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Monday, August 10, 2020

The Perfect Storm Before the Hurricane: 2020 Estate and Income Tax Planning Opportunities


2020 will no doubt go down in history as one of the most chaotic and unpredictable years ever. Although there is no way to predict the outcome of the November elections or upcoming legislative changes to the tax laws, there are clear signs of a potential increase in a variety of taxes in our very near future.


Estate and Gift Tax – Why You Need to Act Now

Commentators have said over and over that there has never been, and perhaps never will be, a better time for planning to minimize the estate and gift tax. With increased exemptions and low interest rates, we have the “perfect storm.” As a result, estate attorneys will soon be overwhelmed with clients asking to draft various documents to transfer wealth, and at some point, they will no longer be able to accommodate everyone who wants to take advantage of the perfect conditions. Thus, leading to a hurricane of chaotic, last-minute planning.

As you may know, the 2017 Tax Cuts and Jobs Act (TCJA) changed the estate and gift tax regime by increasing the amount of assets an individual may pass to their heirs tax-free (referred to as the “lifetime exemption”). The amount of assets (lifetime exemption) that can pass without being subject to the 40% estate/gift tax for 2020 is $11.58 million per person ($23.16 million for a couple).

What you may not be aware of is that the change to the estate and gift tax regime is temporary and currently set to expire on January 1, 2026. Many of the top estate planners in the country believe that Congress may not wait until 2026 for the current law to expire. The change could come as early as next year, so if you do not act now, you could lose the opportunity to shield millions of dollars from the estate tax.


What to Consider Now for Estate Planning

With so much information in the media and on the internet, it can become overwhelming and difficult to make any kind of decision on what the focus of 2020 estate planning should be. Below is our list of the top considerations to focus on:

  1. When we say use it or lose it – we mean it!

    Our number one suggestion right now is to use the increased lifetime exemption before you consider any other technique. Otherwise, you will lose it. This can be done by making outright gifts or gifts to trusts. As a potential added benefit, if assets are transferred to a holding company such as an LLC prior to being gifted, it may be possible to gift interests in the LLC outright or in trust at discounted values.

    There are also many other techniques being discussed right now that are fantastic estate planning methods to use in this low interest rate environment. Techniques such as the grantor retained annuity trust or a sale to an intentionally defective grantor trust are outstanding ideas for taxpayers who have already used up their entire lifetime exemption and want to minimize even more estate tax.

  2. Make a gift to a trust and still have access to the asset. If you are hesitant to gift property out of your estate because you think you might need access to those assets in the future, fear no more! There are various types of trusts where the person who creates the trust can be a potential beneficiary. For example, there are trusts that spouses can create for each other that will remove assets from the estate but allow the spouses to benefit from the assets in the future, if needed.

    What if you make the gift and then the laws do not change next year? Can you change your mind about the gift next year? Typically, you cannot change your mind, however, one of the nation’s leading estate planners, Jonathan G. Blattmachr, has advised that certain language can be added to the trust document that will allow a beneficiary to “disclaim” their interest in the trust so that it reverts back to the grantor/donor. This provision will allow you to unwind the gift in the event you change your mind.

    A qualified disclaimer must be executed within nine months of the original transfer, so assuming the trust document includes the proper disclaimer language, you will have nine months from the date of the gift to decide if you want to unwind it. Requirements for disclaimers differ depending on state law, so consult a good estate tax attorney if you are considering adding this language to a trust.

  3. Use up one spouse’s exemption and keep the other. If you are married and you are certain that you only want to make a $10 million gift or less, consider having one spouse use up all their lifetime exemption and the other spouse use zero of theirs.

    For example, say that a husband and wife decide to gift $10 million to a trust for their children in 2020. If they split the gift, then the husband will use $5 million of his exemption and the wife will use $5 million of her exemption. In 2026 (or possibly sooner), when the lifetime exemption is reduced to an estimated $6 million per person (or even less than $6 million), the husband will have used $5 million of his exemption, leaving $1 million, and the wife will have used $5 million of her exemption, leaving $1 million. If the husband had made the gift alone and used $10 million of his exemption, then in 2026, he would have zero exemption remaining, while the wife would have the full $6 million remaining. This would allow the couple to shield another $4 million of assets from the estate tax even after the law changes.

  4. Ultra-high net worth individuals can do more. If you have taken our advice in #1 above and used up all the current lifetime exemption, there are additional estate planning techniques to consider in this environment where interest rates are historically low:

    1. Grantor retained annuity trust
    2. Sale to an intentionally defective grantor trust
    3. Charitable lead trust
    4. Refinancing old family loans
    5. Private annuities
    6. Self-cancelling installment notes
    7. Sales of remainder interests
    8. Annual exclusion gifting
    9. Paying tuition and medical expenses directly to the institution for loved ones

What to Consider Now for Income Tax Planning

Regardless of the outcome of the November elections, the federal government as well as many state governments will be facing huge budget deficits. All indicators point toward a likely increase in various federal and state income taxes and potential increases in other state taxes.

  1. Charitable planning. Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020, individuals making cash gifts directly to qualified charities can claim a deduction of up to 100% of their adjusted gross income, basically eliminating their income tax liability for 2020. If you have made charitable pledges, consider funding those pledges in 2020 to take advantage of the once-in-a-lifetime unlimited charitable contribution deduction using cash.
  2. Required minimum distributions in 2020 are waived. Under the CARES Act, required minimum distributions (RMDs) for IRA account owners who are more than 70 ½ years old have been waived. Individuals who are typically required to take an RMD may want to consider passing this year to avoid payment of the income tax on the distribution, if they do not need the cash flow. If you have already taken the RMD for 2020, there is a short time period that you can return the RMD to your IRA so that it is not taxed in 2020. The deadline to repay the distribution is August 31, 2020.
  3. Converting an IRA to a Roth IRA. Many taxpayers have already taken advantage of converting their traditional IRAs with depressed values to Roth IRAs during 2020. All future appreciation and earnings will grow income-tax-free for the life of the Roth IRA. If you have already made the conversion in 2020, consider increasing charitable contributions this year to offset the income tax liability associated with the Roth IRA conversion. The combination of a conversion of an IRA to a Roth IRA with increased charitable contributions has the potential to eliminate the income tax hit on the IRA conversion.
  4. If you typically work in multiple states, your taxes may be reduced. States typically tax individuals based on their physical presence in a state as they work. Since COVID-19 has required so many taxpayers to work from their home or other remote locations, it is important to review the number of days you have spent in various states working this year compared to prior years, so you do not overpay your state income tax.
  5. Capital gains tax rates may not stay this low. It is likely that we will see an increase in the capital gains tax rate in the future. As you work with your investment advisors, this should be a consideration as you go through harvesting both capital losses and realizing capital gains in 2020. If you have large concentrations of low-basis stock, this might be a year to consider realizing some capital gains before the rates increase.
  6. Moving to a no-income-tax state. As many states continue to struggle with long-term fiscal imbalances and the potential for increased state taxes, many taxpayers have successfully “moved” out of a high-income-tax state into a no-income-tax state without being harassed by the former taxing state. It is important to understand the rules of each taxing state with regards to both domicile and residency, which may have different meanings depending on the state. If you plan to make a move, be sure to work with a tax advisor who understands the rules of the multiple states involved.

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