Protect Against Potential Retroactive Estate Tax Changes

By Martin M. Shenkman, CPA, MBA, PFS, AEP (Distinguished), J.D.

The Biden Administration may reduce the exemption retroactively, perhaps even to January 1, 2021!  It’s best to protect against a retroactive tax change.

Retroactive tax changes sound unfair! Even Taylor Swift said: “It’s hard to fight when the fight ain’t fair.” But we’ll tell you how to fight that unfair tax fight! The law permits a retroactive tax change. See: Pension Benefit Guaranty Corporation v. R. A. Gray & Co., 467 U. S. 717 (1984); United States v. Carlton, 512 U.S. 26 (1994). The need for revenue, or the desire to reinforce the estate tax to reduce wealth disparity, might result in a retroactive tax change.

Example: You make a gift to use your $11.7M exemption and the exemption is reduced retroactively to $1M (yes, that is the proposal for the gift tax exemption in the Sanders tax proposal which may be a foundation for a Biden administration proposal) you could owe gift tax on a $10.7M gift. Ouch!

Even if you view this as unlikely, you cannot say it’s impossible, so take steps to integrate protection into your planning.

Here are three approaches:

  1. Disclaimer Approach: Make gift transfers to a trust for intended beneficiaries, not out right. Provide in the trust instrument that a particular beneficiary shall be treated as the primary beneficiary and shall have the right to disclaim or renounce interests in any property given to the trust on behalf of herself and all beneficiaries. But, unlike typical disclaimers where the disclaimer results in assets passing to remaining beneficiaries, the trust provision could provide for disclaimed assets to revert back to you as the settlor. That would unwind the transfer so that the gift would arguably not have occurred. That way, if there is a retroactive tax change a spouse or other beneficiary could disclaim sufficient assets to avoid an unintended gift tax. It may be possible to give the trustee the right to disclaim but state law will have to permit that.If you are making a transfer to an existing trust that does not have a disclaimer provision, you might consider adding a disclaimer right in the transfer instrument (e.g., an assignment).

 

  1. QTIP Approach: Make a gift to a marital (QTIP) like trust. Your spouse must be a US citizen, must get income at least annually, have the right to demand that any property held in the trust be made income producing, and no one other than your spouse can access assets in the trust during your spouse’s lifetime. That trust might then qualify for the unlimited gift tax marital deduction (so no use of exemption) with one more step. You can then determine to what extent, if any, that you elect marital QTIP treatment on your 2021 gift tax return which can be filed as late as October 15, 2022. That is a long time and should suffice to know what the new laws will be. To the extent your exemption was reduced retroactively you might then elect QTIP treatment to avoid a current gift tax. The remainder would not be subject to a QTIP treatment and would use that amount of your exemption. Note that the Clayton QTIP technique that works for the estate tax purposes will not work for a lifetime transfer. Also, if one spouse will use this mechanism you might not wish to use this technique for the second spouse as the trusts will inherently be very similar and that might raise a reciprocal trust doctrine issue that could permit the IRS or creditors to unwind the trusts. If your plan will involve two such QTIP-like trusts, you might give different testamentary powers of appointment, the right to make one QTIP a unitrust, etc. Those differences might negate a reciprocal trust attack but be mindful of the risk.

 

  1. Formula Gift Approach: Use a formula in the document assigning a gift to an irrevocable trust to transfer only assets worth your exemption amount as reduced by a retroactive tax change, if any. There is no law supporting this mechanism, but the risk of a retroactive tax change is so difficult and unique that for a taxpayer to try to avoid an unintended gift tax seems so reasonable that it is hoped the IRS and courts would accept this technique. The balance of the gift could pass to an incomplete gift trust or a marital trust to avoid gift tax. This could also be addressed in a manner like a so-called Wandry transfer formula wherein you transfer only the portion of the gift property that equals your remaining exemption (but as retroactively adjusted). If you transfer multiple assets, e.g., interests in 5 LLCs, you should include an ordering provision. It may be safer to have the spillover mechanism rather than limiting the amount actually transferred akin to a Wandry mechanism. Also, if your GST tax exemption might differ from the gift tax exemption you might create a QTIP’able trust that is a reverse GST exemption trust. You could transfer to a family trust your gift tax exemption amount as of the date of the instrument. The remaining value could pass to a QTIP type trust if you have GST exemption in excess of gift exemption. Any balance could pass back to you.

 

This article is featured in Practical Planner® (Jan-Mar 2021, Volume 13, Issue 1) and is reprinted with permission from Martin M. Shenkman.  To download and sign up for Marty’s newsletter, see LawEasy.com.


INSTANT DOWNLOAD: “Tax Planning Opportunities Following Georgia Senate Results” by Jonathan G. Blattmachr, Robert S. Keebler & Martin M. Shenkman

If 2020 wasn’t a jaw-dropping and an unbelievable year we will long remember, within less than a week into 2021 and has already kicked off things with quite a BANG!

The Democrats are taking control of Congress and federal tax policy. Although the pandemic may be dying down in 2021, the rate of tax policy change will likely increase. The “Blue Wave” combined with the fiscal stimulus from Congress will have tremendous implications for your clients given the likelihood for significant tax changes directed towards wealthy Americans.

To better understand what you need to know about all of the tax planning opportunities this now brings, we have enlisted the help of nationally renowned attorney, Jonathan G. Blattmachr, J.D., LL.M. (Taxation), nationally renowned CPA and tax expert, Robert S. Keebler, CPA/PFS, MST, AEP (Distinguished), CGMA, and nationally renowned attorney-CPA, Martin “Marty” Shenkman, J.D., CPA, MBA to put together this immediately downloadable 94-minute presentation entitled, “Tax Planning Opportunities Following Georgia Senate Results”.

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 ABOUT THE AUTHOR

Martin M. ShenkmanMartin “Marty” Shenkman, CPA, MBA, PFS, AEP, JD is an estate planning attorney and Certified Public Accountant from Paramus, New Jersey. He received his Bachelor of Science degree from Wharton School, University of Pennsylvania 1977 with a concentration in accounting and economics. He received a Masters degree in Business Administration from the University of Michigan 1981, with a concentration in tax and finance.

Mr. Shenkman is a widely quoted expert on tax matters and is a regular source for numerous financial and business publications, including The Wall Street Journal, Fortune, Money, The New York Times, and others. He has appeared as a tax expert on numerous television and cable television shows including The Today Show, CNN, NBC Evening News, CNBC, MSNBC, CNN-FN and others. He is a frequent guest on radio talk shows throughout the country and has a regular weekly radio show on Money Matters Financial Network.

Mr. Shenkman is a prolific author, having published thirty-four books and more than seven hundred articles. Mr. Shenkman has served as contributing editor to a host of publications, including: New Jersey Lawyer, The Journal of Real Estate Finance, Real Estate Insight, Commercial Leasing Law & Strategy, The Journal of Accountancy, Real Estate Accounting and Taxation, Shopping Centers Today, and others.

Mr. Shenkman is active in numerous charitable organizations, sitting on many boards and planned giving committees and lectures regularly for these and other organizations.

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