This year should be one of the busiest years for all estate planning attorneys; indeed, it could be a repeat of 2012, when the Economic Growth and Tax Relief Reconciliation Act of 2001 (1) was scheduled to expire on December 31, 2012, in which case the estate and gift tax exemption, and the generation-skipping transfer (GST) tax exemption, would have reverted to $1 million, and the highest transfer tax rate would have reverted to 55%. The fury of planning that took place at the end of 2012 ended up being much ado about nothing, as President Obama signed the American Taxpayer Relief Act of 2012 on January 2, 2013, retroactive to December 31, 2012, which made the laws pertaining to the estate and gift tax, and GST tax, permanent. (2)
The end of 2020 should be similar, but a bit different. The current law, the Tax Cut and Jobs Act of 2017, (3) signed by President Trump on December 22, 2017, essentially doubled the transfer tax exemptions from $5 million to $10 million, indexed for inflation. (4) The current law is scheduled to expire on December 31, 2025, meaning that on January 1, 2026, the exemptions will be $5.6 million, indexed for inflation from 2018. (5) However, on November 3, 2020, there will be a presidential election, along with elections in the U.S. Senate and House of Representatives. Thus, depending on the outcome of such elections, and particularly if a Democrat wins the presidential election, it is quite possible that the exemptions could revert to the 2018 amount even sooner. It is even possible that the transfer tax laws could change even more dramatically if a more liberal candidate is elected president.
Because of the potential changes to the estate, gift, and GST tax laws next year, individual clients who have a net worth in excess of the current exemption of $11,560,000, and married couples who have a net worth in excess of two times the exemption, or $23,120,000, should consider how to use the enhanced exemptions before they may no longer apply. In other words, it is use it or lose it all over again, just like 2012.
This article revisits the planning techniques in the estate planner's arsenal to use the exemptions now. Specifically, this article will address the use of the following estate planning techniques: 1) dynasty trusts; 2) spousal lifetime access trusts (SLATs); 3) inter vivos qualified terminable interest property trusts (inter vivos QTIP trusts); 4) self-settled domestic asset protection trusts; and 5) general power of appointment trusts. The planning technique that will be best suited for any particular client will depend on the facts and circumstances, as there is no one size that fits all. (6)
Before diving into the planning options, it is important to first briefly discuss portability and its usefulness (or lack thereof) in utilizing the enhanced exemptions. Simply put, portability allows an individual to "port" (or transfer) upon death any of his or her gift and estate tax exemption not used by the individual during life or upon death to his or her surviving spouse. Thus, portability generally allows a married couple to fully utilize both of their gift and estate tax exemptions, even where the first spouse to die owns assets at the time of death having a value equal to less than his or her remaining estate tax exemption, or his or her estate plan leaves his or her assets to the surviving spouse or charity so that his or her remaining estate tax exemption is not used. Prior to portability, any gift and estate tax exemption not used during life or upon death was lost.
There are three main flaws with relying on portability in our current tax environment. First, portability is not applicable to the GST tax exemption. Therefore, although it may be possible to utilize portability to plan for the use of both spouses' estate tax exemptions, if an individual does not fully utilize his or her GST tax exemption during life or at death, it is forever lost.
Second, a surviving spouse can only use the ported exemption of his or her last deceased spouse. Thus, if exemption is ported to a surviving spouse who remarries, and the new spouse then dies, the ported exemption of the first deceased spouse cannot be used.
Third, and more applicable to the current tax environment, portability does not ensure full use of both spouse's "enhanced" estate tax exemptions. The reason for this is that portability would only be effective if the first spouse dies prior to the exemptions reverting back to the lower amounts. If the first spouse dies after the exemptions revert back, the enhanced exemption will be lost. In addition, if portability is elected and the enhanced exemption is ported, but the exemptions revert back to their original amounts, the ported exemption available for use by the surviving spouse will be limited to the reduced amount, not the enhanced amount. (7)
Given this existing landscape, it is imperative for estate planners to engage in proactive planning for their clients now to ensure full use of each spouse's gift and estate tax exemptions, and GST tax exemptions. Indeed, it appears to be a use it or lose it situation and, yes, it is 2012 all over again.
* Option 1: Gift to Irrevocable Trust --The easiest (and most common) way for a client to utilize his or her gift and GST tax exemptions is for the client to create an irrevocable trust for the benefit of his or her children and more remote descendants and transfer to the trust assets having a value equal to the lesser of the client's remaining gift or GST tax exemption. (8) The transfer to the trust by the client is a taxable gift. As a result, a gift tax return must be filed to report the gift and, importantly, allocate (either by affirmative allocation or an automatic allocation) an appropriate amount of GST tax exemption to the transfer to ensure the trust has an inclusion ratio of zero. By allocating GST tax exemption to the full value of the transfer, the assets in the trust will pass from generation to generation without the imposition of transfer tax for the longest period permitted by the applicable state's perpetuities period--360 years in Florida. (9) For this reason, these types of trusts are often referred to as "dynasty trusts."
For married clients, dynasty trusts may be implemented in three ways to utilize both spouse's enhanced exemptions.
First, if each spouse owns sufficient assets in their individual names (or if the couple is comfortable transferring assets between themselves) each spouse can create a separate trust for the benefit of their children and more remote descendants. Each spouse would allocate his or her GST tax exemption to the trust he or she created. One benefit of this approach is that each spouse can act as trustee of the trust created by the other spouse. Although this does not permit access to the trust assets...