The Potential for Major Estate Tax Changes During the Biden Administration: What Can You Do?

Earlier this year we shared some initial thoughts regarding the potential estate tax changes that we may encounter with the new Congress and Biden administration (see The Potential for Major Estate Tax Changes During the Biden Administration: What You Need to Know). Since that time multiple Congressional proposals have been brought forth, including the For The 99.5 Percent Act and the STEP Act. These proposals, along with the President’s “American Jobs Plan,” if passed into law in their current form, would bring significant changes to federal estate tax, gift tax, and generation-skipping transfer tax law and to income tax basis and capital gains tax law as well. Some highlights of those proposed changes can be found here.

With that background in mind, now is a good time to take a closer look at a few estate planning tools that potentially could be leveraged as a means of utilizing an individual’s current maximum $11,700,000 unified federal estate and gift tax exemption ahead of any future reduction of that exemption.
 

The Spousal Lifetime Access Trust (“SLAT”)

A SLAT is an irrevocable trust set up by one spouse (the “donor spouse”) for the initial benefit of the other spouse (the “beneficiary spouse”). Typically, after the beneficiary spouse’s lifetime, the remaining trust assets would be divided into separate trusts for the benefit of the couple’s children or other descendants. When the donor spouse transfers assets to the SLAT, he or she ceases to be the owner of those assets and ceases to have any direct beneficial interest in them. The funding of the SLAT will be considered a taxable gift and will utilize a portion of the donor spouse’s lifetime federal estate/gift tax exemption. Assuming the gift is made to the SLAT during 2021, and there is no change in the applicable federal exemption for 2021, the transferor can utilize some or all of his or her remaining federal estate/gift tax exemption to provide an immediate and on-going benefit to his or her spouse and family.

An alternative to a full gratuitous transfer to the trust is for the donor spouse to make a small gratuitous transfer and then sell the remaining assets to the SLAT instead. This can be a particularly powerful option for funding a SLAT while interest rates are low. In simple terms, the assets are sold to the SLAT at their current fair market value takes back a promissory note in an equivalent principal amount with scheduled payments to be made over a number of years. The SLAT then uses the income from the transferred assets to make payments on the note, with the goal that the income would fully cover all of the payments, particularly if the asset continues to grow in value. This transfer method would, all things being equal, require less lifetime estate/gift tax exemption to initiate and thus can be particularly attractive for an individual that has previously used a portion of his or her exemption amount.
 

Creating an Irrevocable Dynasty Trust

State laws in multiple states, including Ohio and Delaware, currently allow for trusts to be created with an unlimited duration. Such trusts are often referred to as “dynasty trusts.” The state laws in other states, such as Indiana and Illinois, do not allow for the creation of dynasty trusts. Luckily even residents of Indiana and Illinois can avail themselves of the dynasty trust advantages of other states by establishing trusts in those jurisdictions. Transferring assets to the trust would, of course, typically use a portion of the donor’s federal estate tax exemption. While assets remain in the dynasty trust those assets should remain outside of the taxable estates of future generations of the family (assuming certain powers are excluded from the trust document). This allows for added planning opportunities as those future generations can potentially use their own federal estate tax exemption on other assets. What’s more, these irrevocable dynasty trusts are often set up as SLATs to create added flexibility for the family. Our attorneys in Columbus, Ohio are adept at establishing these trusts in that jurisdiction, and we work closely with a number of different trusted advisors in Delaware when implementing dynasty trusts in that jurisdiction, as appropriate.
 

Gift of Interests in the Family Business

For many owners of closely held businesses that single business entity makes up a majority of the value in their taxable estates, and such owners are often hesitant to transfer those ownership interests in the business as part of a planned gift. To be sure, business succession planning is not an easy task. However, many business owners are willing to make a gift of economic interests in a company so long as they retain control of the decision making for the company. For businesses that have only a single class of ownership interests a recapitalization of those interests into “voting” and “non-voting” units or shares will allow an owner to gift the non-voting units while retaining the voting units and thus potential control of the company. In fact, those non-voting units can be transferred to a SLAT or a Delaware Trust in order to utilize those tools at the same time. Further, if the non-voting units that are transferred meet certain criteria, the value of the gift could be discounted due to lack of marketability or lack of control. Such discounts would be established through a valuation report prepared by a qualified business appraiser and are subject to review through the federal gift tax return process. That said, a valid discount can allow the donor to transfer a greater amount of assets by using less of the donor’s federal gift tax exemption than had no discount been applied.
 

Closing Thoughts

Although we do not yet know what any of the final changes to these tax laws might look like or when they might become effective, now is an appropriate time to have conversations with your trusted advisors and to develop strategies for making potential gifts. While not every estate plan will warrant a SLAT or dynasty trust, and not every potential donor will be interested in parting with assets in 2021, running through the analysis of what potential estate planning tools might be utilized and what assets might be transferred is a helpful exercise for many individuals to partake in. As ever, our attorneys in the Ice Miller Trusts, Estates, & Private Wealth group are ready to be a part of that process with you.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.