The election is only weeks away, and with it is likely to come significant changes to the tax code. Many economists anticipate that, regardless of the outcome, there will likely be tax increases to reduce the federal deficit, which now stands at over $3 trillion.
Since those changes could take effect as early as January 2021, now is the time to do some year-end planning to reduce your estate and gift taxes. This is especially important for high-income and high-net-worth individuals.
Mind the Exemption
Regardless of the 2020 election results, a reduction in the estate, gift and generation-skipping tax exemption (“the exemption”) is scheduled to occur at the end of 2025 (the “2026 sunset”). The exemption is the value of property you can leave to someone other than a spouse during your life or upon your death without it incurring these taxes. The current exemption is $11.58 million per person. A married couple’s combined exemption is $23.16 million. Most estates fall below these limits and therefore do not pay any taxes.
When the exemption is reduced, a greater share of property passed on at your death or gifted during your lifetime will be subject to a transfer tax. If, for example, the exemption level drops to the adjusted 2017 exemption level of approximately $5.65 million per person (or $11.3 million for a married couple) – which the current legislation provides for, the reduced exemption would generate an additional $2.38 million estate tax for an individual and $4.75 million for a married couple on the death of the surviving spouse.
The current exemption offers an opportunity to engage in proactive planning that could result in profound tax savings. Although the exemption reduction is slated to take effect January 1, 2026, new legislation could accelerate the timeframe or reduce the exemption amount below $5.5 million. Since identifying the appropriate assets, amounts, and recipient vehicles can be an extensive process, often involving discussions with family members, we recommend budgeting enough time to consider possible approaches. This will ensure that you avoid hasty decision-making and achieve the best result for your family.
Strategies to Consider
- Make gifts: Making gifts in 2020 outright or in trust for younger family members will allow you to take advantage of the current exemption and decrease the potential tax liability to your estate.
- Form and fund a SLAT: In addition to traditional gifting, a Spousal Lifetime Access Trust (SLAT) allows you to use part or all of your remaining exemption now. Under this strategy, one spouse (“donor spouse”) creates the SLAT and names the other spouse (“beneficiary spouse”) and their descendants as beneficiaries. Both spouses have continued access to SLAT assets as long as the beneficiary spouse is alive (or still married to the donor spouse). After the beneficiary spouse’s death, assets may remain in the trust for descendants for a set period of time or in perpetuity. The value of the assets and the appreciation on those assets are excluded from your spouse’s gross estate.
In addition to the estate tax savings and long-term tax planning, a SLAT offers creditor protection.
- Accelerate charitable gifts into 2020: The CARES Act, enacted by Congress in the wake of the Covid crisis, allows individuals to make charitable gifts in the form of cash in 2020 to public charities (i.e., not to foundations or donor advised funds) and deduct 100% of those gifts against adjusted gross income. As of the date of this bulletin, the 100% deduction against adjusted gross income is scheduled to be reduced to 60% in 2021. If you are considering making large charitable contributions, or if you have been taking advantage of the law that allows you to pay $100,000 of your retirement assets directly to charity each year, and you would like to make a larger contribution, now is the time to do so.
The 2026 sunset affects more than the exemption; it will also revive the Pease Limitations, which were eliminated as part of the 2017 Tax Cuts and Jobs Act. The return of the Pease Limitations will reduce the available itemized deductions for certain high-income taxpayers. The potential income tax savings through charitable giving in 2020 exceeds the potential income tax savings in 2021 due to the combination of the return of the Pease Limitations, the expiration of certain charitable incentives and a proposal that limits charitable deductions for high income individuals.
What should you do?
If you believe you have more than enough assets to maintain your current lifestyle for the rest of your life and you feel comfortable making gifts before the end of this year, then consider making year-end gifts to your intended beneficiaries to lock in current exemptions.