Take-Away: Probably a wait-and-see approach to estate planning is inadvisable at the beginning of 2021. It is time to build flexibility into estate plans to address a rapidly changing environment for donors, settlors, and their beneficiaries.

A New Planning Environment: With a new year comes a new government, and an unusual set of external circumstances that come together complexity to plan an individual’s estate. Consider the following:

  • Deficits Grow: Billions were borrowed in 2020 to deal with the economic devastation caused by COVID-19. More billions will be borrowed in early 2021 once Mr. Biden is in office to again help families and small businesses survive the pandemic. Consequently, there is a strong likelihood that taxes will be increased (income, gift, estate and GST) to raise revenues to start to pay for that massive governmental borrowing. Wealthy individuals are targets for that increase in federal revenues through higher taxes. Many states are also talking about increasing their income taxes to deal with the loss of revenues at the state level and their deficit spending in unemployment benefits.
  • Asset Values are Diminished: The pandemic has suppressed the value of many assets and small businesses. Given the uncertainty if the pandemic can be swiftly brought under control leads to considerable anxiety about the future of the economy; businesses continue to struggle during this unprecedented downturn in the economy. Consequently, not only are asset values lower, there is a greater opportunity to use larger valuation discounts due to the uncertainty about when a healthy economy will return, especially if the value of a business or income producing asset is based upon the capitalization of a future income stream.
  • Interest Rates at Historic Lows: Interest rates remain at historic lows. The Federal Reserve has promised to keep those interest rates extremely low for the next few years until the pandemic’s impact on the economy is under control. The IRC 7520 rate  of interest for January, 2021 is .6%. These low interest rates can be exploited to shift wealth with very little exposure to federal gift taxes with intra-family loans and sales to grantor
  • Democrat Controlled Federal Government: President Biden is a Democrat. The Democrats have a majority (although not that big) in the House of Representatives. The Senate is equally split between Democrats and Republicans, but if there is a tie vote in the Senate, Vice-President Harris gets to cast the deciding vote. President Biden and Vice President Harris campaigned on a platform to increase the taxes on the wealthy, and in many respects, repeal a large portion of the 2017 Tax Act. No one knows what the tax law changes will be, or when the changes might be implemented, but it is a safe bet that taxes will be increased fairly soon.

Planning Steps in 2021: In light of these unique circumstances that, there are some pretty clear principles that can be followed as individuals are counselled in adopting estate plans for 2021.

  • Timing- Act Now: Some tax law changes can have retroactive effect, especially if it comes in the form of a change in tax rate. Other tax law changes, e.g. creating a minimum value for a GRAT’s remainder interest, i.e. a ‘new’ law, often cannot become effective until after that change in law is adopted. The sooner that a gift is made, or a GRAT funded, or a dynasty-trust created, the greater the likelihood that the tax implications of that estate planning strategy will be ‘grandfathered.’  While President Biden has not endorsed a wealth tax as some of his contemporaries in the Senate have advocated, the cost of the country’s ‘bail-out’ from the pandemic may cause his to reconsider his initial rejection of the imposition of a wealth tax to generate revenues to deal with a once-in-a-generation world-wide pandemic. This is definitely not a good time to adopt a wait-and-see approach to estate planning.
  • Use Exemptions Now: The federal gift, estate, and generations skipping transfer tax (GST) exemptions are at an all-time high. An individual’s transfer tax exemption is $11.7 million for each individual. Now would be a good time to use that exemption before it is reduced, such as to $3.5 million for the federal estate and GST purposes, and $1.0 for federal gift tax purposes, as President Biden has proposed.
  • Encourage Asset Protection: The economy is uncertain and likely to remain uncertain for an extended period of time. Individuals may find themselves faced with more creditor problems than they ever anticipated for the first time in their lives. Transfers to self-settled asset protection trusts like Michigan’s Qualified Dispositions in Trust should be considered, not only to shift wealth to their family members but also to assure themselves protection from future creditor claims. The same can be accomplished with a Spousal Lifetime Access Trust (or SLAT) created for one’s spouse if it is a fully discretionary trust under Michigan’s Trust Code, since the beneficiary of a discretionary trust does not hold a property interest in the trust which can be attached by creditors. Additionally, with a Michigan discretionary trust, there are no ‘exception creditors’ that can access the trust’s assets to satisfy claims, exception creditors like the state and federal governments.
  • Buy More Insurance: Life insurance protection should be considered, even for the wealthy. The death benefit can be held in an ILIT and used to help pay the additional federal estate tax if the estate tax exemption drops to $5.0 million or even lower to $3.5 million. Life insurance can also be used as a wealth replacement asset for heirs who find their expected inheritance diminished by higher estate taxes. Long-term care insurance should be explored if there will be less wealth, or higher income taxes, for an individual who requires assisted living or nursing home care, which is likely to be the case as life expectancies are dramatically increasing.
  • Build Flexibility into Transfers: Obviously there is a great opportunity for future changes to impact an estate plan, with tax laws to generate revenues for the federal and state governments, the impact of the on-going pandemic on asset values, or concerns with regard to future creditors. Building flexibility in estate plans to address these possible changes will be even more important in this period of dramatic change. Consider using some of the following:

Disclaimers: Avoid an unwanted transfer with a qualified disclaimer by the donee, where the disclaimed gift, made within nine months of the transfer, is returned to its donor;

QTIP Elections: Avoid an unintended transfer with a QTIP election on a ‘late-filed’ gift tax return, where the delayed QTIP election is, or is not, made as a taxable gift depending on what happens to the tax laws;

Defined Value Formulae: Use a defined value formula to transfer assets, either as a gift or in a sale transaction, e.g. a sale to a defective grantor trust, to avoid a deemed taxable gift if the IRS challenges the reported value;

Limited Powers of Appointment: Give beneficiaries limited powers of appointment to shift the future use and enjoyment of trust assets in anticipation of future tax laws or creditor issues;

GRATs: Use a GRAT to shift any asset appreciation, above the IRC 7520 rate, to the GRAT remainder beneficiary gift-tax free;

SLATs: Use a SLAT to transfer wealth out of a spouse’s taxable estate, yet the spouse can still indirectly enjoy the asset or the income generated by the transferred assets;

DAPT: Use a Michigan Qualified Dispositions in Trust (DAPT) to transfer wealth away from the settlor, remove the assets from the settlor’s creditors, yet still enable the settlor to benefit from the transfer made to the DAPT through discretionary distributions by the trustee;

Low Interest Loans: Exploit the low interest rates for long-term loans, by making loans to family members, documented by promissory notes, to shift the taxable income earned on the loan proceeds to the borrower who is in a lower marginal income tax bracket.

Conclusion: Estate planning in 2021 will be a challenge, there is no question about it. What is important is that there are as many opportunities as there are challenges to consider. The ‘wait-and-see-what-happens’ may not be the best approach. A ‘plan’ to do something later on is not much of a ‘plan.’