in 2014 to $18,000 in 2015.
  • The catch-up contribution limit for employees (aged 50 or older) who participate in a 401(k), 403(b) and governmental 457(b) plans increased from $5,500 in 2014 to $6,000 in 2015.

The end of the year is a good time to review the beneficiary designations on your pension plan and other retirement accounts (as well as life insurance policies).  Failing to name beneficiaries or keep designations current to reflect changing circumstances can create substantial difficulties and expense (both emotionally and financially) – and may lead to unintended estate, gift and income tax consequences.  You should make certain to designate beneficiaries when participating in a new retirement plan and update beneficiary designations when circumstances dictate (e.g., death of a spouse).  Finally, it is prudent to maintain a current list of accounts with beneficiary designations – which specifies the type of asset, account numbers, account custodians/administrators and beneficiaries designated for each account (primary and contingent).

ARTICLE BY

Gregg M. Simon
OF
Much Shelist, P.C.

In Estate Planning, Where There's a Will There's a Way

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An August 15, 2014 article, by Robert Wood, in Forbes.com, told how many large companies, such as GM and Merck, pay zero taxes. It told how Apple avoided $9 billion in US taxes in 2012, according to a US Senate Report issued in 2013.

In the estate world, billionaires such as George Steinbrenner, the Yankees owner who died in 2010, avoided an estimated $500 million in US estate tax. But that was because he died in 2010, the one year when there was no estate tax. In 2014, US citizens can protect $5 million from estate tax, and that amount is indexed for inflation, so the current figure is $5,340,000. Thus, $10,680,000 protects most American married couples from paying federal estate tax upon the second of their deaths. Married couples fortunate enough to have more than $10,680,000, will pay federal tax at 40%.

Even wealthy families with assets exceeding $10,680,000 (or a single person exceeding $5,340,000) can take advantage of gifting strategies and charitable planning to avoid or reduce estate tax. These strategies include techniques known as “GRATS,” “IDGT’s,” “CRT’s” and “CLT’s,” which mean nothing except to the tax professionals who implement them, and the wealthy who benefit from them. Although Congress has threatened to curtail or eliminate many of these strategies, they currently remain legal options for US citizens upon their deaths to leave more to their families and less to the IRS.

Whether it is multi-national public companies with billions of income, or wealthy US families with millions of assets, when it comes to avoiding taxes, be it income or estate, where there’s a will there’s a way.

ARTICLE BY

John P. Dedon
OF
Odin, Feldman & Pittleman, P.C.

The Complicated Landscape of US Estate Tax

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Canadians who own assets in the U.S. may be subject to U.S. estate tax.

This tax is based on the fair market value of all U.S. assets owned at the time of death. It can reach 40%, depending on the value of U.S. assets and the world-wide estate.

But not all Canadians who own U.S. assets will be subject to U.S. estate tax. A close look at the new U.S. estate tax rules will help you determine whether your Canadian clients are exposed to U.S. estate tax.

New U.S. estate tax rules

On January 2, 2013, President Obama signed the American Taxpayer Relief Act of 2013 (the Act) into law. The Act resolves many of the issues raised by the fiscal cliff.

Pursuant to the Act, U.S. estate tax liability of non-U.S. residents depends on the answers to the following two questions:

  1. Is the value of the U.S. estate more than $60,000?
  2. Is the value of the worldwide estate greater than $5,250,000?

If the fair market value (FMV) of U.S. assets is less than $60,000 on the date of death, then there is no U.S. estate tax. If the value of U.S. assets on death exceeds $60,000, a Canadian’s estate may still be exempt from U.S. estate tax if the value of his or her worldwide estate upon death is less than what is known as the “exemption.”

Worldwide exemption for 2013 and beyond

The Act provides an exemption from U.S. estate tax if a non-resident dies with a worldwide estate with a FMV of less than $5,250,000. This exemption amount is inflation-adjusted. Everything counts when calculating a Canadian client’s worldwide estate—including RRSPs and life insurance.

Additionally, when advising a married couple about U.S. estate tax exposure, it’s important to calculate the value of both spouses’ estates combined.

Clients often ask whether the U.S. estate tax is on the worldwide estate. The answer is no; the IRS does not tax a Canadian resident (who is not a U.S. citizen) on his or her worldwide estate.

The only assets that are subject to U.S. estate tax for Canadians are U.S. assets.

What are U.S. assets?

Common U.S. assets include real estate in the U.S. and personally held stocks of U.S. corporations, both public and private.

Here’s a complete list of U.S. assets subject to U.S. tax:

  • real estate property located in the U.S;
  • certain tangible personal property located in the U.S., such as furniture, vehicles, boats and airplanes;
  • golf club equity memberships;
  • shares of U.S. corporations, regardless of the location of the share certificates (even inside RRSPs or RRIFs);
  • interests in partnerships owning U.S. real estate or carrying on business in the U.S.;
  • U.S. pension plans and annuity amounts (IRAs and 401K plans);
  • stock options of a U.S. company;
  • U.S. mutual funds;
  • money owed to Canadians by American persons; and
  • money market accounts with U.S. brokerage firms.

The following is a list of U.S. assets not subject to U.S. estate tax:

  • U.S. bank deposits;
  • certain debt obligations, such as U.S. government bonds;
  • American depository receipts;
  • term deposits/guaranteed investment certificates;
  • real estate situated outside the U.S.;
  • Canadian mutual funds denominated in U.S. dollars that invest in U.S. stocks;
  • life insurance proceeds payable on the death of a Canadian citizen and resident who is not an American citizen; and
  • non-U.S. stocks, bonds and mutual funds.

Many Canadians own assets subject to U.S. estate tax with vacation homes and shares of U.S. corporations topping the list. How can you help clients who own these assets?

The following scenario provides some answers.

Strategies for Canadians who own U.S. assets

Richard is a Canadian citizen and resident, single, with a worldwide estate of $10 million. He owns an $800,000 property in Ft. Lauderdale, Fla.

Richard’s inherited 25% of the shares of four Florida corporations from his deceased father, which he estimates have a value of $200,000. Each corporation owns an apartment building in South Florida.

The chart “Example estimates” (this page) approximates Richard’s 2013 exposure to U.S. estate tax.

Tax planning for U.S. real estate

The goal of any tax-planning for a Canadian owner of U.S. real estate is to ensure the estate of the Canadian decedent is not subject to U.S. estate tax. Consequently, title should not be in his or her name. Alternative ownership structures include:

  • corporation;
  • cross-border trust (irrevocable or revocable); and
  • limited partnership.

These ownership structures avoid probate and guardianship proceedings in the case of incapacity and can defer or avoid U.S. estate tax.

Tax planning for stocks

Although Richard’s shares of U.S. stock are considered U.S. assets, there are tax-planning techniques for avoiding U.S. estate tax.

01 Sell

This may trigger capital gains tax in Canada, though Richard may have some capital losses to apply against it.

02 Create a Canadian holding corporation

Transfer the shares of U.S. stocks on a tax-free basis into a Canadian corporation, of which Richard is the shareholder.

Should Richard pass away with U.S. stock in his Canadian holding company, there will be no U.S. estate tax because Richard no longer owns shares of a U.S. company; he only owns shares of a Canadian holding corporation that owns shares of the Florida companies that Richard’s father passed on to him.

The U.S. Foreign Investment in Real Property Tax Act (FIRPTA) may apply to Richard’s transfer of U.S. stocks into a Canadian company. FIRPTA requires that 10% of the sale price or transfer value of U.S. real estate by a non-resident of the U.S. be withheld and remitted to the IRS. Richard can avoid this with proper structuring and reporting, which we’ll explain next time. No withholding will be required and no disposition will have occurred.

Example estimates of U.S. Estate Tax Payable for 2013

Article by:

David A. Altro

Of:

Altro Levy LLP