Tax modifications on the switch of items, estates and generations

Monday, February 22, 2021

Due to the recent election results, attention has focused on what awaits the federal transfer tax system. This article describes the status of current transfer tax laws and President Biden’s proposed amendments.

Estate, gift and generation transfer taxes

Three federal taxes affect the transfer of wealth: gift tax, estate tax, and generation-skipping transfer (GST) tax. Not all transfers are subject to transfer tax. Gift tax (which applies to lifelong transfers) and inheritance tax (which applies to death transfers) are “flat,” which means that both taxes have a single tax rate and there is a single “amount of exemption” that anyone can transfer during life or death without the payment of gift or estate taxes. The GST tax is an additional tax levied on certain referrals made to people more than a generation below the donor. The GST tax applies to transfers during life and transfers during and after death.

Current law

Under the Tax Cuts and Jobs Act (TCJA) of 2017, gift, bequest and GST exemptions were doubled from $ 5 million to $ 10 million in 2018, which was indexed for inflation from 2011 onwards. The 2021 gift, rebate and GST exemptions are currently $ 11.7 million. The exemption amount is expected to “go under” on January 1, 2026 or return to the level prior to TCJA. The applicable tax rate for transfers over $ 11,700,000 is 40%.

For married persons, the amount of the inheritance tax exemption is affordable. This means that the surviving spouse can receive and use part of the unused exemption amount of the first spouse during their lifetime or in the event of death if an appropriate choice is made in good time in the estate tax return of the first deceased spouse. So if a spouse dies without using their federal exemption in full, they won’t necessarily be lost.

In contrast to the federal inheritance tax exemption, the GST exemption is not transferable between spouses. If a spouse dies without taking full advantage of their GST exemption, any unused exemption will be lost.

Biden’s suggestions

During his campaign, President Biden published a number of high-level proposals that would undo much of the TCJA. While many of the suggestions were not detailed enough, they included the following:

  • Accelerate the “sunset” of elevated exemptions before January 1, 2026.

  • Raise the estate tax rate to 45%, with exemptions of $ 3.5 million for estate and GST taxes and a $ 1 million exemption for gift taxes (not indexed for inflation, but the estate tax exemption would be sustainable for the surviving spouse ). Note that this suggestion is inconsistent with returning the exemptions to the pre-TCJA level. It was originally published in the “Green Paper” of Tax Proposals during the Obama administration.

  • Assets valued for tax purposes at capital gains rates on transfer by gift or death (with thresholds, exemptions and other details to be determined).

Although the future of the transfer tax system is uncertain, you may find it beneficial to be considering asset transfer strategies now to take advantage of today’s higher exemptions. For more information on the ways you can use your currently available exceptions, please see our September 2020 customer notification.

If any of the proposed legislative changes go into effect, the laws could be applied retrospectively to an earlier date, possibly as early as January 1, 2021. A retrospective legislative change to reduce the gift tax exemption could result in a surprise gift tax on gifts made by taxpayers too a time when the exemptions were higher. While commentators have speculated that Congress is unlikely to pass laws that retroactively change transfer tax laws in 2021, Congress has in the past made some tax law changes retrospectively so the possibility cannot be entirely ruled out.

Protection against retroactive effects

Given the possibility that changes to the tax code can be applied retrospectively, certain strategies to hedge against this risk can now be considered.

Disclaimer of liability

If the recipient of a tax code gift declines the gift within nine months of the date the gift was given, the gift to that recipient will be treated as not given. (Note that many conditions are required for the disclaimer to work that are not covered here.) If a gift were given to an adult child in March 2021, the child would have until December 2021 to decline the gift. The terms of the gift could be formulated so that in the event of a disclaimer, the gifted property would be returned to the donor and the gift would be deemed never to have taken place. In this way, the decision on whether to use the higher exemption can be postponed for nine months when more information is available about tax changes.

Marriage deduction

For a married couple, indefinite marriage withdrawal can help reduce the risk of legislative changes being retroactive. For example, one spouse could transfer assets to a trust that might contain a taxable gift, or qualify as a qualifying QTIP (Terminable Interest Property) trust in favor of the other spouse. The QTIP election could be postponed until a gift tax return is due for such a transaction, i.e. October 2022 (with extension).

If the exemptions are curtailed and retroactive in 2021, a QTIP election could be held, which would qualify the gift for marital deduction and avoid gift tax. The QTIP trust could also provide a “best interest” standard for distributions that would allow easy access to the assets.

Alternatively, if the exemptions are not curtailed, the donor’s spouse could choose not to make a QTIP election and the trust could act as a gift trust for the beneficiary’s spouse to take advantage of the higher exemption. In addition, such a trust could be designed to provide that exclusion of liability of the beneficiary spouse for any and all interests in the trust would result in the gifted property being held in a trust for descendants (this trust could include the spouse as well Beneficiary). These options allow flexibility to handle possible changes in the law within the nine months of the gift, including fully settling the gift or using the higher exemption.

Loans / Forgiveness

An in-family loan can also be used to facilitate asset transfers now. Interest rates are still significantly low. For example, the intermediate AFR rate for February 2021 is 0.562%. The proposed gift could instead be given as a loan that could be given and become a gift if the exemption continues at current levels, or a loan if the exemption is reduced retrospectively.

© 2020 Faegre Drinker Biddle & Reath LLP. All rights reserved.National Law Review, Volume XI, Number 53