How to Plan For Expected Changes In The Estate Tax

It’s widely expected that Congress will be changing the estate tax in this session. A bill hasn’t been introduced yet so we don’t know how the estate tax will be changed. However, there are two scenarios that appear to be the most likely.

The first is that the estate tax exemption will be reduced from $11.7 MM per spouse to $5 MM per spouse. This $5 MM exemption is what was in place when President Obama was in office. It’s important to remember that this exemption amount was a result of negotiations with Republicans. The composition of Congress has changed so they can now pass tax changes with just Democratic support. The second scenario (and perhaps more likely) is that the exemption will be reduced to $3.5 MM per spouse. This is what former President Obama campaigned on and what Biden has promoted as well.

With this being the case, these are some ways to plan for an expected change in the estate tax:

1. Make a transfer to a trust for your spouse. To use up your exemption, you have to make a transfer that’s a taxable gift. If you’re married, the best way to structure this is to transfer assets to a trust that benefits your spouse. This type of trust can go by a number of different names or acronyms (SLAT, SPAT, QTIP, etc.). All of these structures allow your spouse (and you indirectly) to still benefit from the trust even though you’ve given the asset away from an estate and gift tax standpoint. This planning can be done using one spouse’s exemption (up to $11.7 MM) or if your assets are greater than this, using two exemptions (up to $23.4 MM). If two trusts are used, it’s important that the trusts are legally different from each other or considered “non-reciprocal.” This will help minimize the risk that the IRS disregards the trusts and determines you’ve just moved assets to your spouse and not actually made a taxable gift.

2. Make a transfer to a trust for a child. If you have assets you don’t need to live on and are comfortable giving them to a child, you should consider structuring that transfer in trust. The trust can be set up so that child is in charge or you’re the initial trustee and it’s transitioned to the child at a later date. It can also be structured so the funds are protected against a child’s divorce or being exposed to a child’s creditors in a lawsuit. Finally, the trust can be drafted to keep the assets in your family and not being distributed to step-children if your child passes away.

3. Make a transfer to a trust for grandchildren. This type of trust can be structured in a number ways. It can be set up to benefit and fit the needs of a particular grandchild. It can also be structured so that it benefits all of the grandchildren from a particular child. Finally, you could set up one trust for all of your current and future grandchildren. All of these trust structures are very flexible so they can be established for a particular purpose (i.e. education) or more general needs. Finally, it’s important that these trusts are set up to avoid the “generation skipping tax.” This is a tax that is imposed when a transfer is made that skips a generation (i.e. from a grandparent to a grandchild).

If you have any questions about this planning, feel free to contact me at phmulder@cunninghamdalman.com.

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