Transferring Your Legacy
Gift and Estate Tax Changes
Throughout 2021, Congress and the Executive Branch proposed tax code changes that – had they ultimately passed – would have significantly changed various estate planning techniques. Some proposals would have sidelined a number of established estate planning strategies while other proposals could have increased the frequency of use and usefulness of others.
Some proposals would have reduced the estate and gift tax exemption amount from its current level of $12.06 million per taxpayer to $3.5 million – $6.85 million per taxpayer, depending on the source. Although there is certainly no guarantee that such a proposal will not be made in the future, we can nevertheless focus for now on what we do know about the law as written today and what steps we can take to address the coming changes.
Even with no action whatsoever by Congress, the current estate tax laws will expire and reset to the prior laws in 2026. This reset will restore the estate and gift tax exemption amount to $5 million, as it was in 2016 (though it will be indexed for inflation, resulting in an exemption amount of roughly $6.6 million in 2026). Again, this is the law as it stands today; without further action, it will remain the law.
It is therefore important to consider the current values and average rates of return for your investments. Many people are surprised to see that, even with a moderate return of only 7.2 percent annually, their net worth would double in 10 years. If the estate tax exemption amount is halved in 2026 and increases only with inflation at a rate of approximately 2.5 percent per year, you could very quickly find yourself at risk of paying significant estate taxes (currently at a 40 percent rate).
Given the current uncertainty, trying to predict the future and determine which strategies will best accommodate your tax and estate planning goals can be difficult. This is particularly true when we consider some of the other proposals:
You should still consider certain strategies, however, because these changes have not yet been implemented and may ultimately never be enacted. For example, the following strategies, with some adjustments, may still be effective tools if completed before any changes in the law.
A useful strategy that can still be used is to make a gift to an intentionally defective grantor trust. Grantor trust status allows you to treat the trust’s income as your own, with the tax payment constituting a phantom gift to the trust. Grantor trust status also allows you to sell appreciating or income-producing property to the trust in exchange for a promissory note, with the transaction being disregarded for income tax purposes. The trust would repay the promissory note over time, so that any appreciation in excess of the interest payments remains outside your taxable estate.
For married couples, a spousal lifetime access trust is a type of intentionally defective grantor trust established for the benefit of your spouse (and potentially other beneficiaries like children or grandchildren). An independent trustee can make discretionary distributions to those beneficiaries, which can benefit you indirectly, while an interested trustee should be limited to ascertainable standards when making distributions (i.e., health, education, maintenance, and support).
For now, Irrevocable life insurance trusts are still useful to remove the death benefit of life insurance from your taxable estate. This type of trust is established by transferring an existing life insurance policy into the trust or making gifts to the trust so that it can acquire a new policy on your life. The trust is designed so that premium payments are deemed completed gifts of present interests. At death, the trust receives the insurance proceeds, which are excluded from your taxable estate.