Take-Away: With the change in focus in estate planning from saving federal estate taxes to saving federal income taxes, many durable powers of attorney should be updated to accommodate future income tax planning strategies made by an agent on the principal’s behalf. Perhaps even more important to refreshing the powers of an agent under a durable power of attorney is the looming ‘threat’ of future tax law changes, e.g. Bernie Sander’s proposed “For the 99.8 Percent Act” which places a premium on acting quickly to exploit current estate and gift tax exemptions before Congress (potentially) turns blue and the transfer tax exemptions disappear.

Background: We are all familiar with the reasons why estate tax minimization has taken a back seat to income tax planning because of the 2017 Tax Act. With that change in emphasis to income tax planning, many durable powers of attorney should be updated to permit the principal’s agent to take steps to reduce the principal’s exposure to federal income taxes. Some examples of specific powers that might be granted to an agent under a durable power of attorney include the following:

RMDs: If the proposed SECURE Act becomes the law, the calculation of required minimum distributions (RMDs) from an inherited IRAs drops from the use of the beneficiary’s life expectancy to a maximum of 5 or 10 years. The principal’s IRA beneficiary designation might need to be changed by the agent to reflect that much shorter payout duration (i.e. to mitigate taxable income bunching) incurred by the beneficiary. If the shorter RMD period becomes the law it may also cause an IRA payable to a trust (the accumulation variety) to change to a named individual beneficiary who is more likely to be taxed at a marginally lower income tax bracket than the irrevocable trust. The agent should be given the authority to change beneficiary designations with regard to both retirement accounts and tax deferred annuities. Because a significant amount could be transferred by a change in beneficiary, the instrument might require the consent to the agent’s action taken by the agent to assure that the principal’s testamentary wishes are preserved with the change in retirement account beneficiary.

Charitable Gifts: Most durable powers of attorney authorize the agent to make lifetime gifts of the principal’s assets in order to reduce the size of the principal’s taxable estate. The problem is that with lifetime gifts there is a ‘carry-over’ of the income tax basis in the gifted asset to the donee; the transferred asset does not have its income tax basis adjusted on the donor’s death (as the asset is not included in the donor’s estate.) Moreover, as noted below, with the currently large federal estate tax exemption being effectively doubled (at least until 2026) it is much less likely that the donor will have to worry about any federal estate tax paid on his/her death. However, a lifetime charitable gift can reduce the principal’s current income tax liability, and perhaps reduce exposure to the net investment income surtax of 3.8%. Consequently, a durable power of attorney should expressly empower the agent to make charitable gifts using the principal’s assets. Example: My agent shall possess the authority at any time to make charitable gifts on my behalf in accordance with my historic pattern of charitable giving. Even if the asset given to charity is not tax deductible due to the principal’s doubled standard deduction, a gift of appreciated marketable securities still removes the securities’ appreciation from the donor’s taxable estate. {Note: A revocable trust might also empower the successor trustee to advance or accelerate any charitable bequests under the trust, in order to benefit from a current income tax deduction for the settlor. See below}

Qualified Charitable Distributions: If the principal is over the age 70 ½ and has an IRA, the agent should be given the specific authority to direct the IRA custodian to make distributions from the principal’s IRA to charities. A qualified charitable distribution reduces the principal’s taxable income for the year while satisfying the principal’s required minimum distribution (RMD) for the calendar year. These direct gifts from the IRA are the equivalent of a 100% income tax deduction that can be taken while the principal is still eligible to claim the enlarged standard deduction ($12,000 if an individual, $24,000 if married.) Consequently, the authority to direct the IRA custodian to make direct charitable gifts from the principal’s IRA should be added to the durable power of attorney as income tax savings will be dramatically achieved with qualified charitable distributions.

Prepay Charitable Bequests: Less than 1% of decedents’ estates will be exposed to federal estate taxes in light of the enlarged applicable transfer tax exemption amount ($11.4 million per person) and the ability of a surviving spouse to use their deceased spouse’s unused exemption amount to shelter assets from federal estate taxation. If the individual has identified charitable bequests in their Will or trust, the agent or successor trustee should be given the authority under the durable power of attorney or trust instrument to prepay or advance the charitable bequest into a lifetime charitable gift made on behalf of the principal.  If it remains a charitable bequest at death, the principal’s estate will not be able to use the charitable bequest to reduce federal estate taxes, as there will probably be no federal estate tax liability due at death. Consequently, the agent, or successor trustee, should be able to accelerate charitable bequests to lifetime charitable gifts in order to benefit from a charitable income tax deduction. Accelerating charitable bequests to lifetime charitable gifts may also, given the size of the bequest, result in bunching charitable gifts into a single tax year where the donor may actually be able to itemize his/her deductions and benefit from the bunched charitable gifts.

IDGT Planning: Some individuals have established intentionally defective grantor trusts (IDGT) and have transferred or sold assets to the IDGT to reduce the size of their taxable estate. The IDGT is used to either ‘freeze’ the settlor’s estate, by converting appreciating assets into promissory notes with a sale of the settlor’s assets to the IDGT in exchange for an installment note. Alternatively, assets with a low income tax basis can be gifted by the settlor to the IDGT. The problem is that the IDGT may no longer be required to save federal estate taxes in light of the enlarged exemption amounts and portability of the deceased spouse’s unused exemption amount. The IDGT’s assets will not be included in the settlor’s taxable estate at death, which means there will be no income tax basis adjustment to the IDGT’s assets. {Note: this would change if Bernie Sander’s For the 99.8 Percent Act becomes the law.} Most IDGTs are structured as grantor trusts for income tax purposes, and the grantor trust income tax treatment can result from the settlor’s retained right to substitute assets of equivalent value with the IDGT’s assets. That retained right should be available to be exercised by the agent under a durable power of attorney. Consequently, the agent under a durable power of appointment should be given the authority to exercise the settlor’s retained right to substitute assets of equivalent value with the IDGT, swapping high basis assets with the IDGT’s low basis assets. That exchange would bring low income tax basis assets from the IDGT back into the settlor’s name alone, where those exchanged assets would be later be included in the settlor’s taxable estate and thus enjoy an income tax basis adjustment under IRC 1014 on the principal’s death. Example: My agent shall possess the authority without the consent of any third party to exercise any retained rights I may possess under any trust or other arrangement, including the exchange of assets with any grantor trust or irrevocable life insurance trust that I may have created.

Conclusion: Many individuals are now being encouraged to aggressively take advantage of the currently high gift, estate and GST exemptions. We also are now hearing a lot about changing the transfer tax rules by several candidates running for President. An individual’s durable power of attorney should be review to confirm that the principal’s agent possesses the needed authority to take advantage of the many planning opportunities that currently exist, or to respond if the tax laws, e.g. the SECURE Act, quickly change.