Changes To Your Estate Plan-Opportunities Still Exist

By: Randall A. Denha, J.D., LL.M.

New Year and new laws. Opportunities still exist, believe it or not. There are a number of strategies that are most effective in either high- or low- interest- rate environments—but not both. From 2010 through 2021, rates remained at historic lows; however, as rates have begun to rise, it is important to consider (and implement) the estate planning opportunities that are most effective in a low-interest-rate environment and prepare for the strategies that work best when interest rates are higher.

With changes to estate and gift tax exemptions and the retirement laws as I have previously written about, this year promises to be an opportune time to take advantage of a number of estate planning techniques.

While we are still experiencing high inflation, this did bring an increase in the exemptions for federal estate, gift, and generation-skipping transfer (GST) taxes. Additionally, President Biden signed SECURE 2.0 late last year, changing SECURE Act of 2019 retirement plan required minimum distribution (RMD) age restrictions to extend the period for accumulating tax-deferred growth. All of this notwithstanding, the current depressed valuations also present a unique tax planning opportunity for individuals.

The Bottom Line

As always, it’s always a good time, especially this year, to review your current estate planning documents to be sure they continue to reflect your wishes and are appropriate for your family given any changes in financial or family circumstances.

A new year brings hope for positive change and new opportunities. With changes to estate and gift tax exemptions and the retirement laws, combined with the current and anticipated interest rate environment and economic forecast, 2023 promises to be an opportune time to take advantage of a number of estate planning techniques.

CHANGES TO THE FEDERAL ESTATE AND GIFT TAX EXEMPTION

In 2023, the federal estate tax exemption amount, as well as the exemption from GST tax, increased from $12.06 million to $12.92 million per individual (or a combined $25.84 million for a married couple). The gift tax annual exclusion amount, meaning the amount an individual can gift per recipient per calendar year without using gift tax exemption, has increased from $16,000 to $17,000 (or a combined $34,000 for a married couple that elects to split gifts) per person per year. These increases provide gifting opportunities for individuals, especially those who have previously used most or all of their exemption limit, to remove assets and future appreciation on those assets from their taxable estates. With the exemption amount set to be reduced by half (adjusted for inflation) on January 1, 2026, the window for planning for use of the increased exemption is quickly closing.

CHANGES TO RETIREMENT PLANNING

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, which became effective January 1, 2020, significantly changed traditional notions of retirement and estate planning. On December 29, 2022, President Biden signed SECURE 2.0, which changed and expanded aspects of the SECURE Act.

SECURE 2.0 raises the age at which retirement plan required minimum distributions (RMDs) must start from 72 to 73, beginning in 2023. By 2033, RMDs will not need to start until an individual is 75. Roth IRAs will continue to be exempt from the RMD requirements for retirement account owners during their lifetimes. SECURE 2.0 also decreases the penalty for failing to take an RMD by half, from 50 percent to 25 percent of the RMD not taken.

These changes allow individuals who have not previously been required to start taking RMDs to further postpone RMDs and further extend the period for accumulating tax-deferred growth.

CHANGES IN ECONOMIC CLIMATE

Interest Rates Continue to Rise

Interest rates are projected to continue to rise in 2023. Fortunately, several estate planning techniques are especially successful in a higher-interest-rate environment, such as qualified personal residence trusts (QPRTs) and charitable remainder trusts (CRTs). Alternatively, other techniques are especially successful in lower-interest-rate environments, including related party loans, sales to grantor trusts (“defective trusts”), charitable lead trusts and grantor retained annuity trusts.

It is our hope that interest rates will normalize and return to the low levels of the past decade. In the meantime, you may want to consider locking in your lower-interest-rate planning strategies before interest rates rise too high, and then shift your planning to higher-interest-rate strategies, such as the use of QPRTs and CRTs.

QPRT. A QPRT is an irrevocable trust used to transfer a personal residence to trust beneficiaries. The QPRT lasts for a term of years, during which the grantor may continue to use the residence as his or her own. After the initial QPRT term, the residence passes to remainder beneficiaries- oftentimes children or trusts for the benefit of children. If the grantor wants to continue to live in the home, the trust or its beneficiaries can rent it to the grantor at a fair-market-value rent. The initial transfer to the QPRT is a taxable gift of the value of the remainder interest, calculated using the §7520 rate. The higher the rate, the higher the value of the grantor’s right to use the residence as his or her own during the term of years, and the lower the value of the gift of the future remainder interest.

Upon the expiration of the term interest, you can continue to live in the residence by paying rent at fair market value to the remainder beneficiaries. This provides an additional way to transfer wealth since it’s not considered a gift. Additionally, the QPRT is generally structured, so the tax liabilities flow back to you as the grantor. So, in the IRS’ eyes, you’re essentially paying rent to yourself and the rental payments are therefore income tax-free.

The initial transfer to the QPRT is a taxable gift of the value of the remainder interest that’s calculated using IRS published minimum rate (Sec. 7520 rate). The higher the interest rate, the higher the value of your right to use the residence as your own during the term interest, and the lower the value of the gift of the future remainder interest. Therefore, as interest rates increase, the taxable gift decreases, which makes a QPRT an effective wealth transfer strategy with higher interest rates.

CRT. This is the reverse of a CLT; the grantor receives an annual payment from the CRT for a term of years, and charity receives whatever remains at the end of the term. Here, the value of the remainder, calculated using the §7520 rate at the time the grantor creates the trust, gives the grantor an income tax charitable deduction. However, in order to pass IRS review, the value of the remainder must reach a minimum threshold; the higher the §7520 rate, the higher the value of the charitable interest and the more likely that the CRT will pass IRS review. CRTs must also make a minimum annual payment to the grantor; younger grantors who want to create certain CRTs sometimes can have a hard time meeting this minimum payment if rates are too low.

There are two types of CRTs to consider: the charitable remainder annuity trust (CRAT) and the charitable remainder unitrust (CRUT).

The CRAT pays a fixed income stream to you that’s based on a chosen percentage of the initial fair market value of the assets gifted to the CRAT. The annual payment doesn’t change during the term of the CRAT.

The CRUT pays an income stream to you that’s a fixed percentage based on the balance of the trust assets, which are revalued annually. So, the annual payment will change each year throughout the term of the trust.

Upon creation of the CRT, as stated above, you claim an income tax deduction for the charitable portion of the transfer. The charity must receive at least 10% of the initial contribution upon the expiration of the trust. It’s worth noting that CRTs created for younger beneficiaries didn’t pass the 10% test until recently because interest rates were so low. However, when interest rates are higher, there’s a higher charitable deduction upon creation of the CRT. In this case, it’s assumed the assets in the CRT will grow quickly, meaning there will be a larger amount left for the charity when the annuity payment ends.

Decreased Asset Valuations

Current depressed valuations also present a unique tax planning opportunity for individuals. By transferring assets out of an individual’s estate at a lower value, an individual can take advantage of both the lower valuation and the current basic exemption amount before it is reduced in the future. Making such gifts or transfers will not only reduce the size of an individual’s current estate, but will also remove any future appreciation (for example, when markets improve) from the individual’s estate.

CONSIDER YOUR POTENTIAL FILING REQUIREMENTS

We also wish to remind you that if you made gifts in excess of $16,000 during the 2022 calendar year to any individual, it may be necessary or advisable for you to file a Form 709, U.S. Gift (and Generation Skipping Transfer) Tax Return, with the IRS on or before April 18, 2023. In addition to traditional gifts of cash or property, you may be required to report other transactions, even if below the $16,000 threshold, such as forgiveness of loans, additions to life insurance trusts, premium payments paid on policies of insurance held in a life insurance trust, transfers of life insurance policies to such a trust, or other transactions that shift wealth to another person. Form 709 should be filed with your tax return for any year in which you make a taxable gift, but filing this form doesn’t necessarily mean that you’ll owe gift or generation-skipping transfer tax.

KEY TAKEAWAYS

• Form 709 reports taxable gifts and generation-skipping tax lifetime exemption allocations.
• Certain types of financial gifts may qualify as exclusions for the gift tax.
• Generation-skipping tax ensures that the proper amount of estate tax is paid when a generation-skipping trust transfers assets among family members.
• Form 709 must be filed each year you make a taxable gift and included with your regular tax return.

Gifts for tuition or medical expenses must be paid directly to the biller to avoid incurring the gift tax. If you want to help out a grandchild with college expenses, for example, you’d need to make tuition payments directly to the school. If instead, you were to give your grandchild the money to pay their tuition, it would fall under the taxable gift heading. The same is true if you’re paying medical expenses. You’d need to pay the healthcare provider directly to avoid gift tax implications.