2021 Estate Planning Environment: Part Three
The final part of our blog post series focuses on four common planning techniques under current law. Each strategy is summarized along with a description of how proposed legislation would limit its effectiveness:
- Intentionally Defective Grantor Trusts (IDGTs)
An IDGT is a great way to remove appreciation from a donor’s estate while also allowing the donor to make additional “gifts” to the trust without using any additional lifetime exemption.
An IDGT is a completed gift for estate tax purposes but not income tax purposes. This means the fair market value of the assets contributed will be applied against the donor’s lifetime exemption, but any future appreciation will not. It also means the donor is responsible for paying any income tax on the trust’s earnings. Since the donor is responsible for paying the trust’s tax liability, any tax payments are not considered gifts. This allows the donor to further reduce his or her estate by making the tax payments (additional “gift”) while allowing the assets inside the trust to grow.
Limited effectiveness under proposed legislation:
- Senator Sanders’ plan would make IDGTs includible in the donor’s gross estate.
- President Biden’s plan limits the effectiveness of gifting appreciated assets.
- Grantor Retained Annuity Trusts (GRATs)
A GRAT is an excellent technique for removing appreciation out of a donor’s estate without using any lifetime exemption.
A GRAT is created when a donor contributes assets to a trust in exchange for a stream of annuity payments for a term of years. During the term, the GRAT is an IDGT. The gift is valued by subtracting the fair market value of the assets contributed from the sum of the annuity payments discounted by the Section 7520 rate in place at the time of the contribution. GRAT’s are most often structured so that the remainder value (taxable gift) is zero.
GRATs are successful when the contributed assets appreciate at a higher rate than the Section 7520 rate (currently 1.2%). In a “zeroed-out GRAT”, any assets remaining at the end of the GRAT term get transferred to the remainder beneficiaries without using additional lifetime exemption. Note that the donor must also survive the GRAT term.
Limited effectiveness under proposed legislation: Senator Sanders’ plan would require a 10-year term for GRAT’s with a minimum remainder value (taxable gift) of, the greater of 25% or $500,000.
- Spousal Lifetime Access Trusts:
Spousal Lifetime Access Trusts (SLATs) can be a great tool to lock in the increased lifetime exemption while also maintaining some financial protection.
A SLAT is an irrevocable trust where the donor’s spouse is a trust beneficiary. It is treated as a completed gift for estate tax purposes when the assets are contributed to the trust. If properly drafted, the assets in the trust (and any appreciation after the date of gift) will not be included in either spouse’s estate when they die.
SLATs also provide an extra level of protection for a married couple because the donor’s spouse can take distributions from the trust if needed. This can be beneficial if the couple’s financial circumstances change after the donor-spouse creates the trust. The combination of tax-efficiency with an additional layer of protection can make SLATs a great tool in this current estate planning environment. Note that complications can occur with an untimely death or divorce.
Limited effectiveness under proposed legislation:
- Senator Sanders’ plan reduces the estate tax exemption
- President Biden’s plan limits the effectiveness of gifting appreciated assets.
- Valuation Discounts
Valuation discounts are a great way to leverage your lifetime exemption. Valuation discounts reduce the value of gifts for factors such as minority interest and lack of marketability. With proper planning and structuring, this can be a powerful tool.
Limited effectiveness under proposed legislation: Senator Sanders’ plan significantly limits the effectiveness of valuation discounts.
Given the complexity of estate planning and the uncertain estate planning environment, it is important to discuss any potential planning with your advisor(s). The strategies discussed are complex and there are many tax and non-tax factors to consider. An advisor can help you determine the benefits, risks, and what strategies might work best for you.
This correspondence is for general information purposes only and does not constitute legal, accounting, or other professional advice. The information contained herein is not related to any individual situation or concerns and should not be relied upon or used as the basis for making decisions without consulting competent legal, accounting, or other professional advice regarding implications of a particular factual situation.