Pipe Dreams Can Come True: Gifting Opportunities 2023 and Onward

• Publication year: 2023

PIPE DREAMS CAN COME TRUE: GIFTING OPPORTUNITIES 2023 AND ONWARD

Written by David A. Hjorth, ChFC, CLU, AEP^* and Jon J. Gallo, Esq.^**

A note from the author: The following article was originally written in partnership with Attorney Jon Gallo. I was most fortunate to originally meet Jon 35 years ago when I was asked to assist with a complicated business and estate planning case. After receiving a short list of outstanding attorneys, Jon was definitely on the top of the list with his articulate and technical knowledge, which complimented both his humble and humorous disposition. I am grateful that Jon and I had the opportunity to work jointly on many cases together.

When the original article was published in 2012, we agreed that we would revisit the concepts presented at a future date. Unfortunately, Jon passed away in 2014, so we did not have the opportunity to readdress these topics jointly. In honor of my good friend, Jon Gallo, I am carrying on his legacy by providing updated information on these important ideas.

I. INTRODUCTION

In introductory estate planning classes, the instructor often talks about the "Pipe Dream" Trust. This is an imaginary trust into which the client transfers income-producing assets without incurring gift taxes, while retaining the income for life and the power to control the disposition of the assets at death, where the client also manages to keep the assets out of his or her taxable estate. Although some aspects of the Pipe Dream Trust are just that—a pipe dream—there are a number of techniques that allow us to get close to this supposedly impossible goal.

Two major factors that allow us to come close to achieving the results of such a trust are the continued historically low interest rate environment,¹ and the historically high estate, gift and generation skipping transfer (GST) tax exemption amounts ($12.92 million per person in 2023). This high exemption amount was set into motion with gradual increases under the Economic Growth and Tax Reconciliation Act of 2001 ("EGTRRA")² and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "2010 Act"),³ and was further extended with the American Taxpayer Relief Act of 2012 ("ATRA").⁴ The Tax Cuts and Jobs Act of 2017 ("TCJA")⁵ doubled the exemption amount again in 2018, but with one significant caveat: starting in 2026, the estate, gift and GST tax exemption amounts revert to their pre-2018 amounts automatically, unless Congress acts to extend the law. In the current political environment, it would likely require unified control of both chambers of Congress and the White House by the Republican party in 2025 in order to accomplish this, and even unified control by slim margins would create obstacles and roadblocks to an extension.

As a result, planners in 2025 may find themselves having a déjà vu moment taking them back to 2010 and 2012, when similar sunsets threatened the status quo and led to considerable planning activity as a result. Furthermore, many popular strategies involving trusts and wealth shifting are squarely in the crosshairs of many members of Congress. The Inflation Reduction Act of 2022 included major changes to exemption levels and tax rates and took direct aim at certain planning techniques that enable wealthy people to enhance tax results.⁶ This article therefore focuses on lifetime giving techniques that are of interest in the current environment, particularly in light of potential changes to the planning landscape in the future.

As planners, we need to keep in mind that the tax savings inherent in making taxable gifts is not, by itself, reason to urge clients to make gifts of more than they feel comfortable giving away, with the consequence of either

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adversely affecting their standard of living or moving them outside of their "comfort zone." One thing the authors have noticed over the years is how long many of our clients are living. Increases in the estate and gift tax exemptions may well be overshadowed by increases in our clients' longevity, as many of us have clients who are active into their 90s.

Nevertheless, we need to assist our clients in considering those avenues of estate planning with which they feel most comfortable within the current generous gift environment—particularly since we know this environment may only be

available through 2025.

II. FUNDAMENTAL CONCEPTS

When it comes to the gift tax, a fundamental concept needs to be kept in mind: it costs less to transfer assets by lifetime gift, subject to the gift tax, than through transfers at death, subject to estate tax.

First, the effective tax rate applicable to taxable gifts is lower than the effective rate applicable to transfers at death. This difference occurs because the estate tax is tax inclusive—the entire estate is taxed, including the funds which will be used to pay the estate tax, while the gift tax is tax exclusive—only the gift is taxed, and not the dollars used to pay the gift tax.⁷

Assume that a client has fully utilized her $12.92 million gift/estate tax exclusion. The out-of-pocket cost to her in transferring $1 million to her children subject to a 40% gift tax is $1,400,000, comprised of the $1 million gift and $400,000 of gift tax. The cost to her estate of transferring $1 million to her children, subject to estate tax, is $1,666,667.⁸ Since the gift tax is tax exclusive—only the value of the transfer is taxed—the dollars used to pay the gift tax are themselves not subject to gift tax. Unlike the gift tax, the estate tax is imposed on every dollar in the estate, including the dollars used to pay estate taxes.

Second, there are several techniques, some of which are summarized below, which allow the client to leverage the gift tax exemption but which are not available at death. For example, techniques such as Grantor Retained Annuity Trusts ("GRATs"), Grantor Retained Unitrusts ("GRUTs"), and Qualified Personal Residence Trusts ("QPRTs") require the taxpayer to survive the retained term of the trust, thereby rendering the techniques unavailable as a testamentary option. Making gifts to multiple beneficiaries may allow discounted values for fractional interests that would not be available if the transfers were made by the estate at death.⁹

This article therefore focuses on several lifetime gifting techniques that may allow our clients to have their cake and eat it too. They may have to leave some of the icing behind, but it is fascinating to see how far commonly available techniques can take us in an environment with a 13 million (rounded) gift tax exclusion and generation-skipping transfer tax exemption, which allows taxpayers to fully utilize their generation-skipping transfer tax exemption during their lifetime without incurring gift taxes.

As described above, the 2017 tax cuts for individuals are scheduled to revert to prior law on January 1, 2026. As a result, the estate and gift tax exclusion may go from perhaps $13.5 million on December 31, 2025 to $6.7 million overnight, causing an immediate increase of $2.72 million in estate tax exposure for those with sizable estates. It is likely that much planning to utilize the "excess" exemption will be undertaken in advance of a sunset, but there are several important points to be aware of including:

• Anti-clawback regulations finalized in 2019¹⁰ (and modified by Proposed Treasury Regulations in 2022¹¹) prevent gifts that exceed the future lifetime exclusion from being "clawed back" into the taxable estate based on traditional estate tax calculation methodology. This means that most individuals can rest assured that large gifts made today will not be subject to estate tax in the future regardless of future changes in the law. Note that Congress or the Treasury Department could modify the rules, but potential court challenges based on detrimental reliance arguments make that unlikely.
• Gifts of lifetime exclusion come off the "bottom" of the exemption pile, meaning that the increased exemption available under current law is only truly beneficial to the extent gifts exceed the exemption available post-sunset. For example, assume a $5 million gift is made during a $10 million exemption period, leaving an individual with a $5 million estate exemption currently. If a reversion to a $5 million exemption occurs, such individual will be considered to have used $5 million of the available exemption, per the following:

	$12.92M Exemption (2023)	Sunset to $5M12 Exemption (2026)
Estate Assets	7.92M	7.92M
Prior Gifts	5M	5M
Tentative Tax Base	12.92M	12.92M
Tentative Tax	5.11M	5.11M
Unified Credit	5.11M	2.6M
Effective Addt'l Credit	0	0
Net Tax:	0	2.5M

• One additional impact of the methodology to account for large gifts post-sunset is that such gifts may result in the loss of inflation adjustments as well. For example, assume a gift is made that

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exceeded the post sunset exemption amount. It appears that the benefit of future inflation adjustments will not be available to such individual until the new exemption exceeds the value of the prior gift.

Pre Sunset Gift 10M
Exemption Post Sunset 6.7M

No additional estate and gift exemption would become available in this situation until the exemption reaches $10M under inflation adjustments.

Lastly, a related question that should be addressed concerns whether the exemption available under spousal portability is impacted by sunset. For example, assume a husband dies in 2025, allowing his spouse a $13 million portability exemption. If his spouse survives into 2026, the spouse's own exemption would be reduced under the sunset provision but—what about the portability exemption? The final regulations confirm that the reference to "basic exclusion amount" in IRC section 2010(c)(4) refers to the exclusion amount in effect at the time of the deceased spouse's death, rather than when the surviving spouse dies.

III. THE SPOUSAL LIFETIME ACCESS TRUST (SLAT)

The Spousal Lifetime Access Trust (SLAT) has...