Written by The ILS Legal Team
None of us can predict what will happen in D.C.,
but estate planners can take steps now
to prepare clients for changes coming in the near future.
As we write this commentary, Congress and the White House are negotiating over proposed legislation which, if enacted in its current form, would significantly change tax laws that impact estate planning. Last week, InterActive Legal sponsored a 90-minute webinar on this topic (which we invite you to watch for more detail), and below we summarize what we see as the most important potential changes that could affect your clients.
The latest proposals, incorporated into the budget reconciliation bill commonly known as the "Build Back Better Act," come on the heels of earlier proposals from Senators Sanders and Van Hollen. Each of these proposals includes slightly different tax law changes which, if enacted, would have a significant impact on estate planning. Although some of the proposals in the Van Hollen draft would apply retroactively, most of the relevant proposals in the reconciliation bill would be effective as of the date of enactment or as of January 1, 2022. Understandably, estate planners are anxious about advising their clients to take action now in order to preserve certain advantages that could be curtailed by any new legislation. However, given the potential magnitude of the proposed changes and the uncertainty as to which, if any of them, will pass, it can be a challenge to know exactly what we should advise our clients to do.
The bottom line is that we don’t know what the final legislation will look like, or when specific new rules will be effective. All we can do is consider what has been proposed and how to advise clients in the event those proposals do become law. The best advice for estate planning professionals and their clients at the moment is to be prepared – have documents ready to sign (perhaps more than one version, each designed to address a different legislative result) and have assets ready to transfer because time is – and will continue to be – of the essence.
Below are our brief thoughts on the hot-button issues.
For more detail, view the full webinar here.
Estate and Gift Tax Exemption Reduction – Using the Excess Exemption Before it's Lost.
The unified estate and gift tax exemption is currently $11.7 million and is already scheduled to drop in 2026 to around $6 million. Pending legislation would accelerate this reduction, likely effective on January 1, 2022. Most commentators feel this is the most likely change that will impact estate planning, and that it won’t be retroactive (but there are no guarantees). What we do know is that taking full advantage of the higher exemption before it’s gone requires using the full amount – the full $11.7 million – rather than making a smaller gift of say $6 million. This is because a taxpayer’s use of the exemption is cumulative, so using the increased exemption before it is lost requires exhausting the amount of the potentially reduced exemption and making gifts in excess of that amount.
Making Gifts in Trust – Contending with the Grantor Trust Proposals.
For clients who wish to fully use the current high exemption by making gifts, it is usually best to give property away in trust – perhaps to children, a spouse and children, or other beneficiaries – to take advantage of the benefits provided by trusts, including creditor protection, asset management, and the reduction in transfer tax for future generations. In addition, gifts in trust allow for the use of certain safety nets to address the possibility of retroactive changes, as well as the concerns of clients who may be nervous about completely losing the benefit of transferred property. Authorizing a qualified disclaimer of a gift in trust by the trustee or a particular beneficiary may provide a mechanism for unwinding a gift in the event that retroactive changes make the gift undesirable. InterActive Legal subscribers will find the option to add such a disclaimer provision in various irrevocable trust templates within the program. In addition, a trust for the benefit of a spouse or other close family member (commonly referred to as a "SLAT"), or a trust in which a third party holds a broad special power of appointment may provide a level of comfort for a grantor who is concerned about needing access to the gifted property down the road (InterActive Legal subscribers will find SLAT profiles and a Special Power of Appointment Trust in the Wealth Transfer Planning drafting system).
One wrinkle the proposed legislation has thrown into trust planning is the potential for changes to the treatment of grantor trusts. These proposed changes in grantor trust treatment seem to be causing the most concern among estate planners, because they represent a radical shift. Not only would grantor trusts automatically be included in the grantor’s estate at death, any action to terminate grantor trust status before death would trigger an immediate taxable gift, as would distributions from a grantor trust to beneficiaries. As proposed, trusts in existence before the effective date – likely when signed by the President – will be “grandfathered” and not subject to the new rules. This means that grantor trusts already in existence should not be included in the grantor’s estate, as long as no new contributions are made to the trust after the effective date. It also means that drafting non-grantor trusts will become much more common.
If you are drafting a trust to use the increased exemption, it can be difficult to know whether to create an intentionally "defective" grantor trust, or whether it is a better strategy to draft a non-grantor trust. Consider ways to allow for flexibility, such as drafting the trust as a grantor trust and including a mechanism that can fully eliminate grantor trust status before the effective date of the law. Another option might be to draft a non-grantor trust with a mechanism to turn on grantor trust status if this portion of the proposed law is not enacted. It also might be prudent to have two trusts ready to sign – one grantor and one non-grantor – so that you can decide after it becomes clear what changes in the law will take effect (i.e., once passed by Congress but before signed by the President), and take quick action before the law becomes effective. InterActive Legal subscribers have options for creating non-grantor trusts of which the spouse is a beneficiary; please reach out to our Content Team for additional guidance if you are interested in these options.
The Impact of Grantor Trust Changes on ILITs.
The grantor trust changes will impact irrevocable life insurance trusts – or “ILITs” – which typically receive contributions annually to pay policy premiums. Those annual contributions will trigger the grantor trust inclusion even in an existing grandfathered ILIT, so pre-funding ILITs with enough funds to pay future premiums is recommended, to the extent the client can afford it. Split dollar life insurance arrangements may also be a viable option for certain clients.
Don't Ignore Other Proposed Changes.
Although much of the focus in the estate planning world has been on the possible changes noted above, the proposals under consideration include a wide array of provisions that could impact estate planning clients in a number of other ways. For example, the Net Investment Income Tax (NIIT) would be expanded in a way that could seriously impact S Corporation shareholders who currently are not subject to FICA tax. Proposed valuation limits could curtail often-used planning techniques involving the transfer of family-owned entities taking into account valuation discounts. In addition, the proposed grantor trust changes could have other sweeping effects. For example, they would have a chilling effect on GRATs and sales to grantor trusts because satisfying annuity or note payments owed back to the grantor in kind would trigger taxable gain. Additionally, the end of a GRAT term would appear to trigger a taxable gift to the remaindermen under the grantor trust proposals discussed above. Without clarifying language in the statute (or forthcoming regulations), this would impact existing GRATs as well, which seems at odds with the other grandfathering available for grantor trusts created prior to the effective date.
The Takeaway – Be Prepared but Don't Panic.
With the crystal ball cloudy on what provisions will be enacted and when, it’s wise to keep track of the legislative process and keep clients informed and ready to pull the trigger on trust planning in progress. There likely will not be more than a day or two between the time the news breaks that legislation has been passed and the time the President signs it, so the time to prepare is now.
Times of change require attentiveness and diligence, but don't despair – none of us have, or can be expected to have, all the answers in the face of legislative uncertainty. The best thing estate planners can do is to be prepared, and to open a frank dialogue with clients about the potential changes and the possible benefits and risks involved in planning before those changes take effect. With the right drafting tools and good communication, you can help your clients navigate an uncertain and unnerving situation with calm and ease, by planning ahead and being ready to act when the time is right.
Mr. Blattmachr is a Principal in ILS Management, LLC and a retired member of Milbank Tweed Hadley & McCloy LLP in New York, NY and of the Alaska, California and New York Bars. He is recognized as one of the most creative trusts and estates lawyers in the country and is listed in The Best Lawyers in America. He has written and lectured extensively on estate and trust taxation and charitable giving.
Mr. Blattmachr graduated from Columbia University School of Law cum laude, where he was recognized as a Harlan Fiske Stone Scholar, and received his A.B. degree from Bucknell University, majoring in mathematics. He has served as a lecturer-in-law of the Columbia University School of Law and is an Adjunct Professor of Law at New York University Law School in its Masters in Tax Program (LLM). He is a former chairperson of the Trusts & Estates Law Section of the New York State Bar Association and of several committees of the American Bar Association. Mr. Blattmachr is a Fellow and a former Regent of the American College of Trust and Estate Counsel and past chair of its Estate and Gift Tax Committee. He is author or co-author of eight books and more than 500 articles on estate planning and tax topics.
Among professional activities, which are too numerous to list, Mr. Blattmachr has served as an Advisor on The American Law Institute, Restatement of the Law, Trusts 3rd; and as a Fellow of The New York Bar Foundation and a member of the American Bar Foundation.
Michael L. Graham is Chairman of InterActive Legal and practices law with the Houser Firm in Dallas, Texas.
Mike has been continuously Board Certified in Estate Planning and Probate by the Texas Board of Legal Specialization for 40 years. He became a full partner at age 30 in one of the largest, most respected law firms in the US, Baker & Botts, and became a Fellow of the American College of Trust and Estate Counsel at age 34. MIke has served as Chair of the Texas Bar Association’s Real Property, Probate and Trust Law Section, the Houston Bar Association’s Probate Section, and the Dallas Bar Association’s Probate Section. Other professional contributions include Supervisory Council Member of the American Bar Association’s Real Property, Probate and Trust Law Section and President of the Texas Academy of Probate and Trust Lawyers.
In his practice at the Houser Law Firm, Mike limits his current focus to matters involving business and estate planning, administration of estates and trusts, and fiduciary based litigation. He has practiced at both large, international firms and small boutique firms over the last 44 years. He received his J.D., cum laude, from Baylor School of Law (1972), and his BBA from Baylor University (1971).
Elizabeth (“Beth”) Boehmcke graduated cum laude from the University of Michigan Law School in 1993. After graduation from law school through 2003, she specialized in high net worth estate planning, with an emphasis on cross-border and asset protection planning, and the representation of fiduciaries managing complex trusts and family businesses.
During her career in New York, she was an associate attorney at both Rogers & Wells (now Clifford Chance) and Hodgson Russ in New York City. After a hiatus in her legal career to care for her children, she resumed her legal career by passing the Virginia bar in 2014 and began working for the Hook Law Center, P.C., where she expanded her estate planning practice to include elder law, specifically focusing on asset protection planning for Medicaid and Veteran’s benefits.
She is a proud graduate of the University of Virginia where she received a B.A. with distinction in Psychology in 1988 and is also a graduate of SUNY-Buffalo where she received an M.A. in Clinical Psychology in 1990.
Teresa Bush joined InterActive Legal in 2007 and serves as Director of Education and Support Services.
Ms. Bush has been licensed to practice law since 1991, and focused her practice exclusively on issues of estate and gift tax planning, probate, charitable planning, and estate and trust administration. She began her practice in a small law firm, planning for clients of all levels of wealth. Thereafter, she practiced for a number of years in the Tax Section of Kelly, Hart and Hallman, P.C. in Fort Worth, Texas, and as an estate and gift tax consultant for the Dallas office of Ernst & Young, in both cases focusing on planning for very high net worth clients.
Ms. Bush received her J.D. from the University of Texas School of Law, where she was a research assistant for Professor Stanley M. Johanson. She studied at Edinburgh University and the London School of Economics prior to obtaining a B.A. in Economics and Political Science from Rice University in Houston. While studying abroad, she worked as an intern for a Member of Parliament in the British House of Commons.
Ms. Bush taught legal research and writing as a Teaching Quizmaster in law school, and later taught estate planning extension courses for American College of Financial Services CLU candidates. She has presented several online webinars on estate planning and drafting topics, and is the author or co-author of a variety of estate planning articles.
Vanessa Kanaga serves as CEO of InterActive Legal. Vanessa received her J.D. from Cornell Law School and holds a B.A. in Philosophy from Wichita State University, as well as an Advanced Professional Certificate from New York University School of Law. She is licensed in New York and Kansas, and currently lives in Arizona. Prior to joining InterActive Legal in 2013, Vanessa practiced in New York, at Milbank LLP and Moses & Singer LLP, and in Kansas, at Hinkle Law Firm, LLC. She has experience in a range of estate planning matters, including high net worth tax planning and asset protection planning.
In her role as CEO, Vanessa oversees strategic planning and development of InterActive Legal services and solutions, working with her valued colleagues to continuously provide reliable content and forward-thinking strategies to the estate planning and elder law attorneys who subscribe to InterActive Legal products. Vanessa also serves as the Moderator for the InterActive Legal Roundtable webinar series, fostering collegial discussion among a group of expert panelists on trending topics in estate planning.