Continuing Urgency Related to Gift and Estate Tax Planning

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Many advisors experienced a flood of gift and estate tax planning during the last quarter of 2020.  Smart wealthy clients made gifts before the end of the year in order to lock in the substantial exemption amounts available ($11.58 million during 2020 and $11.7 million in 2021).  These exemption amounts are scheduled to sunset at the end of 2025, but the Biden administration has indicated a desire to substantially decrease the exemption amounts much sooner.

The outcome of the Georgia Senate runoff elections on January 5, 2021, confirmed that Democrats control the Senate (with the tie-breaking vote held by Kamala Harris), as well as the House of Representatives and the Presidency.  This new reality has made tax legislation seem far more likely and has caused clients who were previously reluctant to make gifts to rethink that decision.

Making gifts now is more complicated than it was just two short months ago, given the potential for retroactive tax legislation.  While it seems unfair to many, it is possible for Congress to enact tax legislation retroactive within the same year, and that could happen this year.

It is important for practitioners to advise clients with respect to this risk, and also regarding options to potentially mitigate the risk.  For example, a client may gift to a QTIP Marital Trust and evaluate later whether to make a QTIP election or not.

Another option is for a client to gift to a trust that contains a formula allocation clause, providing that any gifted amounts in excess of the client’s exemption (as finally determined for gift and estate tax purposes) would pass to an incomplete gift trust.  The incomplete gift trust can provide the client with the power to appoint the excess gift assets to his or her spouse, thus avoiding the application of gift tax.  If a client is unmarried, the excess gift amount could pass to a grantor retained annuity trust (“GRAT”) rather than an incomplete gift trust.

A similar option is to include a formula in the transfer documents.  For example, a client could assign an LLC interest having a value equal to his or her remaining gift tax exemption, as finally determined for federal gift and estate tax purposes.  While these specific types of formula gifts have not been tested, the documents could be drafted to be as close as possible to the formula used in Wandry v. Commissioner (T.C. Memo 2012-88), and to avoid the issues identified in Nelson v. Commissioner (T.C. Memo 2020-81).

Practitioners should ensure their clients are well informed about the options for gifting, and the risks associated with each of those options.  2021 promises to be another busy year for gift and estate tax advisors!

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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