Reprinted with permission of Estates and Trusts
Make Taxable Gifts
The client may contemplate making taxable gifts in excess of their available federal gift tax exemption because the effective federal gift tax rate is less than the effective estate tax rate. While no gift tax is payable on funds used to pay gift tax, estate tax is payable on funds used to pay estate tax. This result occurs because the federal estate tax is tax “inclusive” and the federal gift tax is tax “exclusive.” Accordingly, even though gift and estate tax rates are the same (40 percent in 2016), the effective gift tax rate is approximately only two-thirds of the effective estate tax rate. Thus, the client may give more to their beneficiaries by making lifetime instead of testamentary transfers, with the added bonus of also transferring any future appreciation on the gift.
A drawback to this approach is that the gift tax on transfers made within three years of the client’s death will be included in the client’s gross estate for federal estate tax purposes. So, if the client dies within three years of the gift, the gift tax paid will be included in the client’s estate, negating the differential in how gift and estate taxes are calculated. However, any post-gift income and appreciation on the assets will escape estate tax.
Finally, the loss of a basis step-up on property transferred by gift must be measured. Generally, assets owned at death will obtain a stepped-up basis and eliminate tax on unrealized gains, and assets transferred during life will have a carry-over basis, with some exceptions.
Reduce State Estate Taxes
If the client resides in a jurisdiction that has an estate tax exemption below the federal exemption amount but no gift tax (for example, New Jersey, New York or Illinois), the client may make lifetime gifts to reduce their taxable estate and fall below the state estate tax threshold. If the client lives in a jurisdiction with a gift tax (for example, Connecticut), consider whether triggering a gift subject to state and federal gift taxes makes financial sense. Or, if the client lives in a jurisdiction without a gift tax but with an estate tax (such as New York), making a lifetime gift can avoid the state estate tax and greatly increase the benefit even if the client dies within three years of the gift (unless the state also has a three-year clawback, such as New York).
Making gifts may be particularly prudent if the client’s taxable estate is close to exceeding their state’s estate tax exemption and there’s an estate tax “cliff”—so that the state’s estate tax exemption disappears entirely if the decedent’s taxable estate exceeds the exemption. For example, New York’s estate tax exemption is $4,187,500 for decedents dying between April 1, 2016 and March 31, 2017. If a New York taxable estate exceeds the exemption by more than 5 percent, then the estate wouldn’t benefit from the exemption. Instead, the entire estate would be subject to New York estate tax.
Transfers to Spouse
If the client owns depreciated assets (the FMV of the asset is less than its basis) at his death, then the built-in loss will vanish because the basis of the assets will be stepped down to its FMV. However, the client could transfer depreciated assets to the client’s spouse to avoid a step-down in basis and preserve the capital loss for the surviving spouse to use. Gifts to a spouse aren’t subject to Internal Revenue Code Section 1015, which would eliminate the loss on a gift to a donee other than a spouse. Gifts to a spouse also aren’t subject to gift tax, unless the spouse isn’t a U.S. citizen (in which case, the spouse has an increased annual exclusion).
The client may create a new will or restate their revocable trust if they've previously executed several codicils or amendments. By consolidating codicils and amendments into a new will or restated revocable trust, an executor or trustee may consult a single instrument to understand the client’s wishes instead of piecing them together by cross-referencing a number of separate documents. Consolidation of the instruments also presents a good opportunity to clean up the documents and make sure the codicils and amendments are up to date, consistent and work together. If the client is incapacitated but has previously executed a durable POA, the client’s agent may be authorized to amend or restate the client’s revocable trust on behalf of the client.
Revisit Designated Fiduciaries
The client should revisit all fiduciary appointments under their will and revocable trust. For example, named executors and trustees may have died, moved across or out of the country or fallen out of touch with the client and their family. Administrative problems will arise if the will or revocable trust fails to identify an individual or entity to act as trustee or executor (or fails to create a process to designate them). If this failure occurs, the estate will have to undertake a lengthy and costly process of asking the court to appoint a trustee or executor. The client should confirm that all individuals or entities named as executors, trustees or guardians are appropriate, given the passage of time and changes in circumstances.
If serving alone as trustee of his revocable trust, the client should consider appointing a co-trustee. If the client is currently serving as a trustee of any other trusts, the client should consider resigning as trustee and obtaining releases if appropriate. This will ensure a smooth transition in trusteeship if a successor trustee or co-trustee can be appointed and brought up to speed before the client’s death.
Review Life Insurance
The client should review all of their life insurance policies and confirm all premium payments are current and no policies will lapse or have lapsed. If an insurance policy has inadvertently lapsed (generally, due to failure to pay premiums), the client (or trustee of an insurance trust) should immediately contact the insurance agent or provider to determine if it can be reinstated. The client should examine all beneficiary designations to ensure a beneficiary is indeed designated. If the client owns the insurance policy, he or she may sell the policy to an irrevocable life insurance trust to avoid estate tax on the policy proceeds.
Additionally, the client may be able to stop or reduce premium payments. For example, if the client has held a policy for several years, the policy’s cash value may be able to completely cover, or significantly reduce, premium payments.
More Tips: See the entire article at 20 Tips for Planning at The Eleventh Hour.
*Authored by David A. Handler and Kristen A. Curatolo. David A. Handler is a partner in the Trusts and Estates Practice Group of Kirkland & Ellis LLP. Kristen A. Curatolo is an associate in the New York City office of Kirkland & Ellis, LLP. Reprinted with permission of the publisher. Discounted subscriptions to their publications are available at Trusts and Estates.