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ESTATE PLANNING SERIES – ESTATE AND GIFT TAX REFORM. Part 1: The Proposals for Estate and Gift Tax Reform Have Begun: Analysis and Considerations Regarding Lower Exemption Amounts

This article is the first installment of a three-part series by Erica Williams that will highlight specific topics contained in recent tax reform proposals that may impact your estate plan.  The first installment will discuss the proposed changes to the estate and gift tax exemptions.  The second installment will discuss grantor trusts and how the use of such trusts may change if the proposals become law.  The third installment will discuss the effect that the proposed changes to annual exclusion gifts would have on certain transfers.

By Erica K. Williams, Esq.

Many estate planners and financial planners have been closely watching Washington for tax reform legislation that was a major topic in President Biden’s campaign and that would make significant changes to many of the estate and gift tax rules.  The first indicator of these changes came late last month with a bill introduced by Vermont Senator Bernie Sanders, titled “For the 99.5% Act” (the “Act”).  While the changes proposed in the Act are not law, there is clearly great momentum for substantial modifications to the current estate and gift tax regime.  The first in a three-part series, this article will address the current estate and gift tax exemptions and the proposed changes to those exemptions.  Finally, the article will discuss planning ideas that should be considered to limit any detrimental impact of the proposed legislation.

The current estate and gift tax exemption is $11.7 million per person ($23.4 million for a married couple) and is adjusted annually to account for inflation.  Under existing law, the exemption is amount is scheduled to decrease to $5 million per person ($10 million for a married couple), adjusted for inflation, as of January 1, 2026.  The estate and  gift tax exemption is unified, which means that amounts not used by lifetime gifting can be applied against the estate tax at death.  Any amount above the unused exemption amount is subject to a 40% tax upon transfer at death.

As proposed in the Act, the estate tax exemption would be reduced to $3.5 million per person ($7 million for a married couple), effective as of January 1, 2022.  The Act also proposes a progressive estate tax rate of 45% (for estates valued between $3.5 million and $10 million), 50% (for estates valued between $10 million and $50 million), 55% (for estates valued between $50 million and $1 billion) and  65% (for estates in excess of $1 billion).  Finally, the Act removes the unified nature of the exemptions by reducing the gift tax exemption to $1 million.  It is important to note that the proposed revision to the Internal Revenue Code to reduce the exemptions no longer includes the provision to adjust the exemption amounts annually for inflation.

With the substantial increases in the estate and gift tax exemptions by the Tax Cuts and Jobs Act in 2018, the focus in estate planning shifted away from estate tax planning for many clients.  The proposed reduction of the estate tax exemption from $11.7 million to $3.5 million, however, will considerably increase the number of estates subject to estate tax.  Clients will have to rethink their planning and documents to address estate tax planning and are encouraged to do so immediately before the enactment of the Act or similar legislation.  The once popular credit shelter trust planning that has taken a back seat to disclaimer trust planning for many clients over the last several years should be reconsidered as a better option for some clients.

The proposed $3.5 million exemption would also significantly reduce the ability of wealthy clients to shift wealth out of their estates.  As a result, a recurring theme among practitioners is “use it or lose it.”  There is a great advantage for clients with estates valued in excess of $3.5 million to use as much of the current $11.7 million exemption now before a change is enacted.  Consideration should be given to lifetime gifting, either via outright gifts to individuals or gifts to irrevocable trusts that, when structured properly, could benefit the settlor, the settlor’s spouse and/or the settlor’s lineal descendants.  (Note:  Changes are coming to these as well; the potential impact on grantor trusts and gifting to irrevocable trusts after December 31, 2021 will be discussed in parts two and three of this series.)  Alternatively, if philanthropic-minded, consider reducing the value of the estate, and maximizing deductions, through the use of donor advised funds or private foundations to benefit charitable organizations.

While changes to the exemption amounts as discussed above are slated under the proposed legislation to not be effective until January 1, 2022, there are several other changes proposed in the Act (to be discussed in further installments of this series) that would be effective as of the date signed into law.  As effective dates cannot be known, you should not rely on a year-end deadline to implement necessary changes to your plan.  Action should be taken now to review your present planning to determine whether steps should be taken immediately to avoid or reduce estate taxes.

We invite you to read other articles in this Estate Planning Series:

This article provides an overview and summary of the matters described therein. It is not intended to be and should not be construed as legal advice on the particular subject.

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