Plan Today for Changes in Estate and Gift Taxes

Hesitate to revise or create your estate plan this year and you’re likely to regret it in a few years.

The environment for estate tax planning is unlikely ever to be more attractive than it is now, as I’ve said before. The estate tax exempt amount is scheduled to be slashed in half after 2025 if Congress doesn’t prevent it. The opposite is more likely. President-elect Biden and many members of Congress want to decrease the exempt amount sooner and by more than a greater amount, and also raise the top estate tax rate.

Keep in mind that there is another round of congressional elections in 2022.

Political analysts say it will be harder for Republicans to defend all the Senators they have up for re-election in 2022 than it was in 2020. Control of the Senate could be solidly in the hands of Democrats after 2022.

Today’s low interest rates also make some tax reduction strategies more valuable than they were when interest rates were higher.

The only event that could make the estate planning environment better than it is today would be a general decline in asset values that allows more property to be removed from estates at temporarily low prices.

You reduce estate and gift taxes by removing existing wealth and expected future wealth from the estate. There also are strategies that eliminate or reduce gift and estate taxes on property transfers.The easiest way to remove current wealth from an estate is to make a gift of property. You can make an outright gift or give the property to a trust set up for the benefit of others.

The taxable amount of a gift often can be reduced by dividing ownership of the property into pieces known as fractional interests.

When ownership is divided, each piece usually is valued at less than its proportionate share of the property’s full value.

That’s because partial ownership interests receive valuation discounts for lack of control and lack of marketability.

Property often is divided into fractional interests by using family limited partnerships or limited liability companies. You can transfer the property to the entity and then give shares of the ownership interests to different family members. The gifts also can be made through trusts.

You can make tax free gifts to any person up to the annual gift tax exclusion amount, which is $15,000 in 2021. A married couple can give up to $30,000 per person per year. You can make these tax-free gifts to as many people as you want.

Gifts above the exclusion amount during the year are tax free because of the lifetime estate and gift tax exemption amount. The amount is $11.7 million per person in 2021, or $23.4 million per married couple. Tax-free lifetime gifts reduce the amount of the lifetime exemption that can be used by your estate. So, if you make $3 million worth of gifts during your lifetime, it decreases the estate tax exemption for your estate by $3 million.

There are a couple of reasons to consider reducing your estate now rather than holding all of the property for life.

One reason is, as mentioned above, the estate tax exemption is likely to be reduced in the future. It probably won’t be reduced all the way to the $1 million level that was in effect in 2000, but there’s a good probability it will be reduced to $5 million or less. Use some of the exemption amount on gifts now while it is available. Your estate won’t be penalized if the exemption is reduced later.

Another reason to make gifts is that transferring property now not only removes the value from your estate, but it also eliminates the future appreciation of the property from your estate. Too many people look at the current values of their estates and conclude they don’t have estate tax problems. They overlook that the values of their assets are likely to increase over time.Another strategy is to sell property to either heirs or a trust for their benefit.

For example, you first can create a trust and transfer property or cash to it. Then, you can sell assets to the trust in exchange for an annuity that lasts for the rest of your life. IRS tables that use current interest rates and the value of the property determine the amount of the annuity payments. If you pass before life expectancy, a significant amount of wealth has been removed from the estate.

A variation is to sell assets to a family member or trust in return for a note that bears the lowest required interest rate. With interest rates so low now, the property is likely to have a higher rate of return than the rate charged on the loan. If that happens, a lot of future growth has been removed from the estate.

Another variation is to lend money or property to a family member or trust, charging the minimum interest rate required by the IRS. The borrow-er invests the money or property and pays little or no interest on the loan because of today’s rates. The invest-ment income and gains are retained by the borrower and are removed from your estate. Ultimately, you or your estate can forgive all or part of the loan if you want.

There are a few precautions to consider when selecting property to remove from your estate.It is possible the value of the property might decline after a gift. For gift and estate tax purposes, the value of the property on the date of the gift is what counts. If the value bounces back within a reasonable time, there’s no harm from the temporary decline in value.

But if the value doesn’t recover by the time you pass away, the total estate and gift taxes would be higher than if the gift never had been made.

A good rule is to avoid giving property that has appreciated significantly, seems overvalued or has a lot of price volatility. Following that rule reduces the probability the value will decline after a gift is made.

Another good practice is to include a right for the donee to disclaim the gift within nine months of the gift. If the property declines in value, the donee can disclaim the gift and it will be returned to you. See our October 2020 issue for details about disclaimers.

Another risk is that appreciated property is given but the value doesn’t increase much after the gift.

That can be a problem because when a gift of property is made, the donee takes the same tax basis in the property that the donor had. When the donee sells the property, he or she will pay capital gains taxes on the appreciation that occurred while the donor owned it. But if the donor had held on to the property, when the donee inherited it through the estate he or she would increase the tax basis to its current fair market value.

The property could be sold at that time without incurring capital gains taxes.

In some cases, the estate taxes from continuing to own the property would be less than the capital gains taxes that the beneficiaries would incur after receiving a gift of the property and eventually selling it.

That’s why it often is a good idea to avoid giving property that’s appreciated a lot, especially if its future growth rate isn’t likely to be high.

We’re likely at a turning point in estate and gift tax planning. People who haven’t had to be concerned with estate and gift taxes need to brush up on the basics and meet with their estate planners to discuss the best strategies for them to use.