The current estate tax exemption is $11.7 million. This is a record. The “permanent” exclusion is $5 million and is adjusted for inflation from the base year 2011. Then the Tax Cuts and Jobs Act doubled that temporarily. At the end of 2025, the doubling disappears. So, in 2026, the exemption will return to only $5 million, and adjusted for inflation it is expected to be around $6 million at that time. Transfers in excess of the exemption are currently subject to tax at the 40% rate. However, those who use their exemption before it falls will not be punished. So, if they used the larger exemption before it fell, they wouldn’t lose it.
There is legislation pending in Congress that would lower the exemption faster and even less than what the current law provides. The “99.5% Act” introduced in the Senate by Senators Bernie Sanders (I-VT) and Sheldon Whitehouse (D-RI) would reduce the exemption effective January 1, 2022. For transfers upon death, it will decrease The exemption is $3.5 million and will not be adjusted for inflation. Only $1 million of the waiver can be used during life. Under the legislation, transfers in excess of the exemption will be taxed at rates starting from 45% and going up to 65%, for those with more than $1 billion.
However, customers can use the exemption this year and avoid reducing the exemption. For example, let’s say a customer has $15 million. They can donate $11.7 million this year and keep $3.3 million. Upon the client’s death, they only owed tax on the $3.3 million in their estate. If clients are married, they can take advantage of the Spouse and Family Exclusion Fund (SAFE), (sometimes called the Spouse For Life Access Fund (SLAT)). Such a trust is established by one spouse for the benefit of the other spouse and their children. If there are enough differences in the trusts, then each spouse can establish such a trust for the other spouse. By doing this, spouses can take advantage of their exemptions but still have access to the assets.
For example, Bill and Mary had $30 million, $15 million each, and they wanted to take advantage of the existing exemption. Bill donated $11.7 million in a fund to benefit Mary and his children. Similarly, Mary was given $11.7 million in a trust fund for Bell and her children. Each spouse now has only $3.3 million in their holdings.
If the trusts are designed to avoid the “mutual trust doctrine,” then no trust is included in any of their estates upon death. Therefore, the terms of trust should differ somewhat. While trusts avoid inclusion and property taxes, this is a double-edged sword. While gifting to a non-cancellable trust such as the SAFE credit avoids estate taxes, only inclusion in the taxable property provides an escalation in the basis upon death. Thus, you can have your cake, but you can’t eat it either.
Under current law, property taxes start at 40%, while long-term capital gains rates generally go as high as 23.8% for federal purposes. Thus, if the granted assets are to be subject to federal estate taxes, the taxpayer is usually better off removing them from the estate, even if that means losing the basis for the increase.
Also, if Bill establishes a trust for Mary, in the example above, there is a risk that Mary may not create a trust for Bill because the trusts were not set up concurrently due to the mutual trust doctrine. Of course, every situation is different, and you want to explain the trade-offs to your clients.
Whether clients choose to use the secure trust or another method, using the existing exemption can make a lot of sense.
Stephen C. Hartnett, JD, LLM
American Academy of Estate Planning Lawyers, Inc.
9444 Balboa Street, Suite 300
San Diego, CA 92123
Phone: (858) 453-2128