In Part 1 of this newsletter series on “The Perfect Storm for Advanced Estate Planning,” we discussed how right now may be the perfect time to undertake advanced estate planning transactions. Why? The reasons include historically low interest rates, relatively low and volatile asset valuations, and an expectation of higher taxation on the horizon. In Part 2, we will be discussing the reasons for undertaking this type of planning, who should be doing this type of planning and to what extent. In our next newsletter, which will be Part 3 on this topic, we will cover the most important advanced estate planning strategies to consider at this time.

I. What are the reasons for undertaking this type of advanced planning?

The primary reason for undertaking this type of planning is the ability to significantly reduce potential wealth transfer taxes, including gift, estate and Generation Skipping Transfer (GST) taxes. Other reasons may include: (i) providing potentially significant asset protection; (ii) locking in the present and future control of assets prior to your passing; and (iii) the possibility of accessing the lower marginal income tax rates of other family members. For purposes of this discussion, we will be focusing on the reduction of wealth transfer taxes.

II. What level of wealth should you have before undertaking this type of advanced planning?

This question is likely the most important, but it does not always have a clear answer.

First, determine the value of your taxable estate for estate tax purposes, which is generally your net worth (assets less debts) plus the face amount of your life insurance policies. You will want to consider both the current value of your taxable estate and the extent you reasonably believe it may grow or decrease over time.

Second, determine your Basic Exclusion Amount (BEA) for yourself, and if married, for both you and your spouse. The BEA is the amount of taxable gift and estate transfers you can have before you pay any gift or estate tax. The BEA was increased to $5 million (indexed for inflation) under the 2012 Tax Act. The BEA was then increased to $10 million (indexed for inflation) under the 2017 Tax Act. However, the 2017 Tax Act increase is scheduled to terminate at the end of 2025, leading to an automatic reversion back to the $5 million figure plus inflation as of January 1, 2026.

So how much BEA do you get? You consider the BEA amount you have available when you undertake taxable transfers, which means the BEA available in the year(s) of any taxable gifts and then you look to the remaining BEA in the year of your death. The BEA for 2020 is $11.58 million. While each spouse gets their own BEA amount, special planning was normally needed before 2013 for the surviving spouse to get access to the first spouse unused remaining BEA amount. However, as of 2013, we have a permanent portability law, which enables the surviving spouse to get access to the first spouse’s unused BEA amount by filing a timely IRS Form 706, Estate Tax Return, after the first spouse’s death. The surviving spouse’s combination of their own BEA and the first spouse’s ported unused remaining BEA is now referred to as the Applicable Exclusion Amount (AEA).

So, for planning purposes, you should consider the following:

A. You have the power to use your available BEA/AEA during your life by making taxable gifts, if desired.

Initially, some concern existed that recapture or claw back of previously used BEA/AEA could happen in the future if you used more BEA/AEA than ended up existing in the year of your death. However, the IRS has since provided us with taxpayer friendly guidance that eliminates this risk.

B. Because you cannot know the exact AEA/BEA amount available at your death, you need can consider the probabilities for planning purposes. It should be noted that the amount of BEA ported over to the surviving spouse (with the timely filing of an IRS Form 706) after the first spouse’s death is locked in as a frozen amount even if the BEA later changes.

C. The most likely BEA predictions:

a. Current law. The BEA is currently $10 million indexed for inflation until it reverts back to $5 million indexed for inflation on January 1, 2026. As discussed above, the BEA for 2020 is $11.58 million. The $5 million amount as indexed on January 1, 2026 is projected to be about $6.5 million. For married couples, the combined BEA/AEA is $23.16 million in 2020 and is projected to be about $13 million in 2026.

b. No political party ends up controlling both houses of Congress and the presidency. In this situation, current law is not likely to be changed. However, it may end up getting modified as part of some larger negotiated budget and tax law bargain. In this case, the most likely outcome is a continuation of the current BEA amount of $10 million indexed for inflation for some time into the future or possibly to be made permanent.

c. Republicans end up controlling both houses of Congress and the presidency. In this situation, the most likely outcome is that the current BEA of $10 indexed for inflation will become permanent. It is possible, but unlikely, that the BEA amount is increased or the estate and gift tax system is eliminated along with changes to the income tax system.

d. Democrats end up controlling both houses of Congress and the presidency. In this situation, the most likely outcomes include: (i) letting current law continue with the BEA reverting to $5 million indexed for inflation on January 1, 2026; (ii) reducing the BEA to $5 million indexed for inflation before January 1, 2026; or (iii) reducing the BEA to a lower figure, likely the 2009 figure of $3.5 million (with or without being indexed for inflation). While possible, it is not likely that the BEA will be reduced to below $3.5 million. Remember, these rules affect the president and those in Congress as well. Other non-BEA changes could include eliminating the so-called, step-up in income tax basis at death.

e. Portability. For married couples, it is safe to assume that portability will be continued no matter the political party that may end up controlling Congress and the presidency.

D. In summary, what level of wealth should you (or you and your spouse) have before undertaking this type of advanced planning?

a. Ultra-wealthy individuals/couples. If you (or you and your spouse) have a level of wealth well beyond the current BEA/AEA amounts ($11.58 million/$23.16 million), then this type of advanced planning should clearly be considered and acted upon.

b. Wealthy individuals/couples. If you (or you and your spouse) have a level of wealth that is expected to be well beyond the projected 2026 BEA/AEA figures under current law (approx. $6.5 million/$13 million), then this type of advanced planning should clearly be considered and possibly acted upon, depending on your situation.

c. Mass affluent individuals/couples. If you (or you and your spouse) have a level of wealth that is expected to be over the 2009 equivalent BEA figures of $3.5 million/$7 million, then this type of planning should be considered and possibly acted upon, depending on both your circumstances and your beliefs about coming congressional and presidential elections.

d. The majority of our society below the wealth of the mass affluent. This group of individuals/couples are fairly safe not worrying about this type of advanced planning. However, if the Democrats end up getting a majority in both houses of Congress and win the presidency, you should keep an eye out for the possibility that radical changes may be made to reduce the BEA/AEA figures below those effectively in place in 2009.

III. To what extent should you take advantage of this advanced planning opportunity?

If you decide that advanced planning could be advantageous in your situation, the next most important question is how far should you go without affecting your financial security? You need to be comfortable that no matter how much your family will benefit, you need to feel financially secure after this planning is completed. It is our belief that most of our clients will overcome any concerns in this regard after being educated about (i) not gifting assets that you are relying upon for your on-going support and (ii) the availability of various release valves to retain practical access and control over any transferred assets.

In our next newsletter, we will cover the most important advanced estate planning strategies to consider at this time. We also plan to have a webinar on this topic in July 2020. In the meantime, if you would like to consider taking advantage of this incredible window of opportunity, please call us at (678) 720-0750 or e-mail us at info@morgandisalvo.com to schedule an estate planning consultation. We can discuss your situation, answer your questions, and determine what might be the best fit for you. We look forward to meeting with you.