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The remaining half of 2021 may be the last opportunity to do effective Wealth Transfer and Estate planning

The Wealthy are under attack:

1. Historic Government Spending & Borrowing will pressure the need to raise taxes.
2. The Green Book released by Biden Administration late last month has an unpleasant surprise for wealthy Americans, provisions lurking halfway through a 114-page document released by the U.S. Treasury take aim at Dynasty trusts and Intentionally Defective Grantor trusts (IDGTs).
3. Joe Biden campaigned on the repeal of the Trump tax cuts and the Annual Exclusion, Lifetime exemption ($22 M for couples) Tax reform 2017 is in question.
4. The tools and Leverage opportunities for wealth transfer may vanish. Currently, many of the top 1% don’t pay estate taxes but that option may be eliminated.
5. 1.  

The Opportunity: Freeze, Discount, Leverage, Transferring  all or part of the assets in your taxable estate:

1. For Private equity members, carried interest is an ideal asset for estate planning because the post-realization value is often much higher than value at inception.
2. FLLC to maintain Control, availability for discounts!
3. SLATS Survivor Lifetime Access Trust
4. Installment sales to Intentionally defective trusts
5. Insurance as a Trust asset class
6. Loans to trusts with asset swaps using, Historically LOW- interest rates

Following historically increased government spending due to the COVID-19 pandemic, President Joe Biden plans to further federal spending with his proposed $6 trillion budget. The 2022 fiscal year budget, proposed on May 28th, will take US federal spending to its highest sustained levels since World War II with deficits running over $1.3 trillion throughout the next decade.

In order to pay for this rising national debt, tax increases for corporations and wealthy individuals have been proposed over the last few months. Currently, Donald J. Trump’s 2017 tax changes, including the gift & estate tax exemption of $11M ($22M/couple), will expire in 2026 and revert back to the previous $5M ($10M/couple) exemption.

Despite this, President Biden’s recent budget proposal signals that tax reform is imminent and highly likely to be repealed this year. The Legislation will be replaced with tax increases that will impact the ability of families to grow, preserve, and transfer wealth. This calls for immediate attention to be directed towards estate planning in order to protect your family’s wealth.

Proposed Changes to Legislation

For the 99.5% Act: This bill, proposed by Senator Bernie Sanders and Senator Sheldon Whitehouse, is by far the most aggressive proposal that impacts estate planning. Not only does it reduce the amount of wealth that can be transferred, but it also attacks the key tools in estate planning that create leverage. The bill includes the following provisions:

• Reduce the gift tax exemption^[1] 
• Reduce the estate tax exemption^[2] 
• Defective grantor trust (DGT) assets will be included in the grantor’s estate. During the grantor’s lifetime, turning off DGT status or a distribution to a beneficiary will be treated as a gift.
  • Irrevocable Trusts will pay their own income taxes
  • Discounted sales to defective grantor trusts will be eliminated
  • Interests on loans to irrevocable trusts will be taxable to the grantor
• Valuation discounts will be eliminated for “planning entities” such as LLC and FLPs (distinguished from operation businesses)

• New Grantor Retained Annuity Trusts (GRATs) will be subject to restricted durations^[3]
• Dynasty trusts, including existing trusts, would be limited to 50-years. For existing dynasty trusts, the 50-year term would start from the day of enactment of the new law, effectively eliminating dynasty trusts
• Currently, anyone can make as many gifts of $15,000 per year as he or she chooses, with no limit on the number of gifts a single donor can make, or the number of gifts a single recipient can receive from different donors. Under the Act, the Annual Exclusion is reduced to just $10,000 per annum, and a donor is limited to giving away just $20,000 in total each year. No recipient can receive more than $10,000 in total in a year.

American Families Plan: This bill, proposed by President Biden, includes the following provisions:

• Increase top tax rate for ordinary income^[4]
• For households exceeding $1 million in income, the top capital gains tax rate would increase^[5].
• Tax carried interest at ordinary income tax rates.
• Eliminate deferral of income tax for real estate exchanges when gains exceed $500,000.
• Impose a tax on unrealized capital gains at death that exceed $1 million, with an exception for family-owned businesses and farms.
• Increase the IRS budget to expand enforcement and auditing efforts

The STEP Act (effective dates not announced): Senator Chris Van Hollen and others introduced a bill that would remove the “step-up in basis,” which currently allows heirs to use the market value of assets at the time of inheritance rather than the actual purchase price as the cost basis for capital gains when the holdings are sold. Additionally, the STEP Act seeks to impose a built-in capital gains tax on a decedent’s estate at the time of the gift or of death, rather than when the recipient sells the asset. This bill includes the following provisions:

• The first $1 million of gains would be excluded
• An additional $500,000 exclusion would apply to a personal residence
• No capital gains tax would be imposed on retirement plans
• Taxpayers would be allowed to pay the tax over 15 years

As of early May, President Biden’s campaign seems to have shifted away from officially increasing the estate tax. However, eliminating the “step-up in basis” and increasing the capital gains tax rate could result in an effective marginal rate as high as 61%. In a state such as Massachusetts with a top estate tax rate of 16%, that could bring the total to 77%

For example, an asset worth $100 million (all of which is a capital gain), the two changes would mean an immediate capital gains tax liability of $42.96 million at the time of death. Upon paying the capital gains tax at death, the value of the $100 million asset falls to $57 million for the purposes of the estate tax. After subtracting the $11.7 million exemption, the 40 percent estate tax rate is levied on the remaining $45.3 million in assets to produce an estate tax bill of about $18.1 million.

Other Proposals

President Biden has previously proposed to increase the federal estate tax rates:

• 45% on taxable estates greater than $3,500,000 but less than $10,000,000
• 50% on taxable estates greater than $10,000,000 but less than $50,000,000
• 55% on taxable estates greater than $50,000,000 but less than $1,000,000,000
• 65% on taxable estates greater than $1,000,000,000

Now that the proposals have been put forward, the next step is for Congress to present a plan that can be approved. President Biden has had conversations with Republican leaders on infrastructure plans, yet it is not clear if a bipartisan bill will be put forward or if the White House will try to pass a bill through budget reconciliation with the slim Democrat majority. Tax increases are never popular and there is an incentive to complete legislation this year so that it will not be a focus in the midterm election in 2022. In order to best protect your family’s future, there is a strong incentive to review estate planning options under the current provisions allowed by the law prior to December 31, 2021. 

Proposed Solutions Offered Through M3 Family Office

The M3 Family Office Gatekeeper Model utilizes a combination of tools (Trusts, SLATs, FLLCs, asset sales, and insurance trusts) to move your appreciating assets outside of your taxable estate in order to maximize your gift tax exemption that may expire or be reduced at the end of the year. Although it is not yet confirmed, existing trusts may be grandfathered into the existing tax code. Therefore, it is prudent to consider all strategies employed now to protect your family from paying inordinate estate taxes in the future.

Family Limited Liability Company, (FLLC): this strategy allows you to transfer assets you believe are going to appreciate, such as income-producing assets or carried interest, into the LLC while retaining the managing interest and gifting the economic interest at a discount to a trust that benefits your heirs. This gift can count against your annual exclusion and lifetime exemption. For further benefit, since you are gifting LLC interests that are not liquid and has no voting rights, you can take a discount for the lack of marketability. Thus, you can retain full control of the asset while reducing your taxable estate and maximizing your gift tax exemption.  

For Private Equity members, Carried interest is an ideal asset for estate planning because post-realization value is often much higher than the value at inception.

1. Future cash flows are discounted to the present value at a relatively high discount rate (e.g. 20%)

• Limited partner/non-managing member interests in Fund GPs are subject to valuation discounts for lack of marketability and lack of control (25%-40%)

• Carried interest can thus be transferred at inception at a low gift tax cost relative to the ultimate wealth transferred

Intentionally Defective Grantor Trust (IDGT): a type of irrevocable trust that contains certain provisions or powers that cause the grantor of the trust to be treated as the owner of the trust assets, but only for income tax purposes. For estate tax purposes, assets held inside the trust remain outside of the grantor’s taxable estate. Consequently, the trust is referred to as being “defective” because the grantor must pay all income taxes associated with trust assets even though the grantor does not actually own these assets or control them. This is positive for estate leverage since the payment of taxes by the grantor on behalf of the trust does not count against annual or lifetime gift limits. If confronted with short-term liquidity issues, the Trust can make a distribution to the member’s spouse if listed as a beneficiary, substitute illiquid assets, or can utilize a direct line of credit.

Spousal Lifetime Access Trust (SLAT): as the grantor, you can make your spouse a beneficiary of an irrevocable trust and allow them to have access to all the income the Trust earns, and even the principal if they need it. You can even set up a line of credit between the Trust and your spouse in the event that there is a temporary cash need. The ultimate goal is that you can provide backdoor access to these assets. However, if you do not need the funds, they will pass them to your heirs as beneficiaries outside the estate tax box.

Irrevocable Life Insurance Trust (ILIT):  a trust that contains provisions specifically designed to facilitate the ownership of one or more life insurance policies. The ILIT is both the owner and the beneficiary of the life insurance policies, typically insuring the life of the grantor and providing liquidity for taxes up to a 40% lower premium. If the trust is structured and managed properly, the life insurance death benefit received by the ILIT will not be subject to income tax or estate tax.

When funded with life insurance, an ILIT can provide:

• Tax-free cash for your beneficiaries to pay estate taxes and other transfer costs
• A pool of assets to increase your beneficiaries’ total inheritance
• Effective management of your assets after your death
• Leverage of your generation-skipping tax (GST) exemption and utilize your annual gift tax exclusion
• Liquidity for estate equalization among heirs
• A tax-advantaged wrapper to use for Trust assets

A specific life insurance policy called second-to-die in an ILIT can increasingly be used as an asset class for more than just ultra-high-net worth individuals in order to optimize estate planning in the face of President Biden’s upcoming tax changes. Most notably Private Split Dollar Survivorship Life, even more, valuable to help mitigate potentially massive income and estate taxes. 

Conclusion

The United States is currently in an environment where tax increases and reforms are looming. The Rising national debt has been the main catalyst that has led to the potential for policy changes like the American Families Plan, For the 99.5% Act, and the STEP Act. To pay for these proposals, the government is coming after the top 1% in the form of taxing their wealth. As a result of this, wealthy families and individuals will become increasingly vulnerable to these tax hikes.

The proposed legislation will have adverse gift and income tax penalties on many estates. The Biden Administration so-called “Green Book,” is specifically targeting dynasty trusts and intentionally defective grantor trusts, common techniques to move millions of dollars out of wealthy families’ taxable estates to benefit heirs.

However, proper estate and financial planning can help to diminish these generational impacts. This is why at M3 we strive to be the long-term gatekeepers of your wealth.

• Wealth Management is all about having financial control.  It’s peace of mind that comes from knowing where your money is and how it’s working for you.
• At M3 we believe that wealth management begins with your vision. We help define, clarify and coordinate that vision.  We then develop and implement strategies for the protection, preservation, and growth of your wealth.
• We serve as the gatekeeper of your wealth. We provide the platform for gaining and maintaining financial control.  We dedicate ourselves to the stewardship of your assets, both for today and tomorrow.

M3 Wealth Advisors and Integrated Financial Partners do not provide tax or legal advice.

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^[1] $11.7M ($23.4M/couple) to $1M per person ($2M/couple)

^[2] $11.7M to $3.5M ($7M/couple)

^[3] ranges from a minimum of 10-years to a maximum of grantor’s life expectancy plus 10 years and must have a minimum gift value of 25% which eliminates “zero GRATs”

^[4] 37% to 39.6%

^[5] 20% to 39.6%.