Making Sense of Political Risks in Estate Planning

Recently, friends who know what I do have reached out to me for my opinion about the transfer tax risks (and opportunities) surrounding the 2020 election.

In follow up to these conversations, and after several Google searches on this topic, it has become clear to me that there is precious little common-sense guidance on estate tax planning in a world of political upheaval. Of course, this topic becomes more acute than ever given the polarization of the two candidates and their positions.

So, the goal of this article is to give some practical advice on how to address estate and gift tax planning challenges created by an ever-changing transfer tax system.

What We Know

• Other than 2010, when those “lucky” enough to die incurred no estate tax, the year 2020 provides the greatest opportunity to transfer wealth without tax since the inception of a transfer tax system. And with respect to making gifts during one’s lifetime, 2020 is the best without exception, regarding giving wealth without the imposition of a gift tax. Currently, the exemption (the amount that can be transferred tax free) sits at $11.58 million. If a married couple works collectively to transfer their wealth to their children, they can transfer $23.16 million without any transfer taxes. That amount is indexed to increase every year. 
• On December 31, 2025, that exemption amount is scheduled, by law, to be cut in half. 
• It takes the acquiescence of the House, Senate and President to change tax law.
• The estate and gift tax policy position of the Democratic candidate seems to be to reduce the exemption to somewhere between $3.5 and $5.6 million.

What it Means- The No Brainers

The examples will use numbers for a married couple. The numbers used should be cut in half for single persons.

• For married couples with assets of less than $7 million: there is nothing in the current state of transfer tax policy to concern themselves with. They will not be subject to transfer taxes.
• For married couples with assets of a value that exceeds the sum of (1) what they want to spend over the course of their lifetimes to accomplish their wishes, hopes, dreams and desires, plus (2) $23.16 million: their planning for legacy assets—what is left after the couple spends what they want for wishes, hopes, dreams and desires—is also simple. Under these assumptions, the legacy assets are worth more than $23.16 million. The goal should, therefore, be to give these assets away now, to not only get their appreciation out of the estate, but also give them away before the exemption amount is lowered.

What it Means

For Couples with legacy assets that exceed $7 million but are less than $23.16 million

Risks

Depending on the value of the legacy assets, there are two potential risks. For couples with legacy assets in excess of $7 million but less than $11.56 million, the risk is entirely political. In other words, their assets will not be subject to transfer tax unless the law changes. Clients with legacy assets in excess of $11.56 million face an additional risk of living beyond 2025. In other words, if they transferred all of their legacy assets prior to 2026, they would owe no transfer taxes, but if they transfer them after 2025, they will owe 40 cents for every dollar in excess of $11.56 million. 

Practical Advice for Handling this Risk

• Rely on the law- Under current law, at the current time, none of these couples owe transfer tax. The best planners take the law as written and plan, as best they can, under that law. 
• Understand the risks- In a nutshell, the risks these couples face is (1) an election wherein Democrats (the party whose written policy is to reduce the exemption) wins the Presidency, House and Senate in 2020, 2022, or 2024; and/or (2) if on December 31, 2025, the Republican party (the party that enacted the current tax act with the current exemption amounts) does not control the Presidency, House and Senate (and thereby lacks the voting power to extend the higher exemption beyond 2025). Click here to read more about tax planning in an election year.
• What if a risk plays out- Even the most expedient changes in the transfer tax laws cannot take effect until 2021. That gives these couples a period of time after November 3, 2020 through the end of the year to implement a plan that takes advantage of 2020’s higher exemption amounts.
• Challenges- Implementing a strategy that takes advantage of the higher exemption could involve the drafting of legal documents. It might be difficult to find an attorney with capacity (given that others are facing the same issues with the same time constraints) to draft documents in that two-month window. This exact phenomenon last took place in 2012, and many potential clients were unsuccessful in retaining an attorney to draft critical estate planning documents.
• Solution- Meet with an attorney now to scenario plan on how to deal with this eventuality if it happens. Have the attorney draft the critical documents right now. Having those documents in place might be wasting resources if the law does not change, but will be a spectacular investment in transfer tax savings if the law does change. At that time, all that will be left to do is to transfer assets, a process that should require little or no attorney attention.

One other challenge

This article assumes that the couple can define what their legacy assets will be. That is a shaky assumption at best. In other words, any financial strategy needs to divide the couple’s financial assets into two groups: (1) independence assets and (2) legacy assets.

Independence assets are those that will be liquidated and used to pay for the couple’s lifetime expenses. Legacy assets are all of the couple’s assets that are not independence assets, which will, by definition, pass to their loved ones at some point in time.

Even with the most sophisticated planning process, defining how much of a couple’s wealth comprises independence assets vs. legacy assets is an inexact science. That is because we do not know when the couple will die, what inflation will be or how the market will perform—not to mention how life might change in unknowable ways that will change the couple’s definition of independence.

The solution to this problem—which allows the couple to use the law to maximize the wealth of loved ones and minimize taxes—is to transfer legacy assets in a way that allows them to transition back to independence assets if the couple so chooses.

In other words, transfer the assets in a way that removes them from the couple’s gross estates but gives the couple access to those assets if they need them for their wishes, hopes, dreams and desires. That type of planning will be the focus of my next article.

ABOUT THE AUTHOR

Joe Maier

SVP Director Wealth Strategy JD, CPA | Johnson Financial Group

Joe has extensive experience helping high‐net worth individuals, family offices, business owners and corporate executives meet their wealth and legacy goals. His areas of specific interest and skill include business succession planning, financial and estate planning, and wealth transfer strategies.