United States

Big Six tax plan calls for prudence in estate planning

Details are sketchy, but the general direction of the plan is not


The Big Six tax plan is out and, as expected, calls for repeal of both the estate and generation-skipping transfer (GST) tax. The Plan does not call for repeal of the gift tax. Unfortunately, the Plan is silent on whether there will still be step-up of basis at death or some variation of a carryover basis. While there is much left to be done and repeal of the estate, and GST taxes are by no means certain, it does make sense for any individuals who now have taxable estates to get a clear perspective on what might make sense for them to do (or not to do) before year end. 

Ever since last year at about this time, it’s been clear that the estate tax is in play. And it’s been standard advice to keep planning but avoid paying gift tax, which would be a down payment on a tax that might be repealed. It has also been clear that any individual who is now ready to make significant wealth transfers should not hesitate to so, but proceed in a way that won’t trigger gift tax.

Why should someone press ahead with wealth transfer planning when the estate tax is on the cusp of repeal? Consider the business owner who intends to pass her successful company onto her children. Planning for the estate tax has always been a concern to the family. In fact, right before the election last November, the owner was ready to move forward with plans to transfer some stock to her children to remove at least some of the appreciation in the company’s value from her estate. After the election and the thought that the estate tax could be repealed, she put the planning aside to see how things developed. But her advisors suggested that, if transition is truly a matter of when and not if and assuming that the gift tax is not repealed, then now would be a good time to act. After all, if the business just continues to grow, then the gift tax cost of a lifetime transfer will correspondingly increase over time. What’s more, if the estate tax, once repealed, is reinstated, a transition more closely proximate to her own transition could cause some significant tax and liquidity problems. Finally, her advisors tell her that this is a nearly perfect environment for making large gifts: Valuation discounts are still available, the proposed regulations under section 2704 are in “suspense” and the ‘hurdle rates’ for the most popular techniques are still close to historic lows.

Her advisors suggest that a wealth transfer technique that many “wealth transfer motivated, but gift tax averse” individuals find attractive is the grantor retained annuity trust (GRAT). While a full description of the GRAT is beyond the scope of this Alert, the appealing features of a GRAT in this environment are that it: (1) can be designed to generate little or no taxable gift, (2) flexibly responds to a successful IRS challenge to the valuation of the transferred asset by automatically increasing the retained annuity so that there is still no taxable gift and (3) has codified, well-established operative guidance under the tax law. True, the GRAT won’t work in every situation, but in this gift tax averse environment, it’s a great place to start the conversation.

Life insurance planning

The real possibility of estate tax repeal has significant implications for the use of life insurance for estate tax liquidity and individuals will hear a lot about this in the coming weeks. Here are three suggestions that can help individuals separate the advice from the noise:

1.    Individuals who are now considering the purchase of insurance for estate tax liquidity (and only for estate tax liquidity) should still consider setting up their irrevocable life insurance trust (ILIT) but, instead of having the ILIT purchase that heavily-funded permanent policy now under consideration, have the trustee apply for a convertible term insurance policy, meaning one that can be exchanged for a permanent policy without evidence of insurability. This approach will protect their insurability while they assess the situation over the coming months. If the estate tax is repealed, maybe they’ll just stop funding the premiums. If it isn’t repealed, they can either support the term policy until a combination of the death benefit, rising exemption and continued planning suggest that they no longer need the liquidity. Or, they can exchange it for a permanent policy and “go long”, as it were. 

2.    If the individual is going to make large premium gifts to his or her ILIT in 2017 for a policy bought solely for estate tax liquidity, the individual might be tempted to hold off to buy time. But, depending on the type of policy, this may be more easily said than done. And, with certain policies, any delay in the payment of a premium could have very negative consequences. So, the individual should ask his or her agent to describe and illustrate the options and the “what ifs”. Of course, individuals should be very careful about surrendering a policy until the estate tax coast is clear and they are satisfied that the benefits of that policy, tax and otherwise, aren’t valuable enough to retain even if there is no estate tax.

3.    If a large taxable premium gift to the ILIT has to be made, the individual should check with his or her advisors about alternatives to a gift. For example, if the ILIT is a grantor trust for income tax purposes, the individual can lend the cash to the ILIT instead of gifting it. If the loan is properly structured, there will be no gift tax implications to it and, again, if the ILIT is a grantor trust, there will be no income tax implications either.

There will be a lot to say about the Plan in the weeks ahead. But these few precepts should serve as good, practical guidance to those who are watching the action from home but have a good deal at stake in the outcome.


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