September 1, 2021
DEAR TRUST OFFICER
My parents are very financially secure, as my father saved several million dollars during his successful career. They are in "senior living now. I've heard that federal estate taxes might be going up. Should my parents be taking estate planning steps right now? Should I? What might those steps be?
-CONCERNED POTENTIAL HEIR
DEAR CONCERNED: I would need much more information before answering this general question for your circumstances. Let me begin by noting that the amount exempt from the federal estate tax has never gone down in American history. Reduction that have never been enacted in the past were subsequently reversed by a later Congress before taking effect. Also although President Biden has proposed significant tax increases for the wealthiest, he has not called for any change in the federal estate or gift taxes. But having said that, I must also point out that under the current law, the amount exempt from federal estate tax will drop roughly in half in 2026. That law does not presently look likely to be amended. Senator Sander of Vermont has proposed dropping the estate tax exemption from the current $11.7 million per person to $3.5 million, starting next year. Those possibilities have many affluent families considering steps to "lock in" today's higher exemptions.
Locking it in
Under current law, in 2021 everyone has one $11.7 million transfer tax exemption which can be used to protect gift and estate transfers from the federal tax, which is generally imposed at the 40% rate on amounts over the exemption. Making a large taxable gift "locks in" the exemption without incurring any immediate tax liability, although it uses up the exemption available at death for the estate tax.
Example one. Joe's total estate is $12 million. If he does this year, only $300,000 will be exposed to estate tax. Should he die in a future year when the exemption is only $3.5 million, the tax will apply to $8.5 million.
If Joe makes a gift of $11.7 million this year, he will use up that portion of his exemption. Then if he does after the exemption is lowered to $3.5 million, only $300,000 will be subjected to federal estate tax.
However, to achieve the lock-in effect, one must go "whole hog" on the lifetime transfer.
Example two. Joe is not willing to part with his entire estate, so he makes a taxable gift this year of only $3 million. His 2021 exemption is large enough that no gift tax is payable. What happens if Joe then dies in a future year when the exemption is reduced?
The estate tax impact largely will be the same as if Joe did nothing at all. If the exemption is worth $3.5 million, Joe will have only $500,000 left to shelter his remaining $9 million estate. None of today's larger exemption is locked in by the smaller gift.
To complicate matter further, no one is suggesting a change to the martial deduction, or to the rule that a surviving spouse may inherit any estate tax exemption not used up by the estate of a decedent spouse (the "Deceased Spouse's Unused Exemption," or DSUE.)
Example three. Joe's estate comes to $16 million, which he will leave entirely to his wife, Martha, in a martial deduction trust. Assume that Joe dies in 2021, when the exemption is $11.7 million. None of that exemption will be used, thanks to the unlimited federal marital deduction. Martha thus will have an $11.7 million DSUE, and that figure is locked in by Joe's death.
Assume next that Martha dies in a year when the exemption has been reduced to $3.5 million. She will have the benefit of that smaller exemption plus the DSUE, a total of $15.2 million. Only $800,000 of Matha's estate would be exposed to the federal estate tax.
Is there a way for Joe to lock in that DSUE amount for Martha short of dying? Yes, estate planners have developed a wide range of trust-based strategies that may achieve this goal. You will need to consult an experienced estate planning lawyer to learn more about these approaches.
The lawyer will need to understand much more about the scope of your parents' assets, their health, and their hopes for their wealth. Nonprobate property, such as retirement plans and insurance policies, will need to be taken into account. This is an area where there are no "cookie cutter" plans, only guidelines.
Our Trust and Asset Management Team is ready and able to help with any estate planning questions you may have.