March 1, 2021
As a result of the recent election results in which Democrats took control of both the White House and the Senate and retained control over the House of Representatives, and in light of significant budget deficits that have ballooned due to Covid, many are expecting significant tax legislation in the coming months that could dramatically alter the tax landscape and, in particular, the estate and gift tax landscape. At present, the estate, gift and generation-skipping transfer tax exemptions are at an historic high of $11,700,000 per person. Even without new tax legislation, these increased exemptions are not permanent and are scheduled to sunset on December 31, 2025. We would expect a reduction in these exemptions to an amount somewhere between $3,500,000- $5,000,000 to be part of any new tax legislation, as these exemptions have always been in the crosshairs of Democratic legislators.
In anticipation of these potential changes, many clients who have not previously fully utilized their exemptions may want to take advantage of these exemptions as soon as possible. However, caution is needed and proper planning is essential because it is possible that Congress may enact retroactive tax legislation.
By way of background, tax legislation is often made prospective and thus effective at some future date, i.e., January 1, 2022. Sometimes, however, tax legislation can be retroactive, in which case it would either be effective as of its date of introduction or potentially even effective as of January 1, 2021. Congress has great leeway in determining an effective date, but for it to be constitutional the law must comply with the due process requirements under the Fifth Amendment. For a retroactive change in the law to be valid, it must be rationally related to a legitimate legislative purpose (as the Supreme Court held in Pension Benefit Guar. Corp. v. R.A. Gray & Co., 467 U.S. 717 (1984) and United States v. Carlton, 512 U.S. 26 (1994)). Raising revenue during a global pandemic would likely meet this requirement.
While it might very well be advisable for clients to maximize their exemptions, it is equally important that they not wind up incurring a large gift tax liability. As a result, those clients wishing to utilize their exemptions in 2021 should plan to do so as quickly as possible to ensure that their planning is completed ahead of any tax legislation that is prospective in nature and build maximum flexibility into their planning in the event that such tax legislation winds up being retroactive to January 1, 2021. For some clients, flexible planning might involve transferring assets to a marital trust for the exclusive benefit of their spouse and waiting to decide whether to elect to have the trust qualify for the marital deduction on a timely filed gift tax return (in April, 2022). For other clients, flexible planning might involve creating a trust and making a formula gift (which is designed to limit the amount being transferred) or giving a beneficiary the power to disclaim the assets and, if properly drafted, effectively unwind the gift for a period of up to nine (9) months from the date of the gift. These are complicated strategies that require careful execution.
Clients should also be aware that other changes might be made to limit future planning, including legislation that would limit the usefulness of grantor retained annuity trusts (GRATs), as well as the use of valuation discounts.
In sum, there are a variety of ways for clients to structure their planning to utilize their increased gift tax exemptions and we encourage those of you who are interested in exploring the possibility to reach out to us to determine what might work best for you and your family. You may also wish to review our webinar (click here), originally broadcast last year, which explores some of the strategies many of our clients have availed themselves of under these favorable, albeit likely temporary, exemptions.