Trump v. Biden: How Their Tax Policies Will Impact Your Planning
During normal times, we recommend having your estate plan reviewed and updated every four years or in the event of a big life change (divorce, remarriage, moving, a significant shift in assets, etc.) That being said, 2020 has been anything but normal. The COVID-19 pandemic exposed financial, health, and other vulnerabilities that resulted in a surge of clients asking to have their estate planning documents reviewed. In addition to the unprecedented health crisis, we are also in the midst of an election cycle.
Along with new administrations come new laws - laws that will impact you regardless of your political ideology. This is why as estate planners, we have no choice but to think about how a changing political landscape may impact our clients. With the 2020 presidential election just over a month away, many more clients are contacting us with questions about how a change in the administration could impact them and what, if any, action they should take now. The first step is to take a look at how the candidates' tax policies stack up.*
As things stand today, very few people are subject to federal estate and gift taxes. The Tax Cuts and Jobs Act (TCJA) of 2017 doubled the estate tax exemption to $11.18 million for singles and $22.36 million for married couples. Indexed for inflation, the 2020 exemption stands at $11.58 million for singles and married couples may now transfer $23.16 million free of Federal estate, gift and GST taxes, either during life or at death. However, the lifetime exemption is set to expire in 2025, when the exemption will revert back to the pre-2018 exemption level of $5 million for an individual taxpayer. Although the current exemption amounts were never intended to be permanent, they could be reduced sooner, and by more than just half, if Joe Biden wins the presidency and Democrats gain control of the Senate. If so, many more estates will likely become subject to estate and gift taxes again.
Issues to Consider:
Outdated Formula Clauses. Formula clauses have been used for many decades to fund a bypass (tax savings) trust with assets up to the maximum amount of the federal estate tax exemption with the “remainder” of the estate (often including IRAs and 401(k) accounts) passing to a surviving spouse. The strategy was developed to take full advantage of the lifetime estate and gift tax credit when it was much lower than it is now.
Suppose an estate was worth $1.5 million when the lifetime exemption was $600,000. Under a standard formula clause a portion of the estate would be transferred to a bypass trust, up to the maximum amount of the lifetime federal estate and gift tax exemption in effect at the time. The rest of the estate would go to the surviving spouse. So, in this case, $600,000 would go into the trust, and the surviving spouse would inherit $900,000. The estate would avoid federal taxes, and the surviving spouse would be provided for.
Today, under such a formula clause, the entire estate would go to the trust, and the surviving spouse would inherit nothing outright. The District of Columbia and the majority of states, including Maryland and Virginia, have "elective share" laws preventing the disinheritance of a spouse absent a valid prenuptial (or postnuptial) agreement, but many of them would give the surviving spouse only one-third of the estate.
Unless your intent is to disinherit your spouse, it is critical to have any old formula clauses revised or eliminated.
State Taxes. According to Tax Foundation, twelve states and the District of Columbia impose estate taxes and six impose inheritance taxes. (Maryland is the only state to impose both.) Under current Maryland law, for deaths in 2020, an estate with a gross value of more than $5 million may owe estate tax. This year, the D.C. Council voted to lower the threshold for imposing estate taxes from $5.6 million to $4 million for decedents who die after December 31, 2020, with inflation adjustment beginning in 2022. These threshold amounts are both far less than the federal estate tax threshold, which means that an estate may not owe federal estate taxes, but still owe Maryland or D.C. estate taxes.
Strategies such as QTIP trusts and lifetime gifts can be leveraged to reduce or eliminate state estate or inheritance taxes.
Lifetime Gifts. In today’s economic and tax environments, many remain uncertain about whether making lifetime gifts still makes sense. Given the the historically high gift and estate tax exemption amounts, and the decreases in value of many types of accounts and properties caused by COVID-19, it may be a perfect time to make significant gifts to loved ones. Many advisors feel that, in certain cases, it makes sense to aggressively use gift tax exemption now because of the risk that Congress will reduce the exemption amount, leaving clients with a missed opportunity. The key to gifting successfully is understanding the legal, tax, and financial implications before making large gifts. Not all gifts are created equal. In fact, some gifts are not subject to federal gift tax.
SLATS. While there are a number of possible strategies that individuals may take advantage of in 2020, a popular technique is the Spousal Lifetime Access Trust (SLAT). SLATs offer married clients another option when considering whether to make a gift this calendar year in order to take advantage of the current estate and gift tax exemptions. A SLAT is an irrevocable trust that allows a married person to give assets as a gift to his or her spouse and/or descendants, and they may receive distributions of income and principal from those assets, typically at the discretion of the trustee. This strategy removes the assets from the grantor’s estate while still affording access through the spouse as long as the parties are married and the spouse is living. The potential access may make the spouses more comfortable with making a large gift and utilizing the current exemption before a potential future decrease in the exemption amount.
The Bottom Line
Legal, tax, and financial considerations should all be weighed carefully - especially during times like these. Soon after the inaugural dust settles, we could see quick action on tax laws. Major tax bills often occur in the first year after a presidential election (2017, for example). What’s more is that it is possible (as well as constitutional) for laws to be made effective retroactively to the beginning of the year. Thus, it has never been more important to have your estate plan reviewed and updated. We are here to help and happy to work alongside your other trusted advisors. Please contact us today to set up a virtual or in-person meeting so that we can assist you.
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