The Senate Went Blue, What Should Estate Planners Do?

Mar 30, 2021 | General Estate Planning, IRS / Tax Guidance, Podcasts, T&E Administration, Uniform Law, Multi-State Issues & Laws

“The Senate Went Blue, What Should Estate Planners Do?” That’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Travis Hayes, ACTEC Fellow from Naples, Florida. When the control of the U.S. Senate changed from Republican to Democrat in January, many estate planning clients were concerned about changes in federal tax laws. To tell estate planning attorneys what they should be thinking about now for those clients, including the possibility of the retroactive application of any tax law changes, I am joined today by ACTEC Fellows Steve Akers of Dallas, Texas, Beth Shapiro Kaufman of Washington, D.C., and Christine Quigley of Chicago, Illinois. Welcome, Steve, Beth, and Christine. Beth will get us going on this very timely and important topic.

Possibilities of Changes to Budget

Thank you. President Biden has a proposal to return the estate and gift taxes to what he refers to as the 2009 parameters, and that means a $3.5 million exemption for estate and GST (Generation-Skipping Transfer Tax) purposes, a $1 million exemption for gift tax purposes, and no indexing. We’re going to discuss today how and when changes to the estate tax could be enacted and what planners can do to anticipate that possibility.

Normally, tax bills start in the House of Representatives. In fact, that’s what the Constitution says has to happen. A bill that passes in the House would then go to the Senate; and in the Senate, most bills are subject to filibuster. A filibuster can only be overcome with a 60-vote majority. Since there most likely is no 60-vote majority for a tax increase, a standalone tax bill that comes up through the House would probably just die in the Senate. But there are alternatives to put tax legislation forward, and that would be to include tax provisions in a budget reconciliation bill. Budget reconciliation bills are not subject to filibuster. They can pass with a 51-vote majority in the Senate, but budget bills have their own arcane process.

Since 1990, the so-called Byrd Rule keeps extraneous matters out of budget bills. Any one senator can call a point of order against a provision that’s extraneous to the budget. Among the matters that are deemed to be extraneous are legislative provisions that cause a reduction in the federal revenues outside of the 10-year budget estimate window. That’s why we often see sunset provisions in bills that cut taxes, like the TCJA (Tax Cuts and Jobs Act), which has a bunch of provisions that are expiring at the beginning of 2026. But, this year, we’re talking about potential tax increases, not decreases. So those will not require a sunset provision.

If budget reconciliation is going to be the vehicle for tax increases, when might that process happen? Well, at the time we are recording this podcast, Congress is currently using the budget reconciliation process to pass a Coronavirus Relief Act. There can only be one budget reconciliation bill for each fiscal year. But because Congress didn’t pass a budget bill for the current fiscal year – the one that started in October 2020 and ends on September 30th, 2021 – we can actually have two budget bills in this calendar year, the bill under consideration now and a second one, which would be the budget reconciliation bill for fiscal year 2022, the fiscal year that starts on October 1st of 2021. Because it’s easier to pass a budget bill, this will be the most likely place to see President Biden’s tax increases if they are coming up at all in 2021.

So, assuming all the stars align for budget reconciliation, one of the questions every client asks these days is, would the tax law changes be retroactive? Steve, how would you respond to that $3.5 million question?

Would Tax Law Changes be Retroactive?

Occasionally, transfer taxes are changed retroactively – very occasionally. That happened with OBRA (Omnibus Budget Reconciliation Act) in 1993. It happened with the repeal of an ESOP (employee stock ownership plan) deduction in 1987. So for example, it would be possible that legislation might be effective January the 1st of 2021. Maybe the date of introduction of a bill. Maybe the date that a bill comes out of the House Ways and Means Committee.

If the gift exclusion amount were to be reduced retroactively, that could be very disadvantageous to a donor. If someone gives $11.7 million today, thinking that that’s covered by the gift exclusion amount, but the gift exclusion amount is changed retroactively to $1 million, then that extra $10.7 million times the Biden approach of 45 percent with the $4.815 million of gift tax that would be owed – clients would be very concerned about that.

Two comments about this retroactivity issue. Is it constitutional? Probably, yes. There have been a number of cases addressing the constitutionality of tax legislation, making very clear retroactive tax legislation can be constitutional, but there are possible outer limits. And interestingly, the most recent Supreme Court case was a transfer tax case, the United States v. Carlton case in 1994, upholding a retroactive change. A concurring opinion suggested there are outer limits:  that was not a wholly new tax, and there was a relatively short period of retroactivity.

Second comment – even though it’s constitutional, realize it is very unlikely that we will have a retroactive change in the gift exclusion amount. First, it would just be egregiously unfair, as that little example showed. Remember, there are 50 Democratic senators. It would take every one of them going along in order to do this. The estate tax legislation is controversial anyway. The likelihood of getting all 50 to go along with an egregiously unfair retroactive gift tax change is extremely unlikely. The timing of this will likely happen late summer or fall at the earliest. To think that Congress would go back to a January 1, 2021 date is just out of the question, really.

Furthermore, practically all changes to the unified credit amount that have been made – over the last decade or so – are effective after December 31 of the year in which it is enacted. Part of the reason for that is a special provision in Section 2505 of the code. So even though it’s very unlikely, because the effect would be so egregiously unfair to a client if there were a retroactive gift tax change, clients may be concerned about that. Chris, what can we do if a client is concerned and wants to do something to protect against it?

Protecting Against Retroactive Tax Changes

Well, Steve, there are several planning tools we have at our disposal. We only have time to discuss a few of them today, so I’ll focus on SLAT, formula gifting, and QTIP (Qualified Terminable Interest Property) and QTIP’able trusts. Spousal Lifetime Access Trusts, or SLATs, allow one spouse to create a trust for the benefit of the other spouse, which could also include descendants as beneficiaries. This creates a safety net for the couple, so long as the donor is alive and they stay married.

Now, if both spouses create SLATs, each for the other, care must be taken to avoid the reciprocal trust doctrine as articulated in the 1969 Grace case (United States v. Estate of Grace) and subsequent case law. That doctrine, if violated, would recharacterize the trusts and treat them as if each party created a trust for himself or herself, resulting in treatment as a self-settled trust and estate tax inclusion under Section 2036.

Formula Gifting

But what are some options for funding trusts, whether SLAT or otherwise? Well, a popular strategy these days is the use of formula gifting, which could either come in the way of a formula allocation clause as approved in accord with its progeny or a Wandry clause, which is going to define the gift in terms of the available exclusion amount. So, you might have, for example, a gift of that many shares of stock as are equal in value to the donor’s available gift tax exclusion amount. I would note that the Service published a non-acquiescence to Wandry, potentially opening these clauses for challenge.

Some clients, though, might want to transfer an entire interest in property for simplicity, even if they don’t want to make a gift in excess of the exclusion amount. In that regard, many practitioners believe it’s possible to make a current gift equal in value to the donor’s gift tax exclusion and sell the remaining interest for fair market value, effectively combining a Wandry-type gift with a price adjustment clause for the sale portion. This technique may be open to challenge under Sections 2036 or 2702, but nonetheless, there may be times when it gives an insurance policy to the donor of sorts.

QTIP or QTIP’able Trust

A final technique that would allow for tremendous flexibility in case of either retroactivity or a reduction in the exemption involves making a gift to a trust that’s either a QTIP trust or a QTIP’able trust. And this could either be done as a direct gift or a pour-over from a formula allocation. This allows the donor to delay the QTIP election until the Form 709 is due in the following calendar year. But of course, the election must be made on a timely filed gift tax return.

A spouse must receive all income from the QTIP trust, even in case of divorce, so access to principal can be controlled by the trustee or denied entirely. There are a couple of notable limitations to inter vivos QTIPs. A Clayton provision that would open the beneficiaries beyond just the spouse, if the QTIP election is not made, likely cannot be used for lifetime QTIP trusts based on the regulation.

Nonetheless, if a donor spouse executes a qualified disclaimer, whether a partial or full disclaimer, the gift property may pass to a trust for descendants. Based on a literal reading of the regulations, however, it’s unclear that the donee spouse could also be a beneficiary of that disclaimer trust. And Beth, I know you’ve considered a lot of other disclaimer types.

Disclaimer Trusts

Yes. I have, Chris. The thing that’s really interesting here is we usually think about disclaimers in the context of the decedent; and here we’re talking about, obviously, lifetime gifts and the potential for disclaimer by somebody other than a spouse. And there, I think the interesting issue is, who has the power to disclaim when there’s a gift in trust?

So, we’ve got a couple of possibilities. The first one is the trustee. The Uniform Disclaimer of Property Interests Act, which has been adopted in 24 states and the District of Columbia, says if a trustee disclaims an interest in property that would otherwise have become trust property, the interest does not become trust property. In other words, under the Uniform Act, it seems that a trustee has the power to disclaim on behalf of all beneficiaries.

What worries me about that is whether a trustee who’s a fiduciary can ever exercise this power. Would it ever be in the best interest of beneficiaries for assets to revert to the donor? We might be able to invent some scenarios where it would be in their best interest. But at a minimum, if you anticipate a disclaimer by a trustee, you should probably draft some exoneration provisions to protect the trustee from liability for exercising that power.

Another possibility would be a disclaimer by a beneficiary; and there you want to be clear whether the beneficiary acts only on her own behalf or on behalf of all of the beneficiaries. One commentator has questioned whether a disclaimer would be a qualified disclaimer if the beneficiary is disclaiming more of an interest than she has. It might be safer to have all of the beneficiaries disclaim rather than having one disclaim on behalf of others.

And finally, perhaps you can give the power to disclaim to a person who is neither a trustee nor a beneficiary. This seems almost more like a limited power of appointment than a disclaimer. And if it is not actually a disclaimer, it might not relate back to the date of the gift. So this technique might be better used if the result of this disclaimer is for the property to pass to a different trust or beneficiary, like a marital trust, for example, and not back to the donor. This is really uncharted territory. We don’t know all of the ins and outs about how disclaimers of lifetime gifts would work. So we need to be really careful when using disclaimers for this purpose.

So, these are possible ways of dealing with the possibility of a retroactive tax change. A formula gift that takes into account a retroactive change in the gift tax law. A transfer to a QTIP’able trust so that if there is a retroactive change in the gift tax law, the donor could make a QTIP election – qualifying for the gift tax marital deduction, that would take away the gift. Or the possibility of someone disclaiming; and as a result of the disclaimer, the asset reverts back to the donor, if there were a retroactive gift tax change.


What if a client doesn’t do any of those? And now there is a retroactive gift tax change. What can we do? Rescission might be a possibility. There is a state law concept of being able to rescind a transfer or a transaction based on a scrivener’s error, a mistake of law, or a mistake of fact. Question is, if that is done for state law purposes, will it then be recognized for tax purposes? The easiest is if the rescission occurs based on a scrivener’s error, but a mere mistake of law – various cases have said that that would be recognized as well.

There are many cases on this that they reach varying results. We do have one case that addressed, specifically, a retroactive tax change. That was the repeal of the old Section 2036(c). Neal v. United States, a 3rd Circuit 1999 case that would recognize the rescission that was done and recognized it for tax purposes; but the IRS fought that case hard. We really can’t rely on that as a planning mode. So it’s hard to rely on recission as a planning mode. Possibly, it’s there if that’s the only argument.

Sell Assets to a Grantor Trust

Another alternative, beside these techniques, may be to sell the asset rather than give it.  For example, sell it to a grantor trust. The client receives back a note. Once the client is comfortable that there is not going to be a retroactive gift tax change, the client could then make gifts by forgiving the note. Almost all of the advantages as if there had been a gift up front could still be there, but the entire trust could still be GST-exempt. Aside from the very small interest rate that is paid on the note, all of the appreciation would be shifted as well.

A possible disadvantage of that approach is that if Congress were to act rapidly to change the exemption amount, the client may not be able to take advantage of the window of opportunity of using the large $11.7 million gift exclusion amount before the tax law change occurs. This whole area – planning for potential retroactivity – is a very hot issue among planners. There is no universally accepted best approach. Just realize there are planning alternatives that are possible.

Thank you, Steve, Beth, and Christine, for educating us on this very timely topic and for helping us know how to advise our clients on possible upcoming tax law changes.

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