2020 Is Over — Now What?

By JEREMY L. MERTENS, J.D., CPASenior Wealth Strategist & Family Office Fellow

As the sun finally sets on 2020 some may take the time to look back and reflect, ultimately concluding, “I’m glad that’s over.” In a year that saw historic fluctuations in the market, a worldwide pandemic, economic turmoil, protests, violence and to top it all off, an election, one may wonder what’s next.

During the latter part of the year, planners experienced a mad dash reminiscent of 2012. Apprehension resulting from a change in political headwinds, as well as a fear of losing out, caused fervor whereby some rushed to complete their estate planning in order to utilize higher lifetime exemptions. Also similar to 2012, we saw other individuals that took a decidedly more wait-and-see approach to their lifetime exemption planning. In late October 2020, the inflation adjusted amounts were released by the Internal Revenue Service in which we saw an increase in the exemption from $11.58 million in 2020 to $11.7 million in 2021. These lifetime exemption levels are currently scheduled to sunset on December 31, 2025, to pre-Tax Cuts and Jobs Act (“TCJA”) levels. While pre-TCJA amounts are indexed for inflation, they would be roughly half what we have today.

With a new year we find ourselves with a new government, and to quote Bob Dylan, “The times they are a-changin’.” The changing of the guard at the federal level could result in legislation being passed decreasing lifetime exemptions prior to 2025, limiting the effectiveness of various planning techniques or both. So, where does this leave us? In times of such great uncertainty it is best to stick with what we know. Surprisingly, those that took the “use it or lose it” mentality, and those deciding to “wait and see,” may find themselves in a similar position. Regardless of the approach, whether comfortable using remaining exemptions or not, under current law a number of avenues remain available to both.

Studies suggest the more you hear something, the more likely you will remember it. At the risk of being repetitive, given the unique times we find ourselves in, it seemed especially important to reiterate some ideas, concepts and planning techniques that not only appear apt, but pertinent as well. (For a previous discussion on similar topics, please see Sprint, Marathons and Hurdles: Estate Planning Techniques for 2020.) Whether you have used some, most, all or none of your exemption, the main planning techniques, currently, remain the same.

The Value of the Freeze

The taxpayer should look to transfer assets that will likely appreciate in value in order to “freeze” the value for transfer tax purposes. The value of the gift will be the fair market value of the asset on the date of the gift, with any incremental appreciation passing along to the beneficiaries outside the donor’s estate. The main methods for accomplishing these goals in the estate planner’s playbook are: outright gifting of assets directly to beneficiaries or to a trust for their benefit; Grantor Retained Annuity Trusts (“GRAT”); and sales to Intentionally Defective Grantor Trusts (“IDGT”). Outright gifting is likely not an option for those having used most, if not all, of their lifetime exemption without incurring a transfer tax. The use of GRATs and sales to IDGTs, however, are two great techniques that can be used by those with little or no remaining exemption, as well as those hesitant to utilize their exemption.

The Gift

For those who have not utilized all of their exemptions, an outright gift may still be an available planning opportunity. Gifting to the right type of trust can provide additional benefits. For individuals seeking more financial flexibility, a Spousal Lifetime Access Trust (“SLAT”) may be appropriate. With this planning, the husband or wife creates a trust benefiting the spouse during their lifetime. The beneficiary spouse can be given a limited power of appointment, exercisable at death, allowing for the trust to benefit a variety of beneficiaries, including future generations. The reluctant planner can take comfort in the fact that the spousal beneficiary would continue to have access to the funds within the trust providing additional financial security to the family.

The GRAT

Simply stated, the GRAT structure begins with the taxpayer selecting assets to place in trust with the expectation that the value of those assets will appreciate. In exchange for the transfer of assets, the grantor of the trust receives an annuity for a term of years, with the minimum being two years (it should be noted that recent administrations have attempted to set term minimums at ten years). The grantor is entering into an interest rate arbitrage, betting that the value of the assets placed into trust will beat the hurdle rate (currently 0.6%).1 If the assets placed in trust surpass the hurdle rate, then the remaining value will pass outright or in trust for the beneficiaries.

Under current law, the GRAT can be established to use little to none of the amount of the grantor’s lifetime exemption. However, along with adjusting term minimums, previous administrations have suggested setting required minimum remainders thereby forcing the utilization of lifetime exemption or making a taxable gift. The main catch is that the grantor must survive the term of the GRAT in order to prevent inclusion of the assets in their estate. While the GRAT can be a powerful method for transferring wealth, it does suffer certain hindrances when it comes to multi-generational wealth transfer. For those seeking something more dynastic, additional techniques are available.

The Sale to a Grantor Trust

One of the options available to individuals having utilized their lifetime exemption, as well as those reticent to do so, is a sale to an Intentionally Defective Grantor Trust (“IDGT”). Here the grantor establishes a trust in which they are responsible for paying the income tax earned within the trust, better known as a grantor trust. Those with lifetime exemption remaining will want to “seed” the trust with an initial gift sufficient to provide economic substance (typically 10% of the value of assets to be sold to the trust). Those with little or no exemption remaining will want to leverage a grantor trust they have already established. For more on the Sale to a Grantor Trust, read our Wealth Council Briefing on the topic.

It seems safe to say we are all glad to put 2020 behind us. For those that rushed at year-end to utilize their remaining lifetime exemption, the planning is not over (arguably, it has just begun). For those of you that have not yet done so, consider acting now. It’s a new year, and steps should be taken to put your lifetime exemption to good use as soon as possible, where doing so appropriately aligns with your overall wealth planning goals. Your Oxford team can help you evaluate your options to identify the optimal solutions for your family.