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May 31, 2019
Don’t put off to tomorrow what you can do today. This old adage is true for many aspects of our lives, including estate planning. Current federal estate and gift tax exclusions are set to expire in January 2026. And while this seems like ample time to put a plan in place, the reality is the laws could change before then—and the new rules may not be as favorable.
Legislators from both sides of the aisle have introduced multiple bills that range from increasing the maximum estate tax rate to 77% (currently 40%) to repealing it altogether. With three election cycles before 2026, where we ultimately wind up is anyone’s guess.
Creating and funding certain planning structures today helps eliminate this uncertainty while potentially minimizing the amount of taxes your heirs pay.
Under the present rules, few American families actually end up paying estate taxes thanks to the sizable exclusions—$11.4 million for individuals, $22.8 for married couples (2019 limits). However, this could change. Current or future legislators could decide to reduce the exemptions or get rid of them entirely. At the very least, if Congress doesn’t act, the amount you can exclude will decline dramatically in 2026. The exemptions will revert to 2017 levels, which will essentially cut them in half—$5.49 million per individual, $10.98 for married couples.
Think of it this way. Imagine the estate and gift tax exclusions are the stock of a company. The value of this stock has gone up eighteen-fold over the past twenty years, and over the past two years alone has doubled in value. A wonderful investment, indeed, but mid-term and long-term prospects for this “company” are less rosy due to many factors. What conclusion would many reasonable investors draw? It’s time to consider ways to preserve this growth. In other words, use the exclusion at its current lofty levels rather than waiting to see what future Congresses may do.
Worried about what could happen if you act now and the allowable exemptions are later reduced? Could the IRS try to “claw back” a portion of what you have transferred to your estate? The IRS has said no—nothing will be “clawed back” if the exclusion amount is lower at the time of your death. In other words, the gift “locks in” the use of the exclusion at the current level irrespective of what happens in the future.
Note: Gift tax and estate tax can be thought of as a unified system of transfer tax, with larger gifts made during life aggregated with amounts passing at death. The gap in the estate tax exclusion chart for 2010 reflects the one-year repeal of the estate tax in that year.
What, specifically, does it mean to “use the exclusion” now? Should you make outright gifts to the next generation to “lock in” the exemption? That is certainly one option, but many wealthy families prefer to set up “Dynasty Trusts” to be the recipients of these lifetime gifts.
A Dynasty Trust is an irrevocable, multigenerational trust that can continue indefinitely, benefitting successive generations of a family. The assets can be passed from one generation to the next without ever being subject to estate taxes. These trusts are sometimes referred to as “generation-skipping trusts,” which is misleading. With most Dynasty Trusts, the only thing being skipped is federal estate taxes, not people.
Once in the Dynasty Trust, assets are effectively removed from the estate tax system. Each generation can enjoy and use the funds in the trust, sheltered from claims and liabilities, and then pass the assets on to heirs free of estate taxes. Let’s look at an example.
As the owner, you retain control of the trust and make all important decisions, including whether or not to tell beneficiaries about its existence. Additionally, Dynasty Trusts offer several features that may influence your decision to create one:
If you create a Dynasty Trust today, fund the maximum excludable amount possible under current law, and give it time to grow to an even higher value, could future Congresses change the rules to take away some or all of the benefits?
Of course, anything is possible. However, it’s generally difficult to change the rules relating to a gift after it has been made. Here’s why:
This is not to say, however, that the rules in this area will not change. We know in fact that they will—on January 1, 2026, and perhaps sooner depending upon the results of elections in the intervening years. Given this, individuals and families of wealth should consider using the substantial gift exclusions currently available to fund Dynasty Trusts sooner rather than later. The benefits of planning now are invaluable.
Our planning specialists have extensive experience helping clients implement Dynasty Trusts and other wealth transfer solutions to achieve their estate planning goals and mitigate taxes. Contact one of our advisors to learn more.
Please read important disclosures here.
Paul is the Chief Planning Officer and a Partner in the New York office. He has over twenty-five years of experience in helping families create...
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