Susan Herendeen
As the current administration nears its first 100 days in office, legislation and immediate priorities continued to focus on containing the COVID-19 pandemic and strengthening the economy after the US rescue plan was passed. However, discussions are ongoing in Congress about possible changes to the current tax law that could affect income, business and estate planning for high net worth individuals. It will likely take some time before major changes are made to tax legislation. However, for taxpayers looking to transfer assets to future generations, it is wise to conduct careful and proactive planning now to minimize risk and maximize their investments.
In the current political landscape, the proposed changes that could potentially affect estate planning include reducing the amount of tax exclusion for gift and estate taxes, increasing both capital gains and estate tax rates, and removing the top-up cost base in the event of death.
Under current law, federal estate tax exemption is $ 11.7 million for individuals and $ 23.4 million for couples. The current administration and members of Congress are considering whether this exemption can be reduced to between $ 3.5 million and $ 5 million for individual earners. Gradual increases in the estate tax rate could range from 45% to 65% depending on the total value of the estate, and capital gains tax could double from 20% to 40% for taxpayers in the top income tax bracket.
Eliminating the top-up cost base would significantly change the valuation of real estate when passed on after death. Rather than “increasing” the cost base of an inherited property without incurring capital gains taxes, the change could lead to tax increases for those inheriting properties that have grown in value significantly over time.
While the question of whether these changes will be made retrospectively remains open, there are a few possible solutions and planning strategies that can take advantage of the current foreclosure amount and reduce a potential long-term tax burden.
Use your estate exemption now
A Spousal Lifetime Access Trust (SLAT) is an estate planning strategy that can be used to transfer assets outside of an estate and protect the transfer of assets to future generations. A SLAT enables a grantee or donor to give a gift in the form of a trust or other chosen family member in the form of large, permanent gifts that reduce the size of the grantee’s estate. For example, for a married couple, a SLAT can allow use of the waiver for lifelong gifts and federal estate taxes while retaining limited access to the assets.
With SLATs, you can, among other things, take advantage of the current federal tax exclusions before changes are made. Because an SLAT, if properly structured, is considered a taxable gift, the grantor or donor pays taxes at the current tax rate, and any appreciation in the value of those assets remains in the trust before the law changes. If the exemption is used before it’s gone, donors will only have to pay income tax on the income generated in the trust rather than inheritance tax on the assets at a potentially higher rate, which represents a future tax benefit.
Reduce your taxable estate
Rather than using an exemption, another cheap option in a rising tax environment is to reduce the size of your estate by removing assets through the use of a non-profit residual antitrust law, or “CRUT” as it is commonly known. A CRUT is another type of irrevocable trust that generates a potential stream of income for donors or other beneficiaries, with the majority of the donated assets going to one or more public or private charities. Ideal for donors with charitable or philanthropic inclinations, this split-interest trust serves multiple purposes.
One advantage of creating a CRUT is that the donor can make a partially tax-deductible donation. After the trust has been funded with assets such as real estate, stocks, mutual funds, or ETFs, the partial tax withholding is determined based on the life of the trust, projected income payments, and current IRS interest rates. In simpler terms, if you put money into a trust and that money then goes to a charity, you are receiving a charitable allowance at the current rate that allows you to leverage your assets while taking advantage of the current low tax rates.
Using low-base stocks for a CRUT provides additional benefits to donors when changes are made to the capital gain rate or the increase in the death cost base is eliminated at the federal level. If you were contributing low-base stocks to a CRUT, you would not be paying tax on the profits. In essence, this can be viewed as a tax elimination strategy that allows you to leave other assets to higher-based dependents.
For future tax benefits, after the CRUT ends or the last income recipient dies, the remaining assets will be distributed to the designated charities and not included in the estate, thereby eliminating the potential for an estate tax.
Combine both strategies
For some people, it may be wise to consider a combination of these strategies rather than choosing one over the other, as each has advantages and disadvantages that need to be considered. Assessing the pros and cons of these trusts is crucial in devising a plan to protect your wealth and estate over the long term.
Even if current proposals or tax law changes stall for a period of time, implementing these strategies can protect you from future risks as profits from a SLAT or CRUT are considered outside of the estate for tax reasons. To determine the estate planning strategy that is right for you, consult with trusted professionals before taking any action to ensure that your strategies are aligned with your goals. Working with a team of attorneys, CPAs, investment professionals and trustees will help you create a comprehensive estate plan. If you act now, you will benefit today and in the future.
Susan Herendeen is the Head of Department for ESL Trust Services. During her career in financial services, she has focused on the areas of personal financial planning, including estate and trust planning, investment management, and nonprofits. Before joining ESL Trust Services, Herendeen worked as a planning manager and investment advisor and has more than 22 years of experience in the financial services industry. Working with a team of ESL Trust Services specialists, she provides strategies and tools to help clients and organizations achieve their estate planning and financial goals. She holds multiple industry certifications including Certified Financial Planner, Certified Trust and Fiduciary Advisor, and Accredited Estate Planner.