Children, someday, all of this will be yours…
The patriarch’s promise to the next generation has traditionally been a given; more, a rite of passage. And it made perfect sense when the generation-skipping transfer (GST) tax exemption was minimal, and the GST tax rate was massive. (As it was in 2000, for example, when the exemption was just $1 million, and the tax rate was a whopping 55%.) Why not transfer wealth directly to one’s children? Skipping a generation made no sense.
That was then.
And then along came the 2010 midterm elections, which gave Republicans control of the House; a power shift that raised the unified federal estate/gift/GST tax exemption to $5 million and cut the GST tax rate to 35%. Which is where it stood, give or take, until The Tax Cuts and Jobs Act of 2017 (TCJA), which more than doubled the exemption to $11.6 million and spawned this adaptation of the patriarch’s promise:
But it now appears that the pendulum will swing back; indeed, on the campaign trail last year, then-candidate Biden floated exemption cuts to $3.5 million for estates and $1 million for gifts. With the Democrats’ sweep last November, this is a distinct possibility.
More, it’s assumed that under the Democrats any cut to the exemption will likely be accompanied by an increase in the top GST tax rate, from 40 percent to 45 percent.
The Goods News: There’s Time to Plan. And That Time is Now.
Despite the Democrats’ control of the White House and both houses of Congress, many believe that a window for estate planning will remain open this year for high net-worth Americans. “The exemption and rates will eventually be on the table,” said one well-placed observer, “but I don’t think it will be this year. The administration will be focused on the pandemic and economic relief, and likely won’t be eager to take money out of the economy.”
Said another noted observer, “The Biden Administration may well choose to avoid the politically charged estate-tax debate this year, given the relatively small revenue it generates; it’s a drop in the bucket in terms of paying for things like the stimulus package. And so even with a Democratic president, House, and Senate, the estate tax may not be at the top of their agenda.”
Bottom line: The window to use the $11.6 million exemption may remain open through 2021.
The question: How to use the year to prepare for the rollback many expect?
The answer: Set up GST trusts, fund with appreciating assets, and establish processes to monitor performance and educate the beneficiaries. Here’s how:
A. Work with your estate and trusts attorney to draft GST documents:
- Set up one large GST trust for all children and grandchildren, less tax filings and investment accounts, but bookkeeping involved when one beneficiary takes more distributions than the others. Estate planning and operating businesses restrict beneficiaries’ access to principal, and opportunity to diversify – which may or may not agree with the Grantor’s wishes.
- Establish for each child their own GST trust, which works well with investment accounts and uneven distributions. For example: Son #1 is given approval by trustee to receive 50% of his trust for a new house and college education for children, and he requests remaining assets be invested in liquid safe securities. Daughter #1 puts her trust assets in private equity where there is minimal liquidity and greater upside for appreciation.
- Determine age of distribution, Trustees and Successor Trustees, and the specifics surrounding the power to distribute. Numerous decisions must be made by the Grantor when setting up the trusts: At what age can children receive distributions; for any request or only for medical/education, etc. Or you may leave these decisions for the Trustee to make on a case-by-case basis.
- Tax: Does the Grantor want the trusts to pay their own tax and CPA fees, or will the income be taxable to the Grantor (via Grantor trust)? The type of trust to be set up will be determined by the tax brackets, annual distribution requirements, and the Grantor’s preference for reducing his/her estate planning or having his children pay their way.
B. Investment advisor:
- Open investment accounts (if funding trusts with liquid securities) and instruct advisor of trading restrictions (no margin trading, etc.), trustee preferences (no distressed debt etc.), annual distribution requirements, education of trustee and beneficiaries on a periodic basis, and quarterly portfolio reviews.
C. Make the gifts in 2021:
- If you have highly appreciated assets – tech stocks, private equity, and real estate, for example – these investments are ideal on a tax basis; after three years, the assets are not includible in the Grantor’s estate. More, the tax on the gain is deferred until the trust sells it. Set up a process for future years in which annual gifting is completed to these trusts each January via the annual gifting exclusion of $15,000. (Every year, U.S. citizens can gift $15,000 to a recipient without incurring gift tax. Payments of medical and education are unlimited and fall outside of this law.)
D. Get your paperwork in order:
- The grantor should file gift tax returns by the extended due date of his personal tax return (Oct 15th for most; April 15th otherwise)
- Crummey letters should be filed with 30 days of gifts. This tells the beneficiary that the gift is being made and the beneficiary has only 30 days to take possession of the gift, or it will be placed in the trust. Parents will sign on behalf of children.
- In the event of uneven distributions, Son #1 and Daughter #1 keep capital accounts internally and make them available to children to avoid future misunderstandings.
Wealth transfer is not as clear-cut as it used to be. Now more than ever, you need a top-notch estate planning team in place!