The results of last week's federal election put a Republican in the White House and hand control of the Senate and House to the Republican Party. What does all this mean for the future of estate planning, especially the steps to consider today?
Exemption from wealth tax
The federal estate tax exemption will be $13.99 million in 2025. I believe it will likely stay on its inflation-adjusted course for at least four more years instead of sunsetting in 2026 as projected in the Tax Cuts and Jobs Act. Especially given the fact that significant gifting strategies, including gifts to a so-called limited spousal access trust, have similarly significant disadvantages associated with them, including an increase in the income tax basis from the loss of assets transferred upon the transferor's death, practitioners will need to reconsider these strategies and potentially put them on hold in all but the largest estate situations (in which gifts likely have already been done).
When combined with the existence of spousal portability elections (where a surviving spouse can, in effect, choose to increase the tax exemption on a former spouse's inflation-adjusted estate), married couple households with combined assets taxable estate of $28 million or less may be significantly harmed, on an after-income and estate tax basis, by the couple making unduly significant lifetime gifts of assets evaluated. It is possible that a single individual with an estate of less than $14 million or a married couple with an estate of less than $28 million would save $0 in federal estate taxes for their family by making transfers large over the lifetime of the appreciated assets, but would instead cause family members to eventually pay significant capital gains taxes when they eventually sell the gifted assets.
Income tax rates
Another tax benefit that should remain now for at least another four years is the lower federal income tax rates that are currently in effect. An important tax strategy this presents is in the area of individual Roth retirement account conversions. Especially for retired individuals, converting taxable IRA plan benefits and Internal Revenue Code Section 401k to tax-free Roth IRAs for a period of 4 years or longer than all prior to 2026 can produce significant long-term income tax benefits for the account owner, especially knowing that federal income tax rates are likely to increase over the long term. Doing so tax-wise will also produce significant after-tax benefits for the account owner's spouse and other heirs.
A related option is to convert some of an individual's taxable IRA or Section 401k funds into tax-free life insurance. The additional tax benefit this option creates stems from the fact that it is currently still possible for the life insurance policy to be owned outside the individual's taxable estate, for example, by the individual's children or a tax-exempt life insurance trust on the property for the benefit. of the individual's spouse and descendants. If the estate tax exemption ends at a future date, by converting all or a portion of the taxable benefits of the IRA or Section 401k to life insurance in the near term, the tax-exempt life does not an increase in the individual's family will cause a loss of income tax base because the life insurance proceeds are received by family members tax-free.
Structuring the Trust
In light of the beneficial elements described above, when drafting trusts for a surviving spouse and descendants, it is essential to build into the trust agreement the potential to create a step-up income tax basis upon the death of the trust beneficiary. , to the extent that it will not cause an estate tax liability upon the death of the beneficiary or the beneficiary's surviving spouse. Trust agreements must also be structured to intentionally cause trust income to be taxed at the beneficiary's federal income tax rates, so long as those rates remain lower than the federal income tax rates applicable to trusts.
Practitioners should also consider modifying existing irrevocable trusts, either under the state's “trust decanting” rules or under a similar provision included in the trust agreement itself, to achieve the above income tax benefits for the trust. existing and its beneficiaries. For example, an existing irrevocable trust can be modified to create a step-up in income tax basis upon the death of the trust beneficiary or to have trust income taxed at lower income tax rates of the individual beneficiary in lieu of the trust's high federal income tax rates.
Thinking revised
The above recommendations represent just a few areas where last week's federal election will impact estate planning. The election results, and in particular what they will mean for the exemption from federal estate taxes and income tax rates over at least the next four years, require practitioners to reexamine current plans for large lifetime gifts and explore all available techniques. to take advantage of the current low federal income tax rates.