The Biden administration has promised to lower the Unified Credit for Estate taxes from $11.7 million to $3.5 million, and the credit for gift taxes to $1 million. The question on many planner’s minds is whether Congress has the political will to make those changes retroactive: that is apply them to all gifts and estates in 2021, not just the ones happening after the changes are passed. Some commentators predict that there is not the political will to make the changes retroactive, and they may be right. However, the changes to the estate tax will apply retroactively to 2021 gifts, even if the legislation does not specifically state that it is retroactive. Here is why and what you can do about it.
Some describe the $11.7 million as an exclusion from estate or gift tax when it really is not – it is a credit against estate and gift tax applied under IRC section 2505. Specifically, the credit against gift tax for a gift made any time in 2021 is the same as the credit against estate taxes, as if the donor died on the last day of 2021. Financially, the implications of this are, if you gifted the full $11.7 million in June of 2021, and Congress lowers the estate tax credit to $3.5 million on October 1, 2021, the tax credit for the gift in June 2021 is now taxed retroactively at the new rate of $3.5 million credit rather than on the previous $11.7 million credit.
This leaves clients open to very large gift tax bills for gifts in 2021, maybe as much as 50% of the value of the gifts transferred. What I recommend to our clients to lock in the higher $11.7 million credit without risking paying an increased gift tax is to make the gift revers1ble.
Making a gift reversible, if the tax becomes retroactive, involves using Irrevocable Trusts. Specifically:
· An Irrevocable Trust where one beneficiary to disclaim for all, within 9 months of the gift being made;
· A Spousal Limited Access Trust,
· A Trust with income paid out to a spouse, that allows a Qualified Terminable Interest Property (QTIP) election. The election is made on the 2021 gift tax return which is filed in 2022,
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· Use a formula gift (either outright or fractional interests in LLCs where the Numerator Available Exemption and the Denominator is the value of the gift as finally determined for gift tax purposes, and
· Sell the assets to the Trust, but take back a promissory note and treat the transaction as an Installment Sale, repaying the amount of the principal of the note in excess of the tax credit.
None of these trusts are simple to implement, and requires careful planning. The cost and time involved in setting up a gift that can be undone is quite small in comparison with the potential gift taxes, when and if Congress changes the tax credit rate.