Saturday marked 60 years ago that Ray Charles’ cover of the Hoagy Carmichael song Georgia on My Mind hit No. 1 on the Billboard charts. Now, the entire nation has Georgia on its mind because balance of power in the Senate depends on runoff elections for Georgia’s two Senate seats on January 5, 2021. With Joe Biden becoming the next President of the United States and Democrats maintaining a majority in the House of Representatives, what might the Georgia runoffs mean for future tax reform?
If Republicans hold the Senate, quick or sweeping tax reform is unlikely in the near term because major tax reform has been enacted only when one political party controls the presidency and Congress. This means that the federal exemption for estate, gift, and generation-skipping transfer (GST) taxes of $11.7 Million per person in 2021 likely will not come down any time soon. Current law provides that this heightened exemption will revert to $5 Million (as upwardly adjusted for inflation) on January 1, 2026, but this scheduled reduction could happen sooner depending on the results of the 2022 mid-term elections.
On the other hand, if Democrats control the presidency, House, and Senate, we may see major changes to the estate and gift tax rules – as soon as early 2021 – that could reverse parts of the Tax Cuts and Jobs Act of 2017 and significantly limit opportunities for estate and tax planning. As proposed by President-elect Joe Biden, these may include: (1) reducing the federal estate and gift tax exemption from $11.7 Million to $5 Million or even $3.5 Million before the scheduled sunset on January 1, 2026; (2) increasing the estate tax rate, which is currently a 40 percent rate; and (3) eliminating the automatic adjustment of income tax basis of assets to the fair market value at death, which often erases any capital gain on appreciated assets owned by a decedent. Still, even if Democrats win both Georgia Senate seats, Democrat control of the Senate means only a 50-50 split, with Vice President-elect Kamala Harris holding the tie breaking vote. This could pose a roadblock to tax reform if even one Democrat Senator has less of an appetite to change certain tax law.
Based on these considerations, we encourage you to be proactive and review your estate and tax planning now instead of waiting for potential changes in the law based on the results of an unpredictable election. Regardless of the final election results, current factors, like depreciated asset values as a result of a global pandemic, record-low interest rates, and historically high estate and gift tax exemption amounts, provide unique opportunities to minimize your tax exposure. In a previous Client Alert, which can be found here, we discussed several tax-efficient strategies to take advantage of depressed asset values and low interest rates, including: intra-family loans; Grantor Retained Annuity Trusts; Intentionally Defective Grantor Trusts; and Charitable Lead Annuity Trusts. Additionally, taking advantage of the heightened exemption amounts now, particularly for single individuals with an anticipated gross estate in excess of $3.5 Million and married couples with a combined anticipated gross estate in excess of $7 Million, should also be considered. Some techniques to consider while the exemptions are higher include: Spousal Lifetime Access Trusts; Grantor Retained Annuity Trusts; sales to Intentionally Defective Grantor Trusts; Charitable Lead Annuity Trusts; and gifts to family members. More information about these and other techniques can be found here.
Even beyond the outcome of the 2020 election, several proposals have been discussed among lawmakers for years that, if enacted, would repeal or greatly curtail the effectiveness of popular estate planning tools that are possible under current tax law. Especially if the government is looking to raise additional tax revenue, any of the following could be implemented at any time in the future:
- Restricting Valuation Discounts. Valuation discounts are particularly useful when transferring closely held business interests. Lack of control or lack of marketability discounts lower the value of an interest transferred, thereby reducing tax consequences. Restricting valuation discounts would take this benefit away.
- Mandating 10-Year Terms for GRATs. A Grantor Retained Annuity Trust (GRAT) involves transferring assets to an irrevocable trust with the individual who created the trust retaining a stream of annuity payments from the GRAT for a set term of years (currently a minimum term is 2 years). At the end of the term, assets remaining in the GRAT are distributed to the trust beneficiaries. This is a great technique to consider currently as the effectiveness of using GRATs increases when interest rates are low. If GRATs are instead required to have a minimum term of 10 years, their utility would be significantly limited.
- Eliminating Gift Tax Advantage of Grantor Trusts. A grantor trust is a trust in which the trust creator retains certain powers over the trust so that he or she is liable for the income tax on the trust assets instead of the trust itself. By doing so, the creator effectively makes a tax-free gift to the trust beneficiaries because the trust income is not reduced by the payment of taxes. This leaves more assets to beneficiaries and less in your estate. Current proposals would eliminate this strategy by imposing gift tax consequences on a creator’s payment of trust income taxes.
- Eliminating GST Exemption for Certain Long-Term Trusts. Allocating GST exemption to a trust for the benefit of your descendants can be an effective wealth-preservation tool to move assets from one generation to the next while avoiding estate and GST taxes at each generation. However, current proposals would restrict this benefit for long-term trusts (i.e., a trust that will last 50 years or more).
Review your estate plan while you wait to hear the results of the Georgia runoffs. Until the results are announced, there are still plenty of tax-saving estate planning options to consider, so let’s start the conversation now. Please contact one of Michael Best’s Wealth Planning attorneys if you would like to discuss opportunities and implications in light of the 2020 election, especially if you are considering making lifetime gifts.