Wealth Protection Strategies in an Election Year
With 23 days until the election, I thought it would be prime time to throw another reason to panic on the internet for everyone to grapple with. Kidding, this is helpful I promise. As many of you already know a political party change this November could very well mean lower federal estate and gift tax exemption amounts. Why should you care? Well, any work you have done in estate planning so far may need to be adjusted, and if you haven’t done any planning yet, now would be a great time to get rolling.
1. Why Would the Election Impact My Estate Plan?
Effective estate planning is wealth management. Let me say that again, estate planning is wealth management. A properly constructed estate plan can save your beneficiaries a substantial amount of money. You spend a lot of time and effort raising your beneficiaries and accumulating your wealth, so do them a solid and get an estate plan. Just do it.
Ok, the election. The Democratic party has hinted, not so subtly, that a win in November means legislation to reduce the federal estate tax. What is the federal estate tax now? Currently, the federal estate and gift tax exemption is set at $11.58 million per taxpayer. Assets included in a person’s estate at death that exceed their exemption amount are taxed at a federal rate of 40% (with many states adding additional state estate taxes on top of the federal rate). So, it is of great importance to know, and plan for a reduction federal estate and gift tax exemptions, otherwise more of your estate will be exposed to that whopping 40% tax.
Additionally, the election could mean the end of the longtime taxpayer benefit of stepped-up basis at death. As the law stands, each asset included in a person’s estate at death receives an income tax basis adjustment so that the asset’s basis equals its fair market value on the date of death; therefore a beneficiary can realize a capital gain on the subsequent sale of an asset only to the extent of the asset’s appreciation since death.
With the potential changes to the estate tax exemption and step-up in basis in flux, there are a few wealth transfer strategies worth discussing with your estate planning attorney before year-end. I will discuss three here, and then I know I am out of time for the average adult attention span, but never fear there are MORE (feel free to call me or your estate planning attorney and ask about GRATs SLATs and all sorts of other goodies).
2. Intrafamily Sales and Loans
In response to COVID-19, the Federal Reserve lowered federal interest rates with an eye towards stimulating the economy. Accordingly, families should consider loaning funds or selling income-producing assets, such as an interest in a family business or rental property, to a family member. The donating family member will receive a promissory note charging interest at the lowered federal interest rate, while providing a financial resource for a beneficiary family member on more flexible terms than they would otherwise receive on a commercial loan. Further, if the investment of the loaned funds or property produces income greater than the interest rate, the donating family member will have effectively transferred wealth to the beneficiary family member without using any of their estate or gift tax exemption.
3. Irrevocable Trusts to Preserve Basis
Assets transferred into an irrevocable trust do not receive a step-up in income tax basis at the donor’s death. These assets will retain the donating family member’s carryover basis, which depending on the asset, may result in significant capital gains realization upon the sale of such appreciated assets. Wary of the permanence of an irrevocable trust (remember these trusts cannot be amended once created) and looking for a bit of flexibility? The “swap power” permits the donating family member to exchange one or more low-basis assets in an existing irrevocable trust for one or more high-basis assets currently owned by the donating family member’s estate. So, low-basis assets are positioned to receive a basis adjustment upon the donor’s death and the capital gains realized upon the sale of any high-basis assets, whether by the trustee of the irrevocable trust or any trust beneficiary who received an asset-in-kind, may be reduced or eliminated. Sound like gibberish? Right, that’s why CPAs and lawyers work together to manage your assets, so you don’t screw this part up.
4. Irrevocable Life Insurance Trust
If you have life insurance, your existing policy can be transferred into an irrevocable life insurance trust (ILIT), pronounced “eye-LIT” for those of you like me who cannot read a new acronym without immediately googling how to say it (here’s looking at you “VSCO”). The purpose of an ILIT is to allow a policy holder to make gifts (which qualify for the annual gift tax exclusion) to the trust to pay the policy premiums. By doing so, the premium payments and the full death benefit of the policy are not included in the policy holder’s taxable estate AND are exempt from income taxes. This differs from a scenario where life insurance death benefits are paid to an individual, because the proceeds are included in the taxable estate of the decedent. Don’t have life insurance? No problem, you can still set-up an ILIT and the trustee can purchase an insurance policy in the name of the trust. Again, the “I” in ILIT means this trust cannot be amended after it is created so if you are looking for liquidity this option isn’t your wealth management vehicle.
When Should You Hire An Estate Planning Attorney?
Yesterday. Seriously, you are dealing with a global pandemic during an election year—what are you thinking? If any of the strategies outlined above interest you, or you feel that potential changes in legislation will impact your wealth, I strongly encourage you to schedule a call with your estate planning attorney and CPA before the end of the year.