Even if we could predict which candidate will win in November, there’s no way we could know if they would be able to enact their stated tax proposals.
In spite of all this uncertainty, planners should inform clients of the very different proposals from Donald Trump and Hillary Clinton and how planning should be undertaken, or adjusted, to consider both possibilities.
Currently the estate planning world is buzzing about proposed regulations under Code Section 2704 that might eliminate valuation discounts. Any planning should also consider the election’s outcome on estate and gift taxes.
In her campaign, Clinton has proposed reductions in both the estate and gift tax exemptions. If passed, they could affect how clients invest and plan for future transfers of wealth.
Her proposals include:
- A $1 million gift tax exemption, a dramatic decrease from the current $5 million inflation adjusted exemption ($5.450 million in 2016).
- A $3.5 million estate tax exemption, which is a significant decrease from the current $5 million inflation adjusted exemption ($5,450,000 in 2016). Bear in mind that the gift and estate tax exemption are unified so if you make a $1 million gift, you will only have $2.5 million of estate tax exemption left.
- Elimination of the inflation adjustment. This is significant, as even the $3.5 million exemption would be substantially eroded by inflation over time. No longer will clients be able to assume that some or all of the growth in their net worth will be offset by a commensurate inflation increase in the exemption. While inflation might be low now, consider how one or two decades of additional inflation before a client dies might emasculate the exemption.
- Increasing the estate tax rate to 45% from the 40% current rate.
Clinton’s estate tax proposals are likely to include President Obama’s past proposals to restrict grantor retained annuity trusts, note sale transactions, grantor trusts, and more.
Given growing populist sentiment against the wealthy, these techniques could be viewed as inappropriate loopholes and be terminated regardless of the composition of Congress. Ignoring this possibility, however likely you might view it, could be a grave mistake for wealthy clients.
The Trump plan is to eliminate the estate and gift tax. If clients are undertaking estate planning, e.g. the creation of irrevocable trusts, GRATs or LLCs, consider warning them that if Trump is elected, and his estate tax plan implemented, the hoped for tax benefits might not prove necessary.
Advisers should structure planning to provide as much flexibility and benefit to the client as possible.
This was the mistake many estate planners made in 2012 in a rush to plan. They set up trusts for children or grandchildren and excluded the client and spouse. This proved a misstep for many, not because the exemption did not get reduced as anticipated, but because clients lost access to their own wealth.
This type of planning can be a dangerous and unnecessary mistake. There is generally no need to exclude the client or their partner from planning. Many techniques (spousal lifetime access trust, self-settled domestic asset protection trust, a sale that permits payments on a note) can assure future access to trust assets by the client or spouse. Planners should make sure clients rushing to lock in discounts before the end of the year should include protections for themselves and their spouses.
Emphasize the non-tax goals to the client as well, so if the estate tax is repealed they might still perceive the merits to having proceeded with the plan.
WHAT IT MEANS
This year could be a replay of 2012, when there was a rush to plan before the year's end before the estate and gift tax exemption was anticipated to decline.
The 2016 planning rush will be different as it will be focused on wealthier clients and more specifically on clients with business or real estate holdings that can be valued at a discount. These discounts might disappear by the end of 2016 (although exact dates and details are not yet known) and the possibility of more planning techniques being curtailed in 2017 should be factored into the planning in 2016.
If a client plans to secure discounts, that planning should also try to lock in benefits of techniques a second Clinton presidency might eliminate. The need for planning is not only about the drop in exemption and increase in rates. It is likely that restrictions on GRATs and limitations on other techniques the ultra-wealthy have used to minimize the estate tax may be enacted as well.
For those clients who have not used all of their exemptions, there may be a 2012-like rush to exhaust it by gifting assets to non-reciprocal spousal lifetime access trusts for married couples or to domestic asset protection trusts for single clients.
For clients who have used all their exemption (or do so in their2016 planning) they may implement long term GRATs to lock in the current low interest rate and to implement the technique before any proposed restrictions are implemented. There might be more of this before changes occur.
The longer planning is postponed, the greater the risk that valuable planning techniques are lost before they can be implemented.
THE NEED TO PLAN
The most important service any planner may provide is getting clients to focus on the need to plan. Communicate with clients to inform them of the possible estate tax changes that might occur.
Get involved with the planning before any irrevocable trusts are established, and help guide clients as part of a team of advisers.
Be certain that planning has multiple purposes and benefits so that if the estate tax is repealed the planning still serves a purpose.
Flexibility and the ability to change even irrevocable planning, to the extent it will not jeopardize tax goals, should be a priority. Be certain that the planning, documents and implementation maximizes flexibility to keep options open since the future is so uncertain.
When discussing planning to be implemented with clients and their estate planning attorneys, use abroad classes of beneficiaries so income and principal can be directed with flexibility in the event the estate tax law pendulum swings right or left.
A person, who will act in a non-fiduciary capacity, might be given the right to add new beneficiaries. This might even include the spouse or client setting up the trust (settlor) if the trust is formed in a state that permits this.
Use trust protectors to effect change to documents, especially those that are irrevocable. A protector can be given a laundry list of rights and powers that can provide flexibility to make permissible changes in an irrevocable trust without court action.
Include swap powers in grantor trusts so that assets can be moved in or out of the trust depending on changes in the law. This is important for financial planners to discuss with their clients, as the input of a financial planner is integral to the effective use of a swap power if the planner is managing the securities in the trust that has such a power.
Finally, include a power for someone to loan the grantor trust assets without adequate security to provide another safety valve.