The mid-term election is coming in a little over two months and according to an article recently the Democrats have a 75% chance of gaining control of the House of Representatives. Given that, the Democratic leadership has been clear in their desire to repeal or change elements of tax reform passed last December that provided what they believe was an unfair advantage to the “Rich”. It is reasonable to ask what a Democrat controlled congress or White House would mean to your estate plan and what you should be exploring now.
Tax reform, a review
The Tax reform law had the following impact on estate planning.
- Doubles the estate tax free transfer to $11.5 M per person
- Estate taxes retained, top rate 40%.
- Preserved the step up in basis of assets upon death.
- State estate taxes such as Massachusetts’s top estate tax rate of 16%.
- Estates over $22M per married couple could have combined tax rate of 56%.
- Changes can be revisited by future congress.
- The $11.5 M transfer exemption will Sunset in ten years.
No question the tax reform bill opened the window on a family’s ability to transfer assets estate tax free to their children and grandchildren, but the political winds threaten to close that window causing many people to consider a use it or lose it mentality for planning.
The estate and gift tax system are unified, which means the IRS defines that you can give away up to a maximum of $11M while you are alive, or upon death. The advantage of giving it away now Is that you are gifting the asset plus all its growth without gift or estate taxes. For example, if you give away $11M today, at a 5% rate of return it could be worth almost double in 15 years, $21.7M.
An added advantage of gifting early is you can transfer the assets to a special trust called an IDGT. Intentionally Defective Grantor Trust, which mean you as the donor retain the responsibility to be the income tax payer on appreciation of the assets. So, you have the opportunity to give the asset, the growth, and you can pay the taxes on the trust growth each year. This is like putting your gift plan on steroids which all means that there will be less of your estate subject to taxes if Congress changes the laws or closes the transfer window.
The M3 outlook
There may be reasons that families are reluctant to act now to use their exemption, such as not wanting to give up control, or the concern about what happens if you need the assets in future. One approach is to create a financial plan that calculates your core capital which is the amount you and your spouse need for the rest of your life.
In our firm we use our M3 Command Center to model this considering:
- Income and Life Style needs
- Charitable Objectives
- Cash flow analysis
- Investable funds
- Asset Diversification and Location
- Monte Carlo simulation
- Qualified retirement Plans
- Inflation and taxes
- Health care needs
Once you calculate your core capital, you can determine if you have any excess capital. The excess is the amount remaining after you die and it can go to three places, Family, Charity, or the IRS. If your goal is to maximize family and charity and minimize tax payments, there are some specialized strategies that can allow for maximum transfer to your desired recipients and minimize or get you to a zero-estate tax plan.
The core and excess capital model can give you confidence in the amount you can give, but what happens if things change and you need more money for your core capital that you already gifted to the trust? A skillful estate planning attorney can draft a trust with claw back provisions that provide the ability to decant the trust or make your non-grantor spouse a beneficiary. So, if you and your spouse want to give now to benefit your children and grandchildren, your spouse could be a beneficiary so if you need any money it can come back to your family checkbook.
The other concern that may cause families to delay gifting is not wanting to give up control, and in our firm, we work with clients and their attorneys to set up FLLC’s Family Limited Liability Companies. In this arrangement you set up an LLC, and transfer assets to the LLC, it could be cash, investments, real estate. You can be the manager (control the LLC) and you can gift limited partner (economic interests) to the trust. You may be able to take a discount of 30% to 40% on the limited partnership interest due to lack of marketability and control, which means you could potentially gift over $15M using your $11M exemption. In this arrangement you could control the assets your whole life, and the value and growth will be outside your estate and free from transfer taxes.
There are many more tools in the kit to enhance the value of gifting and minimize taxes that include an installment sale of assets, other discounts on the value of transfers and substitution of high appreciation assets.
For our clients we can create a customized model of their estate plan and illustrate the impact today and in the future of planning options. The window is open, elections are coming, and you can benefit from being well informed of your current estate plan and options no matter who is running the Government.