Florida Bar Journal

Estate Planning During an Election Year: Will It Be 2012 All Over Again?

This year should be one of the busiest years for all estate planning attorneys; indeed, it could be a repeat of 2012, when the Economic Growth and Tax Relief Reconciliation Act of 2001^[1] was scheduled to expire on December 31, 2012, in which case the estate and gift tax exemption, and the generation-skipping transfer (GST) tax exemption, would have reverted to $1 million, and the highest transfer tax rate would have reverted to 55%. The fury of planning that took place at the end of 2012 ended up being much ado about nothing, as President Obama signed the American Taxpayer Relief Act of 2012 on January 2, 2013, retroactive to December 31, 2012, which made the laws pertaining to the estate and gift tax, and GST tax, permanent.^[2]

The end of 2020 should be similar, but a bit different. The current law, the Tax Cut and Jobs Act of 2017,^[3] signed by President Trump on December 22, 2017, essentially doubled the transfer tax exemptions from $5 million to $10 million, indexed for inflation.^[4] The current law is scheduled to expire on December 31, 2025, meaning that on January 1, 2026, the exemptions will be $5.6 million, indexed for inflation from 2018.^[5] However, on November 3, 2020, there will be a presidential election, along with elections in the U.S. Senate and House of Representatives. Thus, depending on the outcome of such elections, and particularly if a Democrat wins the presidential election, it is quite possible that the exemptions could revert to the 2018 amount even sooner. It is even possible that the transfer tax laws could change even more dramatically if a more liberal candidate is elected president.

Because of the potential changes to the estate, gift, and GST tax laws next year, individual clients who have a net worth in excess of the current exemption of $11,560,000, and married couples who have a net worth in excess of two times the exemption, or $23,120,000, should consider how to use the enhanced exemptions before they may no longer apply. In other words, it is use it or lose it all over again, just like 2012.

This article revisits the planning techniques in the estate planner’s arsenal to use the exemptions now. Specifically, this article will address the use of the following estate planning techniques: 1) dynasty trusts; 2) spousal lifetime access trusts (SLATs); 3) inter vivos qualified terminable interest property trusts (inter vivos QTIP trusts); 4) self-settled domestic asset protection trusts; and 5) general power of appointment trusts. The planning technique that will be best suited for any particular client will depend on the facts and circumstances, as there is no one size that fits all.^[6]

Revisiting Portability

Before diving into the planning options, it is important to first briefly discuss portability and its usefulness (or lack thereof) in utilizing the enhanced exemptions. Simply put, portability allows an individual to “port” (or transfer) upon death any of his or her gift and estate tax exemption not used by the individual during life or upon death to his or her surviving spouse. Thus, portability generally allows a married couple to fully utilize both of their gift and estate tax exemptions, even where the first spouse to die owns assets at the time of death having a value equal to less than his or her remaining estate tax exemption, or his or her estate plan leaves his or her assets to the surviving spouse or charity so that his or her remaining estate tax exemption is not used. Prior to portability, any gift and estate tax exemption not used during life or upon death was lost.

There are three main flaws with relying on portability in our current tax environment. First, portability is not applicable to the GST tax exemption. Therefore, although it may be possible to utilize portability to plan for the use of both spouses’ estate tax exemptions, if an individual does not fully utilize his or her GST tax exemption during life or at death, it is forever lost.

Second, a surviving spouse can only use the ported exemption of his or her last deceased spouse. Thus, if exemption is ported to a surviving spouse who remarries, and the new spouse then dies, the ported exemption of the first deceased spouse cannot be used.

Third, and more applicable to the current tax environment, portability does not ensure full use of both spouse’s “enhanced” estate tax exemptions. The reason for this is that portability would only be effective if the first spouse dies prior to the exemptions reverting back to the lower amounts. If the first spouse dies after the exemptions revert back, the enhanced exemption will be lost. In addition, if portability is elected and the enhanced exemption is ported, but the exemptions revert back to their original amounts, the ported exemption available for use by the surviving spouse will be limited to the reduced amount, not the enhanced amount.^[7]

Given this existing landscape, it is imperative for estate planners to engage in proactive planning for their clients now to ensure full use of each spouse’s gift and estate tax exemptions, and GST tax exemptions. Indeed, it appears to be a use it or lose it situation and, yes, it is 2012 all over again.

Planning Options

• Option 1: Gift to Irrevocable Trust — The easiest (and most common) way for a client to utilize his or her gift and GST tax exemptions is for the client to create an irrevocable trust for the benefit of his or her children and more remote descendants and transfer to the trust assets having a value equal to the lesser of the client’s remaining gift or GST tax exemption.^[8] The transfer to the trust by the client is a taxable gift. As a result, a gift tax return must be filed to report the gift and, importantly, allocate (either by affirmative allocation or an automatic allocation) an appropriate amount of GST tax exemption to the transfer to ensure the trust has an inclusion ratio of zero. By allocating GST tax exemption to the full value of the transfer, the assets in the trust will pass from generation to generation without the imposition of transfer tax for the longest period permitted by the applicable state’s perpetuities period — 360 years in Florida.^[9] For this reason, these types of trusts are often referred to as “dynasty trusts.”

For married clients, dynasty trusts may be implemented in three ways to utilize both spouse’s enhanced exemptions.

First, if each spouse owns sufficient assets in their individual names (or if the couple is comfortable transferring assets between themselves) each spouse can create a separate trust for the benefit of their children and more remote descendants. Each spouse would allocate his or her GST tax exemption to the trust he or she created. One benefit of this approach is that each spouse can act as trustee of the trust created by the other spouse. Although this does not permit access to the trust assets, it allows the marital unit to retain control over investment and distribution decisions with respect to all assets transferred to the trusts.

Second, if substantially all of the couple’s assets are owned jointly, the couple can create and fund a single dynasty trust for the benefit of their children and more remote descendants. Both spouses would allocate their GST tax exemption to the trust. The downside with this approach is that neither spouse can act as trustee and, upon the first death, the administration of the trust may become more complex because for income tax purposes there will be two trusts, one of which is treated as a grantor trust and one of which is treated as a complex trust.

Third, if substantially all of the couple’s assets are owned by one spouse, the spouse owning the assets can create a single dynasty trust and fund it with assets having a value equal to two times his or her exemption amounts (or, if his or her spouse has less exemption remaining, two times the remaining exemption amounts of his or her spouse). The couple will then elect gift splitting, which will result in each spouse being treated as having transferred 50% of the assets to the trust. This effectively allows for the utilization of both spouse’s exemptions, despite all of the assets coming from one spouse. With this approach, the nonfunding spouse can act as trustee of the trust, and the trust will continue to be treated as one trust for income tax purposes upon the first death.

With an objective of fully utilizing the enhanced exemption amounts, dynasty trusts are best suited for clients who are either not married or married, but do not have a need (or desire) to retain any level of access to the gifted funds. This is because, with a dynasty trust, neither the client nor the client’s spouse (if the client is married) has direct access to the funds transferred to the dynasty trust. With the exemptions as high as they are today, many clients may not be comfortable creating and funding a dynasty trust with assets having a value equal to the full enhanced exemption amounts; they often fear that the assets they will retain will not be sufficient to maintain their current lifestyle.

• Option 2: Spousal Lifetime Access Trusts — As discussed above, one impediment to the implementation of a dynasty trust is the loss of access to the gifted funds. However, for individuals who are married, they may just be able to have their cake and eat it too.

A SLAT is a technique that can be utilized by a married couple who want to fully utilize their enhanced exemptions, but also need (or desire) to retain access to the gifted funds. A SLAT is similar to a dynasty trust, except that the individual creating the SLAT includes his or her spouse as a beneficiary of the trust. In situations where both spouses are seeking to fully utilize their exemptions, each spouse will create a SLAT for the benefit of the other spouse and their children and more remote descendants. Each spouse will then gift to the SLAT that he or she created assets having a value up to his or her remaining exemption amounts. The transfers to the SLATs will be taxable gifts. Each spouse will be required to file a gift tax return to report the gift and to allocate an appropriate amount of GST tax exemption to the transfer. As with the dynasty trust, by allocating GST tax exemption to the full value of the transfers, the assets in the SLATs will pass from generation to generation without the imposition of transfer tax.

By including the spouse as a beneficiary, the spouse will have direct access to the SLAT assets (as a beneficiary) and the client will retain indirect access to the SLAT assets (as the spouse of a beneficiary). Thus, as long as both spouses are alive and married to each other, the marital unit will have access to all of the assets transferred to both SLATs.^[10] However, upon the death of one spouse, or upon divorce, access to 50% of the assets will be lost.

If a married couple owns assets in excess of two times the exemption amounts, but one spouse does not own in his or her individual name a sufficient amount of assets to fully utilize his or her exemption amounts, assets can be transferred between spouses as necessary to allow for the full utilization of both spouses’ exemptions through the creation of two SLATs. This shifting of assets between spouses should not be subject to transfer tax as a result of the unlimited gift tax marital deduction.^[11] Although transferring assets between spouses is an effective way to ensure both spouses fully utilize their exemptions, clients may be reluctant to cede any control over the ultimate disposition of their assets by transferring them to a spouse — even if for purposes of implementing a SLAT structure.

SLATs need to be drafted carefully to avoid the so-called “reciprocal trust” doctrine.^[12] Under the reciprocal trust doctrine, if the SLATs created by each spouse for the benefit of the other have substantially similar terms, the IRS may argue that the SLATs should be “uncrossed,” so that each spouse is deemed to have created a trust for his or her own benefit. If the IRS is successful, the intended planning will be defeated, as each spouse will be treated as having created a self-settled trust, which will be included in their respective estates for estate tax purposes upon death. To help reduce this risk, the SLATs should have — at a minimum — different independent trustees and the dispositive provisions should differ.

• Option 3: Inter Vivos Qualified Terminal Interest Property Trust — An inter vivos QTIP trust is an additional technique worth considering where the objective is to fully utilize both spouses’ gift and GST tax exemptions. Inter vivos QTIP trusts are often used in situations where the wealthy spouse owns significantly more assets than the other spouse. This technique may be preferable to a SLAT, which, as discussed above, may require reallocating assets between spouses in order to fully utilize both spouses’ exemptions because it allows for the wealthy spouse to retain control over the ultimate disposition of the assets.

An inter vivos QTIP trust is an irrevocable trust created by the wealthy spouse for the sole benefit of the other spouse during his or her lifetime. The wealthy spouse will generally fund the inter vivos QTIP trust with assets having a value equal to the other spouse’s gift and GST tax exemptions. The inter vivos QTIP trust would be structured to qualify as a QTIP trust under §2523(f) of the Internal Revenue Code of 1986, as amended. To qualify as a QTIP trust, generally, 1) the other spouse must be the sole beneficiary; 2) all income must be distributed to the other spouse at least annually for the rest of his or her life without limitation; 3) during the other spouse’s life, no distributions of principal may be made to anyone other than the other spouse; and 4) a timely QTIP election must be made on a gift tax return filed for the year in which the initial transfer is made to the inter vivos QTIP trust. When making the QTIP election, it is important not to make a reverse QTIP election (which is often made on an estate tax return with respect to a QTIP trust created upon death) with respect to the inter vivos QTIP trust. If a reverse QTIP election is made, the wealthy spouse would be treated as the transferor of the asset for GST tax purposes upon the other spouse’s death (or upon disclaiming the interest in the trust, as further discussed below). This would prevent the other spouse from allocating his or her GST tax exemption to the assets.

The result of the inter vivos QTIP trust qualifying as a QTIP trust is that all transfers to the inter vivos QTIP trust will qualify for the unlimited gift tax marital deduction and, upon the other spouse’s death, all of the assets of the QTIP trust will be included in his or her gross estate for estate tax purposes. This effectively allows for a portion of the wealthy spouse’s assets (i.e., those transferred to the inter vivos QTIP trust) to be shielded from estate tax by the other spouse’s estate tax exemption. And, causing the assets of the inter vivos QTIP trust to be included in the other spouse’s gross estate (and not making the reverse-QTIP election, as previously discussed), results in the other spouse being treated as the transferor of the property for GST tax purposes. This will allow the personal representative of the estate of the other spouse to allocate his or her GST tax exemption to the assets owned by the inter vivos QTIP trust upon death.

To avoid the risk of the exemption amounts being reduced prior to the other spouse’s death and ensuring the full use of the other spouse’s enhanced gift and GST tax exemptions, a nonqualified disclaimer by the other spouse could be utilized in connection with the inter vivos QTIP trust. A nonqualified disclaimer is a disclaimer that does not satisfy all of the requirements under I.R.C. §2518 for a qualified disclaimer. With a qualified disclaimer, the disclaimant is not treated as making a gift when he or she executes a disclaimer. Contrariwise, with a nonqualified disclaimer, the disclaimant is treated as making a gift and is treated as the transferor for GST tax purposes. Consequently, by executing a nonqualified disclaimer when the exemptions are enhanced, the other spouse can use his or her gift tax exemption and allocate his or her GST tax exemption to the gift so that his or her GST tax exemption can be utilized. As a result of a disclaimer, the property interest being disclaimed terminates, and the property being disclaimed passes pursuant to the terms of the governing instrument.

Generally, the dispositive provisions of an inter vivos QTIP trust provide that, upon the other spouse’s death, if he or she predeceases the wealthy spouse, assets of the inter vivos QTIP trust having a value equal to the other spouse’s remaining estate tax exemption pass to a bypass or credit shelter trust for the benefit of the wealthy spouse, and assets in excess of such amount pass to a marital trust for the benefit of the wealthy spouse. If the other spouse executes a nonqualified disclaimer, the other spouse’s interest in the inter vivos QTIP trust will terminate, and the assets of the inter vivos QTIP trust will be disposed of as if the other spouse had died (and the other spouse will be treated as the transferor of the assets for gift and GST tax purposes). As a result, if the wealthy spouse funds the inter vivos QTIP trust with $11,560,000 and the other spouse makes a nonqualified disclaimer in 2020 (when his or her gift and GST tax exemptions are $11,560,000), the bypass or credit shelter trust created for the benefit of the wealthy spouse would be funded with $11,560,000. For gift and GST tax purposes, the other spouse would be treated as making a $11,560,000 taxable gift to the bypass or credit shelter trust. However, the other spouse’s $11,560,000 of gift tax exemption would fully shield the transfer from gift tax. Further, due to the other spouse being treated as the transferor of the assets for transfer tax purposes, the other spouse could allocate $11,560,000 of his or her GST tax exemption to the trust.

The use of the nonqualified disclaimer technique effectively allows the wealthy spouse to fully utilize the other spouse’s gift and GST tax exemptions to create a “self-settled” trust for the benefit of the wealthy spouse and his or her descendants. Generally, the assets of a self-settled trust (i.e., a trust created by an individual for the benefit of himself or herself) are exposed to the settlor’s creditors; and, significantly from a transfer tax perspective, such assets are includible in the settlor’s gross estate upon his or her death because the transfers to the trust are considered to be “incomplete gifts” for gift tax purposes. The reason for this is that technically, the continuing trusts created under an inter vivos QTIP trust upon the other spouse’s death (whether by actual death or “deemed” death because of the disclaimer) for the benefit of the wealthy spouse are self-settled trusts because the assets in those trusts originated from the wealthy spouse. However, some states have statutes that specifically exclude inter vivos QTIP trusts from treatment as self-settled trusts. For example, under F.S. §736.0505(3), upon the death of the other spouse, the assets of the inter vivos QTIP trust that are distributed to the continuing trusts for the benefit of the wealthy spouse are deemed to have been contributed to such trusts by the other spouse and not by the wealthy spouse. Thus, by statute, the continuing trusts for the wealthy spouse are not self-settled trusts; and, consequently, they would not be included in the gross estate of the wealthy spouse upon his or her death.

While the Florida statute clearly addresses the treatment of the trust upon “actual” death, it is unclear whether the statutory exception would also apply if the continuing trusts are funded as the result of a “deemed” death following a disclaimer. The statute speaks to the “death of the settlor’s spouse.” Taken literally, it would not apply to a deemed death. Furthermore, in jurisdictions that don’t have such a statute, arguably the continuing trusts are “self-settled” trusts. To avoid any risk that the continuing trusts created as a result of the disclaimer for the benefit of the wealthy spouse will be treated as self-settled trusts (subject to the wealthy spouse’s creditors and includible in the wealthy spouse’s gross estate), it is best to establish the inter vivos QTIP trust in a jurisdiction that has a domestic asset protection trust statute, such as Alaska, Delaware, Nevada, or South Dakota, to name a few. These jurisdictions generally allow an individual to create a trust for his or her own benefit without the assets of such trust being subject to the claims of his or her creditors or included in his or her gross estate. Therefore, even if the continuing trusts created under the inter vivos QTIP Trust as a result of the disclaimer are deemed to be self-settled trusts, the assets of such trusts would remain creditor protected and removed from the wealthy spouse’s gross estate.

• Option 4: Domestic Asset Protection Trust — An additional option to consider for clients who are not married or who want to retain access to all of the gifted assets is a dynastic trust created in a jurisdiction with domestic asset protection trust legislation (a DAPT). As discussed above, these jurisdictions generally allow for an individual to create a trust for his or her own benefit without the assets of such trust being subject to the claims of his or her creditors or included in his or her gross estate. Furthermore, and imperative to the technique in this instance, is that transfers to the trust can be structured as completed gifts for transfer tax purposes. Accordingly, a client who owns assets in excess of the enhanced exemption amounts may create a DAPT for the benefit of his or her children and more remote descendants (if any) and also be named as a discretionary beneficiary of the DAPT. Although the individual creating the trust can be a discretionary beneficiary of the trust (and, thus, have access to the funds transferred to the DAPT), in order for the DAPT to be respected for asset protection and transfer tax purposes, the client should retain sufficient assets outside of the trust to maintain his or her current lifestyle.

Transfers to the DAPT will be taxable gifts. A gift tax return will need to be filed to report the gift and allocate an appropriate amount of GST tax exemption to the transfer. As with the above techniques, by allocating GST tax exemption to the transfer, the assets in the DAPT will pass from generation to generation without the imposition of transfer tax.

• Option 5: General Power of Appointment Trust / Using other Family Members’ Exemption — Clients very often have a mismatch between the amount of gift and GST tax exemptions remaining. For example, if a client has been transferring $200,000 per year to an irrevocable trust (e.g., a life insurance trust) that includes withdrawal (i.e., Crummey) powers, the entire $200,000 may qualify for the gift tax annual exclusion, but not for the so-called “GST tax annual exclusion.”^[13] As a result, although the $200,000 gift each year does not reduce the client’s gift tax exemption, $200,000 of the client’s GST tax exemption is allocated to the trust each year. As a result, after 10 years, it is possible for the client’s gift tax exemption to exceed his or her GST tax exemption by $2 million. If the client were to utilize one of the above techniques to fully utilize his or her gift tax exemption, two separate trusts would need to be created — one funded with $9.56 million to which GST tax exemption is allocated, and one funded with $2 million to which no GST tax exemption is allocated. The assets in the trust to which no GST tax exemption is allocated will be subject to GST tax upon the death of the client’s children.

Clients who are faced with the above scenario often have family members, such as parents, who do not own sufficient assets to fully utilize their exemptions.^[14] Accordingly, it is desirable to implement techniques that may allow for the client to utilize a family member’s exemptions that otherwise would go to waste.

One way to achieve this objective is for the client to create a trust for the benefit of his or her children and more remote descendants and grant his or her parent (or other family member with available exemption) a general power of appointment, exercisable in favor of the parent’s creditors. The general power of appointment should be structured to lapse on December 31 each year with respect to a portion of the trust assets having a value equal to the parent’s GST tax exemption. As a result of the lapse of the general power of appointment, the parent will be treated as having made a gift to the trust in an amount equal to the value of the property subject to the lapse. The gift will be shielded from gift tax by the parent’s gift tax exemption. As a result of the parent being treated as making a gift to the trust, the parent will also be deemed to be the transferor for GST tax purposes, which will allow the parent to allocate his or her GST tax exemption to the property subject to the lapse. As a result of the transaction, the client is able to fund a trust with assets having a value equal to the excess of his or her gift tax exemption over his or her GST tax exemption, which would otherwise be GST nonexempt, and utilize his or her parent’s GST tax exemption to make the trust GST exempt.

For example, if the client has $2 million of excess gift tax exemption, the client would create an irrevocable trust for the benefit of his or her children and more remote descendants and fund the trust with $2 million on December 20, 2020. A gift tax return would need to be filed to report the gift. The client would not have any GST tax exemption to allocate to the transfer. The trust would be drafted to grant the client’s parent (who has minimal assets and $11,560,000 of gift and GST tax exemptions) a general power of appointment. The general power of appointment lapses on December 31 each year over a portion of the trust assets having a value equal to the parent’s GST tax exemption. On December 31, 2020, the general power of appointment would lapse with respect to the entire $2 million owned by the trust. As a result of the lapse, the parent would be treated as making a $1.9 million gift to the trust (the lapse of a general power of appointment is only a taxable gift to the extent the value of the property subject to the lapse exceeds the greater of $5,000 and 5% of the value of the trust property).^[15] The client’s parent would need to file a gift tax return to report the gift and allocate $1.9 million of his or her GST tax exemption to the transfer. Each subsequent year, as the exemptions increase for inflation, the client could gift to the trust assets having a value equal to his or her excess gift tax exemption, if any, utilizing the parent’s GST tax exemption in the same manner.

Even if a client has used all of his or her gift tax exemption, the above technique can still be utilized to achieve significant transfer tax savings by the client making taxable gifts to the trust. Although clients are often reluctant to write a check to the IRS, paying gift tax now is cheaper than paying estate tax later (and the benefits are magnified if you are able to allocate another individual’s GST tax exemption to the gifted funds). The reason for this is that the gift tax is “tax exclusive” and the estate tax is “tax inclusive.” What this means is that the dollars used to pay the gift tax are not subject to gift tax, but the dollars used to pay the estate tax are subject to estate tax. The result is that the effective tax rate on gifts is lower than the effective tax rate on assets passing at death.

Finally, an estate planner is likely to encounter an individual (possibly a child of a client) who does not own significant assets in his or her individual name, but is the beneficiary of one or more trusts that may be otherwise subject to estate tax upon such individual’s death. Despite not owning any assets in his or her name, it may still be possible to utilize his or her enhanced exemptions before they are lost. In order to utilize the child’s enhanced exemptions, an independent trustee could distribute to the child (provided that the terms of the trust permitted such distributions) assets having a value up to his or her enhanced exemption amounts. The child can then use these assets to implement one or more of the techniques discussed above. By pulling assets out of the trust now and engaging in the above planning with those assets, they will no longer be subject to GST tax upon the child’s death and will pass from generation to generation without the imposition of transfer tax.

With potentially one of the busiest years for estate planners ahead, now is the time to begin discussions with clients regarding the various planning opportunities that are available to utilize the enhanced exemptions before they revert back to the lower amounts. Bear in mind that there is no one-size-fits-all approach. Each client’s circumstances must be carefully considered.

This column is submitted on behalf of the Tax Law Section, Janette M. McCurley, chair, and Taso Milonas, Charlotte A. Erdmann, and Jeanette E. Moffa, editors.