There has been, and there will continue to be over the next several months, much discussion and prognostication with regard to the repeal of the federal estate tax and the impact of that repeal on estate planning as we know it. But before we get too far ahead of ourselves, we need a bit of a reality check when it comes to the repeal of the federal estate or the federal generation skipping transfer {GST} taxes. Unfortunately many clients now act as if ‘death tax’ repeal has already occurred, they are dancing in the streets,  and many have stopped  their estate planning assuming that repeal is a reality. But, to quote the brash retired sports broadcaster Lee Corso, “not so fast my friends.”

The reality is that there are not enough votes in the Senate to assure a permanent repeal of either or both federal transfer taxes. Consequently, with not enough votes to enact a permanent repeal, and in order to avoid any Senate filibusters where the repeal bills would never see the light of day, the best to expect from the Senate is  repeal via a reconciliation bill process. Under the Senate’s byzantine rules, a reconciliation bill, which avoids filibusters, cannot last longer than ten years. As such, if the Senate votes to repeal the federal estate and GST taxes, that repeal will have a shelf-life of only ten years. We might have a new President in another four years, or we might have an entirely different make-up of Congress in another 4 or 8 years, so it is even a reckless assumption that the repeal of the federal estate and GST taxes will have a minimum ten year shelf-life.

You might recall, if you are old enough, that this is exactly what happened in 2001 when George W. Bush was elected and Congress quickly passed EGTRRA, which phased the federal estate tax out over a period of ten years, leading to 2010 when there was no federal estate tax, and only a lucky few died in that one calendar year. In short, history may again repeat itself in 2017 if Congress repeals these federal transfer taxes, but the repeal will only be for a maximum ten years. At best, what we might reasonably tell our clients is that a repeal of these dreaded federal transfer taxes is at best temporary.

It is less clear what Congress will do with the federal gift tax.  The federal gift tax was retained under EGTRRA supposedly as a backstop to the federal income tax, to prevent wealthy taxpayers in the highest marginal income tax brackets from avoiding income taxes by gifting income producing assets to their children and grandchildren who are in lower income tax brackets. While this backstop rationale sounds plausible, even it is a bit hard to swallow. How many wealthy parents are going to make outright gifts of significant assets to children or grandchildren with no guarantee that those assets will ever be returned to the parent? Parents already  worry that their child or grandchild might lose their inheritances to creditors or in a divorce; how much more painful would it be for a parent to watch a lifetime gift disappear to a child’s creditors or in a divorce? Consider the reality that many wealthy parents do not even tell their children the size of their estates, or consider how those same parents regularly use trusts to distribute the inheritances to their children over time prompted by the fears that the child will blow the assets once they are in the child’s possession. Yet we surmise that in order to avoid high income tax rates these same parents are going to make large lifetime gifts of their assets to their children and grandchildren just to minimize income taxes?

The planning that we should be talking to our clients about, if it is only a temporary repeal of the federal transfer taxes,  is consideration of a dynasty-type trust for the family’s benefit, or a spousal lifetime access trust [SLAT] that morphs into a dynasty-type of trust upon the donee-spouse’s death. These transfers would be sheltered by the existing gift and GST lifetime exemptions of $5.49 million per taxpayer. If there is a temporary repeal of the federal transfer taxes the client could aggressively fund an irrevocable dynasty-type trust for the family’s benefit when there is no GST or possibly no gift tax on the transfer. If the federal estate tax returned after ten years, all of the assets held in the dynasty trust would escape estate taxation on the client’s death, and escape taxation on the subsequent deaths of their children and grandchildren. If the federal estate tax never returns, but it is replaced with a capital gain tax on death, all of the appreciation in the dynasty trust’s assets will also avoid that tax as well.

While a dynasty trust can be created in Michigan, I would recommend the client seriously consider establishing a dynasty trust in Delaware, where Greenleaf Trust will soon hold trust powers, due to its more favorable trust laws. A dynasty trust might actually be preferred to hold a child’s inheritance over outright ownership of the inheritance for a variety of reasons. Considerable flexibility can be built into a dynasty trust that could provide to the child beneficiary a level of control and enjoyment equivalent to outright ownership of their inheritance. For example, some of the features of a dynasty trust that might appeal to clients, and possibly even their heirs, include:

  • The child’s interest in the trust can be protected from creditor claims or inclusion in a marital estate in a future divorce if the trust contains a spendthrift clause;
  • The child could serve as an investment advisor to the trustee and thus control the trust’s investments;
  • The child (or preferably some trusted family friend) could direct distributions from the trust, if there was an ascertainable standard used to limit the trustee’s distribution discretion;
  • The child could hold the power to remove and replace the trustee, but the new trustee should neither be related or subordinate to the child;
  • The child could serve as co-trustee of the trust;
  • The child could use or enjoy assets held in the trust, e.g. the Naples condominium; the Aspen ski chalet,  if the trust is drafted to give that right to the trust beneficiaries;
  • The child could be given a limited lifetime or testamentary power of appointment over the trust assets, to address changes in family financial circumstances;
  • If the trust is wholly discretionary and the child exercises the limited power of appointment over the trust’s assets, the transfer of assets from the trust by virtue of that power of appointment will be gift-tax free;
  • Depending upon the state where the trust is administered, it is possible to avoid state income taxes on income accumulated in the trust;
  • The trust, if fully discretionary, could function as a special needs trust for a disabled trust beneficiary who receives governmental benefits; and
  • As noted, if the federal estate tax returns in later years, none of the assets held in the trust would be subject to estate taxation on the child’s death, or more remote heirs who are also beneficiaries of the trust.

In sum, we  need to have a ‘reality-check’ discussion with our clients about the repeal of the federal estate tax, and the likelihood that any repeal will only be temporary. At the same time we should identify their opportunity to fund a dynasty trust, perhaps starting with a SLAT, whether or not the federal gift tax is repealed, in response to the temporal nature of any federal transfer tax repeal. Rather than react to Congressional repeal, clients should  plan ahead.