To Gift or Not to Gift: Year-End Gifting Considerations in Light of Biden’s Proposed Tax PlanDecember 8, 2020
As it becomes increasingly certain that President-Elect Joseph R. Biden, Jr. will take office in January, 2021, almost everyone is interested in President-Elect Biden’s tax proposals. While many know that part of his proposal is an increase in federal income tax rates as applied to high income individuals and families, fewer people are aware that he proposes to dramatically reduce the federal estate and gift tax unified credit, more commonly known as the federal exemption.
For major tax reform to take effect under President-Elect Biden’s first term, most experts opine that democratic victories in the Georgia Senate races are pivotal. Currently, the democrats hold a majority in the House of Representatives, which makes passing legislation in the House an easier task. However, absent bipartisan agreement for tax reform in the Senate (which most experts find unlikely, but not impossible), the democrats in the Senate will have a greater challenge than their counterparts in the House in passing tax reform. Victories in Georgia by democrats will give the democrats split control of the Senate with the republicans, which means any tax reform legislation proposed by the democrats will need full democratic support in order for Vice President-Elect Kamala D. Harris to cast the tie-breaking vote, presumably in favor of such tax reform legislation. If either republican incumbent is victorious, the challenge becomes even more daunting.
Presuming democratic victories in Georgia, it is important to consider the timing of possible tax reform legislation. Considering the ongoing COVID-19 pandemic, President-Elect Biden has made it clear that ending the pandemic is his administration’s top priority. Additional high priority issues include foreign relations and trade, climate control, banking and financial services, infrastructure, and anti-trust policies. If tax reform is also a priority in President-Elect Biden’s first year and democrats find success in passing tax reform legislation, it is possible that legislation could be passed during 2021 and made retroactive to January 1, 2021. While we think it is unlikely that dramatic tax reform will occur and, additionally, take effect on January 1, 2021, in the event it does occur, there are important federal estate and gift tax considerations for our clients that require action before year-end.
The large federal exemption that is currently in place offers an opportunity for individuals and married couples alike to transfer significant assets to children, grandchildren, etc. without incurring any estate or gift tax liability. President-Elect Biden’s tax proposal would reduce the federal exemption from its current amount of $11,580,000 per individual ($23,160,000 for a married couple) to $3,500,000 per individual ($7,000,000 for a married couple), a decrease per individual in the amount of $8,080,000 ($16,160,000 for a married couple). It is important to keep in mind that, as discussed above, if tax reform takes effect and the federal exemption is reduced as proposed, one may be required to give in 2020, whether via outright gifts or in trust, all or a majority of the current federal exemption in order to utilize either all or most of the federal exemption before it is lost. For example, if an individual has a taxable estate of $14,000,000 which would be subject to the federal estate tax, such an individual can make a gift in 2020 of approximately $11,500,000 and utilize most of the current federal exemption. While such an individual would not have any federal exemption left if he or she died in 2021 with the federal exemption then lowered to $3,500,000, what would be subject to the federal estate tax at that time would only be the remaining $2,500,000. However, if such a gift was not made in 2020 and the individual died with the same taxable estate of $14,000,000, the amount subject to the federal estate tax at that time would be $10,500,000 in 2021, a difference of $8,000,000. In other words, if you do not use the increased federal exemption now, you will lose it if it is a lower amount in the year in which you die. As a final point, it is also important to consider the capital gains and state tax implications associated with any such gifting, to the extent that they may be applicable.
While making large gifts (outright or in trust) to children, grandchildren, etc. may be effective and advisable, this gifting strategy bypasses entirely one’s spouse. However, married individuals do have the opportunity to make a large gift to an irrevocable trust for the sole benefit of such individual’s spouse for the spouse’s lifetime (known as a “Spousal Lifetime Access Trust” or “SLAT”) while still using such individual’s federal exemption. Generally speaking, the terms of a SLAT allow the spouse to use and access the gifted assets in a limited fashion. Furthermore, each spouse can establish a SLAT for the benefit of the other spouse so long as the trusts do not run afoul of the “reciprocal trust” doctrine. Such a strategy is a great way of: (1) using federal exemption currently; (2) maintaining some right to use the gifted assets; and (3) not having to give such assets to a younger generation until a later time.
It is not appropriate for all clients to consider gifting in 2020; it will be dependent on each individual client’s facts and circumstances. Generally speaking, clients who should consider gifting before year-end are those who: (1) are willing to give all or most of their current exemption now; (2) own property that is likely to appreciate in value before death; and/or (3) are certain they will never need the gifted assets and can continue to support themselves financially without such gifted assets.
While the outcome of the Senate elections in Georgia may play a pivotal role in the federal tax structure for at least the next two years, it may be appropriate to plan for the worst case scenario if the circumstances are right. The circumstances will not be right for every client, but we encourage you to reach out to your attorney in our office to discuss whether or not taking advantage of any gifting strategy is advisable.
For additional information related to anything contained in this Client Alert, please contact one of the authors listed above, or any member of our Trusts & Estates Law Practice Group.