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Monday, May 24, 2021

Planning NOW for the Estate Tax Overhaul

The recently proposed “For the 99.5% Act” would bring dramatic changes to gift and estate taxes while proposals in both houses of Congress and the White House would impose immediate income taxation on gifted and inherited gains. 

This tax overhaul could be the costliest in generations, if enacted.  Here are just some of the structural changes we might see: 

  • Slashing the estate tax exemption down from $11.7 million to $3.5 million, with significant tax of around 50% on inherited assets exceeding that threshold.  
  • Elimination of valuation discounts in most situations. 
  • Structural changes to the tax code that would reduce efficacy of traditional estate planning tools like grantor trusts and dynastic planning.
  • “Deemed realization” on transfer: Assets transferred by gift or at death to be treated as sold for income tax purposes with gain recognized and taxed to the transferor.  

Since some of the proposed legislation could be retroactive to the beginning of 2021, charitable planning may be a family’s best chance to take advantage of significant planning opportunities under current law.  

Gifts of Appreciated Stock to a Qualified Charity 

Deemed realization of inherited gains could pose an opportunity for charitable giving in order to avoid the devastating impact of a capital gains tax on death.  By making gifts of appreciated long-term capital property to a qualified charity, a taxpayer can avoid gain recognition and achieve a present income tax deduction up to the fair market value of the asset.  

In 2021, such transfers are deductible up to 100% of adjusted gross income and any unused charitable deduction may be carried forward to offset income earned for up to five years.  Taxpayers considering this strategy should only donate appreciated property held for at least one year and one day.  A qualified charity receiving appreciated stock will need to have a brokerage account to accept the shares and a Board-approved policy of how to handle investments once received.  

A Beneficial Charitable Trust Structure to Consider

The charitable lead annuity trust (“CLAT”) has emerged in the current planning environment as a beneficial strategy to consider.  A CLAT separates the current and future interest in property so that a qualified charity receives an initial annuity for a term of up to 20 years and anything left over winds up with noncharitable beneficiaries, allowing a donor to accomplish strategic wealth transfers for the benefit of family members, as illustrated in the following example: 

Artemis owns a stock portfolio worth $10 million, which is expected to continue to grow at a rate of 5.5% annually, generating about $550,000 of taxable income to Artemis.  Artemis establishes a 20-year CLAT and funds it with the portfolio.  The CLAT pays its own taxes during the initial term, thereby eliminating Artemis’s annual tax burden by the taxable income earned by the portfolio.  The CLAT will make annual charitable contributions to a qualified charity in an amount determined based on current interest rates.  

A properly administered CLAT established when interest rates are lower than expected growth should result in a transfer to noncharitable beneficiaries at the end of the initial term of assets that should be worth more than the original $10 million portfolio.  Under the rules governing CLATs, the noncharitable transfer will be $0 for gift tax purposes, allowing Artemis to benefit a qualified charity while also pushing out wealth to heirs – all without triggering estate, gift or income taxes.  


Conclusion

Despite challenges charities encountered in recent years, 2021 presents an opportunity to take advantage of increased incentives for charitable giving.  Donors will be focused on their charitable intent, and nonprofits should stay in the know with how these tax incentives and their timing can be leveraged for donations to their mission.

Sophisticated strategies can be very powerful but require skilled and thoughtful practitioners.  In this uncertain, ever-changing tax environment, collaboration between and among professional advisors and charitable organizations could be essential to limiting tax exposure and crafting transfer strategies that incorporate charitable giving goals.

About our author: Joy Matak, JD, LLM is a Partner at Sax LLP and Co-Leader of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning.  She can be reached at jmatak@saxllp.com.

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