Planning Ahead for the Sunsetting of the Tax Cuts and Jobs Act Exemptions

“Planning Ahead for the Expected Decreases in the Estate, Gift and GST Exemptions,” that’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Travis Hayes, ACTEC Fellow from Naples, Florida. The increased estate, gift and GST tax exemptions under the Tax Cuts and Jobs Act are scheduled to sunset at the end of 2025, making this a good time for estate planners to help clients explore tax planning strategies. So what do estate planning professionals need to be aware of when discussing ways to reduce future individual tax liabilities for clients? ACTEC Fellows Kim Kamin of Chicago, Illinois, Stephen Liss of New York City, and Chris Siegle of Phoenix, Arizona join us today to discuss this time-sensitive topic. Welcome, Kim, Stephen, and Chris.

The Urgency of Planning Before the TCJA Sunset

Kim Kamin: Thanks, Travis. As estate planning professionals, we’re all acutely aware of the ticking clock until the scheduled expiration of the TCJA bonus exemptions, and we know the remaining months will race by. Exemptions in 2024 are $13.61 million per person, expected to be $14 million something in 2025, and then to go down into the $7 million range for 2026.

Historical Context and Skepticism

Some of us may be skeptical. We’ve been here before in 2012 when exemptions were scheduled to decrease. There was scrambling and madness and poorly thought-out trust instruments that often didn’t truly capture clients’ wishes. And then – no decrease. We worried again after the 2020 election with legislation threatening to reduce exemptions. There was fear and panic, and yet – no decrease. But this time, we may be even more wary. Regardless of the results of November’s election, it’s difficult to imagine Congress taking action to change the law and stop this. And we recognize that we are always planning in the face of uncertainty. We don’t know when a client will die, what the value of their taxable estate will be at that time, and we don’t know what the transfer tax laws will be. All we can do is plan for the law as it is now and hope we’re building in sufficient flexibility to be prepared for all the changes to come.

Using exemptions to gift into an irrevocable trust with maximum flexibility is therefore crucial. Dynasty trusts, lifetime family trusts or SLATs (Spousal Lifetime Access Trusts). Any trust designed for maximum flexibility, I call a “Gumby Trust.” Here are a few of the things I personally like to see in them.

Elements of Trust Designed with Maximum Flexibility

Broad Class of Beneficiaries

The first is a broad class of beneficiaries. If it’ll be a GST-exempt trust funded with a large sum, it’s best to permit all the descendants to be permissible beneficiaries for optionality. You can clarify that each generation has priority as a primary beneficiary so that the trustee doesn’t need to worry about the younger generation’s interests and can favor their parents, but then at least they could distribute for the benefit of grandchildren or more remote descendants if it’s deemed desirable while the older generations are still alive. Or vice versa, the primary objective, because these are GST-exempt trusts, is for them to be utilized for future generations so that at least the parents or a spouse, if it’s a SLAT, could be permissible beneficiaries during the interim.

Flexible Distribution Standards

The second thing I like to see is flexible distribution standards. If a beneficiary or a related or subordinate party is making the distributions as trustee, then of course they need to be limited to an ascertainable standard like HEMS (“Health, Education, Maintenance, and Support”). But ideally, the trust will always permit for an independent trustee, even if there isn’t one acting now, one who could be appointed, who could then make distributions subject to a non-ascertainable standard like “best interests”. And the settlors can always leave letters of wishes to expand on their intentions in this regard.

Powers of Appointment

Next, I like to see powers of appointment. Why not give the primary beneficiary both lifetime and testamentary powers of appointment and broad special powers that allow them to appoint to anyone other than themselves, their estate, or the creditors of either are the best to maximize flexibility? I just request that the testamentary powers not need to be exercised in a will for privacy.

Trust Protectors

Next, we like to see trust protectors – trust protectors who can be appointed as surgeons. That means that there would be the ability for somebody as a fiduciary appointer to appoint an independent party who can act as a trust protector with the power to amend and restate the trust so they can fix administrative, and tax, and investment, and fiduciary provisions.

Also, if the trust protector is not a fiduciary, they can have the power to add beneficiaries too. This can be incredibly helpful. This means that if you’re in a jurisdiction where the settlor could set up a domestic asset protection trust, you could have it be a springing DAPT (Domestic Asset Protection Trust). Or if you’re only naming the descendants as beneficiaries, you could have it be a springing SLAT and add the trust protector could add the spouse later. It’s also nice when the trust expressly blesses decanting. An independent trustee with the power to distribute in trust for the benefit of beneficiaries already can do common law decanting, but the trust instrument can be even more explicit in permitting decanting and waiving statutory requirements such as notifying contingent remaindermen about the changes. Or even not giving current beneficiaries the right to object and be given notice, something that we’re all concerned about given the recent CCA.

Grantor Trusts

And then, finally, grantor trusts. These trusts are going to be typically set up as grantor trusts initially so that the settlor grantor will continue to pay the income taxes for these trusts but you need to make sure that you’re including a power to turn off grantor trust status and even better to also include for an independent trustee who could reimburse a grantor for taxes here and there as necessary so that they don’t turn off grantor trust status. So those are just a few ideas about building in flexibility.

Kim Kamin: Chris, what else should folks be thinking about?

Economic and Emotional Challenges for Clients

Christopher Siegle: Thank you, Kim. That was a great description of what the common planners are definitely talking to their clients about. I’ve seen an uptick in the number of clients who are coming forward concerned, as you reflected on, about the potential tax changes. But we have to understand that in the wealth transfer conversation, we have to acknowledge that our clients are facing both economic and emotional types of challenges. We have to understand that the need for retained control and retained access to income build into the challenge for us as planners in designing these trusts with the maximum flexibility you have described.

It’s very evident that even in today’s legislative and regulatory environment, the attack on the wealthy – the wealthiest of our clients – is increasing. We’ve had activity and bills introduced even this week, even yesterday, that deal with mergers and acquisitions and eliminating tax-free transactions between trusts, between individuals, and between businesses. We see that the scrutiny is increasing. As a result, we have to think about clients and their situations based on income and access preservation, even with irrevocable trust planning. We also have to consider that sometimes clients are not going to be in this situation to be able to have the capacity to use the $27.22 million 2024 lifetime exclusion.

Spousal Lifetime Access Trusts (SLATs)

So, maybe it might make sense to encourage clients, who have the capacity, to use one of the spouse’s exclusions and not the others instead of balancing and making split gifts. Maybe we think about a husband and wife (stable marriage is assumed), if a husband and wife can use $10 million, Spouse 1 uses $10 million to gift to a spousal lifetime access trust or a dynasty trust or outright to a child, or whatever that looks like. $10 million in 2024. Let’s say that the sunset happens. Let’s say that, indeed, the exemptions and exclusions go down and get cut in half on January 1, 2026. After that, Spouse 2 has $7 million worth of exclusion in his or her pocket. Spouse 1 has already used $10 million. Together, they would ordinarily have $14 million. Instead, they now have the capacity for $17 million worth of wealth transfer either during life or at death.

Even using one spouse’s complete exclusion or up to complete exclusion can make sense. For those clients who have the capacity, you want to use some of those spousal lifetime access trusts or other trusts. We have to think about the overall concerns with using spousal trusts in general. We have to think about the reciprocal trust doctrine. We have to go back to that. We have to go back to sensitivity about creating trusts with different terms and different timing. Timing is not our friend. If we wanted to think about making a trust in 2024 and 2025. Our process is slower, so maybe we can only do one in 2025. We may not have that exclusion in 2026.

We lose that different tax year difference factor. So when we think about SLATs, we also think, as you explained, we think about the access to income and the need for independent trustees, the limitation. Some people view health, education, maintenance, and support and then ascertainable standards as a limitation. Some view it as very enabling. Whatever you think, it needs to be augmented with independent trustees.

Finally, let’s make a trust where one spouse is the ongoing beneficiary, and the other trust can include that spouse later. Outright gifts, direct gifts – let’s encourage those, but let’s understand that it’s very difficult to get the GST exclusion also.

Christopher Siegle: Stephen, I’d like to turn it over to you to talk about the exclusions and how we integrate those into the planning.

Utilizing Bonus Exemptions and Valuation Clauses

Stephen Liss: Thanks, Chris.

So over the next two years, there will be clients who want to utilize every dollar of bonus exemption they have, whether that’s using all the exemption of one spouse or both spouses, they’re going to put pressure on their advisors to take maximum advantage of the bonus exemption. As planners, we need to accept that we don’t know how much gift and GST exemption our clients have left. There are lots of ways clients make gifts that only come out on an audit, where there might have been a hard-to-value asset that was gifted and the statute of limitations hasn’t run, or where you think you adequately disclosed a gift and you didn’t. So, the valuation of that gift is still unsettled.

To account for this uncertainty, advisors should explore valuation clauses, whether that’s a price adjustment clause under the King case, or a Wandry-style clause, or a reallocation clause like was used in McCord, or Christiansen, or Heder. You should be using these clauses to hedge against this risk and you should be open to using more than one type of valuation clause in your planning.

You should be looking for ways to use bonus GST exemption, as well as gift tax exemption. You may have clients who can’t or don’t want to make any more gifts. These are very large numbers, but they may have established non-exempt trusts. Maybe they did successful GRAT planning in previous years. You can make a late allocation of GST exemption and utilize that valuable tax attribute before it sunsets.

We also need to think about more exotic strategies. So, as a community, we’re going to have to consider some strategies that are more exotic than we generally use. Austin Bramwell introduced the idea of gifting with a promissory note back in 2012, and that idea gained more traction in 2020. I think as we push towards the end of 2025, that’s something that more and more people are going to be looking at. Also, consider completed gift asset protection trusts for unmotivated clients to make large gifts, often because they’re young and don’t have a spouse or children, a completed gift asset protection trust can be a nice solution. Think about the back-end SLAT made popular by George Karibjanian. It’s another technique to explore.

Addressing Common SLAT Issues

So SLATs, as Chris mentioned, are very popular, but they have two problems that often come up. One is the beneficiary spouse may die. The other is the couple may divorce. And in both cases, access to the trust assets is eliminated for at least one spouse. The back-end SLAT addresses the risk of premature death by having SLAT assets continue in a trust that benefits the donor spouse. It’s not available in every state, but it’s something you should understand because it may allow your clients to take advantage of the bonus exemption when they would otherwise find such a large gift too risky.

Be sure to brush up on which TCJA provisions lapse and which ones don’t. For example, the change in how alimony payments are taxed, that is permanent. That’s not going to sunset. In contrast, the cap on state and local tax deductions is set to sunset and come back in 2026.

Summary: Embrace Uncertainty and Innovate

In summary, the sunset of the TCJA is going to drive engagement and we have a chance to add real value as advisors, not just as document generators. Seize on that. There’s a lot of uncertainty coming your way. You need to embrace it and design flexible plans that can adapt. Be open to unconventional, even aggressive solutions. Because as we get closer to the end of 2025, that may be all you have to offer.

And finally, remember that you are not alone. Reach out to your network for ideas and support in the estate planning community. We’ve been here before in 2012 and 2020. And like then, we’ll get through this together. Thank you for your time.

Travis Hayes:  Thank you, Kim, Chris, and Steven, for highlighting planning considerations in light of the potential decrease in transfer tax exemptions at the end of next year.

You may also be interested in:

• Tips for Preparing a Federal Estate Tax Return (Mar 2024)
• Powers of Appointment: From Snoozy to Sexy (June 2018)

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