Six High Net Worth Planning Techniques to Increase Plan Flexibility in 2021

Insights | Six High Net Worth Planning Techniques to Increase Plan Flexibility in 2021

Author: Andrea D. Costa, Esq., Vice President, Financial Planning, HORAN

Estate planners across the country are attempting to read the tea leaves of the current political climate. While no one is quite certain what to expect, the consensus is grim for the ultra-high estate tax exemption currently in place. 

Even if Democratic politicians are unable to pass tax reform, the prevailing estate tax thresholds are scheduled to sunset in 2026. However, many believe the political climate indicates that estate tax exemption is likely to fall well in advance of 2026.

Without any legislative intervention, the estate tax exemption is expected to fall to approximately $7 million in 2026. The Trump-era Tax Cuts and Jobs Act (TCJA) signed into law in 2017 was the largest overhaul of the tax code in recent history and doubled the estate tax exemption from a base exemption amount per person of $5 million to $10 million. The estate tax exemption is adjusted for inflation every year and now sits at $11.7 million per person in 2021. The TCJA is scheduled to sunset on December 31, 2025, at which point the base exemption will revert to $5 million and after inflation adjustment, the 2026 estate tax exemption would fall to approximately $7 million. 

Legislative intervention could take a variety of forms but the estate tax exemption is expected to decrease. Several pieces of legislation have been introduced regarding the Internal Revenue Code in 2021 and two early bills hint at what lies ahead for tax reform.

  1. The Death Tax Repeal Act of 2021: A bill designed to permanently eliminate the estate tax was introduced on March 10, 2021. While any attempt to permanently eliminate the estate tax is virtually certain to fail, this bill speaks to the razor-thin majority held by Democrats in the House of Representatives.
  2. The 99.5% Act: A bill designed to increase taxes on wealthy Americans, was introduced on March 25, 2021. Among other changes, the passage of this bill would reduce the estate tax exemption to $3.5 million with tax rates ranging from 40% to 65%. The gift tax exemption would be reduced to $1 million; the generation-skipping tax exemption would be applied with no exclusion to any trust set up to last longer than 50 years, and certain inherited assets would no longer receive a step-up in basis at death.  Importantly, each section of this bill indicates an effective date after the date of enactment, which may ease some concerns that tax reform could be retroactive to January 1, 2021. 

Many estate planners remain concerned that legislation to change the estate and gift tax thresholds could be made retroactive to January 1, 2021. This could leave clients seeking to maximize available exemption through large 2021 gifts open to significant gift tax liability. The following six planning techniques may allow for more flexibility in 2021 estate planning.  

  1. Leverage the power of a disclaimer. A qualified disclaimer can be made within nine months of any gift made in 2021. Clients may decide to wait to make large gifts to trust until spring of 2021 so that the gift can be disclaimed by December 31, 2021. Such a trust should provide that the disclaiming beneficiary is empowered to disclaim for all beneficiaries of the trust. This is an unusual application of the concept of a qualified disclaimer, so it is unlikely that form disclaimer language will achieve the desired result. Thoughtful drafting is critical. 
  2. Establish a Spousal Lifetime Access Trust (SLAT). Perhaps the most popular strategy of 2020 and 2021, the spousal lifetime access trust removes assets from the grantor spouse’s estate while continuing to provide access to the beneficiary spouse. An inexpensive term life insurance policy may protect against the risk of the beneficiary spouse’s untimely passing. A significant risk to this strategy lies with the reciprocal trust doctrine. This doctrine pulls assets back into the estate when spouses seek to remove assets from the joint estate if it results in approximately the same economic position and beneficial enjoyment of the estate.  In many instances it will make more sense to pair a SLAT with the purchase of a substantial life insurance policy within an irrevocable life insurance trust (ILIT) rather than execute two SLAT strategies.
  3. Make Spousal Trusts QTIP-able.  Make a gift to a trust with income paid out to a spouse and permit the Qualified Terminable Interest Property (QTIP) election to be made under the trust terms. The election is made on the 2021 gift tax return, which would be timely filed in 2022.
  4. Use a carefully crafted formula to determine the value of a 2021 gift. For difficult-to-value assets, it may make sense to use a formula gift such that the numerator of the formula is the available exemption in 2021 and the denominator is the value of the gift as finally determined for gift tax purposes. Practitioners using this technique should refresh their understanding of this area of gift tax law to determine whether a particular strategy is likely to succeed.  
  5. Forgive a Portion of a Bona Fide Loan. In specific circumstances, a client with existing and bona fide intra-family loans in place could choose to forgive such a loan to the extent of the client’s available gift tax exemption in 2021 as finally determined for gift tax purposes. Clients considering this strategy could also simply want to wait to forgive the note until 2021 estate tax reform comes into sharper focus. 
  6. Installment Sale of Assets. Building on the concept of loan forgiveness above, a client could sell assets to an irrevocable trust in exchange for a down payment and a promissory note.  Treating the transaction as an installment sale could allow the grantor to forgive all but the amount of principal in excess of the 2021 gift tax exemption.

These techniques, alongside all high-net-worth estate planning, should be implemented in consultation with an experienced estate planning attorney. These techniques are complex and may ultimately be challenged by the IRS.

The content of this blog is offered by HORAN Wealth Management, an SEC registered investment advisor. Ms. Costa is an employee of HORAN and a recognized expert in Estate planning but does not manage investment advisory solutions. This information is not intended as legal advice or as a substitute for the particularized advice of your own counsel and should not be relied upon as such, as the advice appropriate for you will be dependent upon the particular facts and circumstances of your situation. The transmission or receipt of this information does not create an attorney-client relationship.  We provide links to other sites that we believe may be useful or informative. These links to third-party sites or information are not intended as and should not be interpreted by you as constituting or implying our endorsement, sponsorship, or recommendation of the third-party information, products, or services found there. Neither the information nor any opinion expressed constitutes a solicitation to use our services or to purchase or sale of any security. Any reference to past performance is not to be implied or construed as a guarantee of future results. Market conditions can vary widely over time and there is always the potential of losing money when investing in securities. HORAN and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only and is not intended to provide and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.