Business Roundup
In this article, Gift and Estate Exemption Clock Ticking for 2 Million Families, Randy A. Fox notes that “many of the estate planners, appraisers, and other professionals” needed by such families “are swamped, retired, or simply not knowledgeable enough to help you” (emphasis added).
This last point is why this newsletter exists – to help you be knowledgeable enough because I think that judgment sells you short. But, optics count, and sometimes it is hard to avoid being painted with this broad brush if you are not part of a huge firm or if you are not an ACTEC fellow. Nonetheless, this article just happened to shoehorn well with the materials I published this week (summarized below) on planning for the sunset of the basic exclusion amount. And, while there are several good points in this article, there are some issues worth adding.
The need for lifetime cashflow funding is highlighted – with the author noting they “had many clients with large stacks of unsigned, unfunded trusts.” Looking forward at future cashflow needs after making irrevocable transfers is paramount, and there is a non-zero chance that the sunset actually happens. But, looking forward is not the only thing that affects clients. They must also look backwards, and this can at least be a partial cause for a client’s hesitancy to make irrevocable wealth transfers.
When we look backwards, we find that this is not the first time in history a sunset has been threatened. In fact, back in 2012, the basic exclusion amount was scheduled to be reduced from $5,000,000 to $1,000,000. The outcome was two-fold. One, lots of people did indeed wait until November and early December of 2012 to make gifts to trusts. Two, when the $5,000,000 base for the basic exclusion amount was made permanent in mid-December of 2012, lots of people regretted those gifts. Many of the families who seem “hesitant” may remember what happened in 2012.
And before a client or family can look forward and backward, they must know where they are right now. Those “large stacks” of trusts – funded or unfunded – have a broader effect on the entire wealth transfer plan. It is one thing to review the basic estate plan that will take effect at death, but it is another matter entirely to also review the many lifetime trusts and entities created by a family - especially the multiplication factor of trusts that will be split into separate shares per stirpes or per capita after the current generation passes. A holistic, side-by-side comparison of these trusts is something that few, if any, advisors, attorneys, or even wealth strategists are implementing based on what I have seen in the marketplace. (And whether you are or are not, this is not intended as a judgment or lack of recognition – this is simply my observation of a gap in the marketplace.)
I will have more to come on that issue, but it is an issue that will surely be magnified by the “wealth wave.” When each member of the next generation stands to have several different shares of various trusts – all with different terms, perpetuities savings periods, accountings, tax returns, distribution priorities, and even trustees – it can seem difficult if not impossible to keep track. This is exacerbated even more when you layer in closely-held business interests. If you are an advisor looking to add value in the future, this is low-hanging fruit.
Article Summaries
Planning for the Sunset of the Basic Exclusion Amount
This video presentation, slides, and transcript represent my attempt to bring some semblance of sanity to an otherwise myopic focus on transfers of sufficient wealth to use the pre-sunset basic exclusion amount “before you lose it.”
The problem is that using it before you lose it has some odd math using the anti-clawback regulations finalized in 2020 under Treas. Reg. 20.2010-1(c), and a limited universe of options using the proposed anti-anti-clawback regulations published here. Long story short, we run into two problems if we focus solely on the sunset.
One, using the “greater of” formula under Treas. Reg. 20.2010-1(c) means that to completely avoid losing your pre-sunset basic exclusion amount before 2026, you have to gift away the entire basic exclusion amount - including the inflation adjustment for 2025 - plus any deceased spousal unused exclusion amount you might have.
Two, the level of wealth needed to make irrevocable transfers of these amounts can increase the risk of gross estate inclusion under IRC Sections 2035-2038, thus nullifying the use of pre-sunset basic exclusion under the “greater of” formula if the proposed regulations linked above are indeed finalized in their current form.
So, the use of such a significant chunk of basic exclusion has to be balanced against traditional gifting principles such as value freezing, focusing on gifts of appreciating discountable assets, preserving sufficient cash flow for a donor’s anticipated needs (including income tax liabilities payable by the donor for grantor trusts), and considering the income tax trade-off of a carryover basis versus a step-up in basis.
Likewise, lifetime transfers have to be weighed against the general estate plan structure that will be implemented at death. Allocations of GST exemption pre- and post-sunset cannot be ignored. In addition, use of structures such as QTIP trusts may not be ideal for assets you wish to preserve until the death of the surviving spouse – and high lifetime gifts may “skew” funding towards QTIP trusts under both traditional and modern estate tax funding formulas.
While there is a large alphabet soup of transfer techniques, I focus on two techniques that seem to most move the needle when it comes to pre-sunset use of basic exclusion amount. Gifts to SLATs remove some of the risk of losing the economic benefit of large lifetime gifts, but the trade-off is a risk of loss of indirect access in the event of a divorce or the death of the beneficiary spouse. Sales to intentionally defective grantor trusts (IDGTs) preserve some flexibility to later use basic exclusion amount by forgiving a note payable from the trust to the grantor, but with the trade-offs of increased transaction risk, valuation risk, and a pesky interest rate (now higher than it was a few years ago) that eats into your ability to freeze estate tax values.
Also, whether a gift or sale is used, formula gift clauses and price adjustment clauses respectively can reduce some gift tax audit risk if the appraised value of transferred assets has not yet been finalized at the time of the transfer. This could somewhat mitigate the supply/demand problem described above for valuation experts. But, as with anything else, there are trade-off risks – especially given the history of IRS challenges to formula gift clauses. (While I did not raise this point in the course, combining the two could be an effective hedge such that transfers in excess of the available exclusion are treated as a sale.)
Some other techniques may also fly under the radar. Gifting of joint tenancy interests to non-spouses can preserve access to one-half of the assets, with a higher gross estate inclusion attributable to disproportionate contributions at death under IRC 2040. This gross estate inclusion is not subject to the proposed regulations above, but is tempered by the trade-offs and risks of direct joint ownership of transferred assets. Also, lifetime use of deceased spousal unused exclusion (DSUE) must occur before basic exclusion amount can be applied to lifetime gifts, but it is possible to use DSUE to fund completed gift trusts that will intentionally be included in the gross estate (such as a GRIT) without running afoul of the proposed regulations.
C and S Corporations for Estate Planners, Mini-Feature: PLR 202407005
This article summarizes a recent private letter ruling, allowing a late QSST and ESBT election for nine subtrusts created from a revocable trust after the death of the settlor. Without such relief, the S corporation election would have been inadvertently terminated by virtue of the trusts being ineligible S corporation shareholders under IRC Section 1361.
While the outcome seems simple and avoidable, the risks involved highlight the importance for executors and successor trustees of revocable trusts (or irrevocable grantor trusts for which grantor trust status terminates at the death of the grantor) to pay special attention to the presence or absence of an S corporation election for business entity interests. Given that LLCs and partnerships that qualify can make S corporation elections, it is easy for such an election to sneak under the radar.
This also has special importance in an M&A transaction, especially one taking place after the death or lifetime wealth transfers (as discussed above) of an individual equity owner. Transactional attorneys may not be as well-versed at navigating trust and estate ownership of S corporation stock. As practices become more specialized by practice area, I think there is a lot of room for trust and estate attorneys from outside firms to have a role in the diligence for a transaction involving trusts.
This PLR also highlights that the current income beneficiary of a QSST is responsible for the QSST election – a requirement that is often not communicated.