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Considering how to take advantage of current gift tax exemption amounts, but concerned about changing legislation?

Caroline McKay

February 17, 2021

Three ways to build flexibility into your planning.

This is the third blog in a four-part series that focuses on purposeful planning this year amidst some uncertainty.
Read part 1: 
Is uncertainty preventing you from planning?
Read part 2: Considering whether life insurance fits within your wealth plan
Read part 4: Four planning ideas that can help further your wealth planning goals

If you are contemplating making a gift this year to take advantage of the historically high gift and generation-skipping transfer tax exemptions (currently $11.7 million per individual), you are not alone. Many individuals are considering making gifts this year, particularly in light of the possibility that these exemptions could be reduced if some of the tax proposals set forth by President Biden are enacted. In addition, there has been some speculation that tax legislation enacted this year could be retroactive to the beginning of the year. If a law reducing transfer tax exemptions is retroactive, an individual making a large gift this year could potentially be subject to gift taxes. To address this possibility, consider the following three planning strategies: 

1) Disclaimer

 A disclaimer is when a gift recipient renounces part or all of a gift transferred to that recipient. When a gift is made to a trust, the trust instrument can specify how the assets pass in the event of a disclaimer. If a grantor makes a gift to a trust but is concerned that the gift could become subject to tax under retroactive tax legislation, then the trust can provide that the assets revert to the grantor in the event of a disclaimer.  

  • Disclaimers must generally be made within nine months of the transfer, so there will be a nine-month window to see if the transfer tax exemptions are reduced.
  • In order for there to be favorable tax treatment of the disclaimer, the disclaimer must be a “qualified disclaimer” by meeting several requirements under federal and state law.

2) Qualified terminal interest property (QTIP) trust

A QTIP trust is a trust that provides a grantor’s spouse with mandatory income and, if desired, access to principal until the spouse’s death. After the spouse’s death, the remaining assets can be held for the benefit of other named beneficiaries, like children and grandchildren. When a QTIP trust is established during the grantor’s life, the grantor can decide whether to make a “QTIP election.” By making such an election, a gift to the trust would qualify for the marital deduction; if no election is made, a gift to the trust would require use of the grantor’s gift tax exemption to avoid gift taxes. Consequently, if a grantor is contemplating a gift to a trust but is concerned that the gift could become taxable under retroactive tax changes this year, making the gift to a trust with QTIP provisions affords the flexibility to avoid this tax exposure.

  • A QTIP election for a gift to trust must be made on a gift tax return, which is typically due by April 15 of the year after the gift is made (or as late as October 15, if an extension is filed).  This allows the grantor to wait until next year to decide if the gift to the trust is taxable and covered by the exemption, or is a nontaxable marital deduction gift.
  • For a QTIP trust to qualify for the marital deduction, certain requirements must be met, including that the grantor’s spouse is a U.S. citizen.

3) Formula gift

When making a gift, individuals often transfer a fixed dollar amount or certain asset(s) to the intended recipient. However, when there is uncertainty with respect to what the value of the gift should be for gift tax purposes, another option is to define the gift using a formula. With a formula gift, if an individual wants to use his or her remaining gift tax exemption, but is concerned that the exemption amount might change retroactively, the transfer documents can describe the gift as an amount equal to the individual’s available exemption at the time of the transfer rather than referencing or transferring a specific dollar amount. The purpose of this type of formula gift is to limit the donor’s liability for gift taxes should the gift tax law change.

  • If the gift tax exemption is retroactively reduced after the gift is made, then the formula automatically adjusts the amount of the gift rather than the individual having to pay tax. 
  • Formula gifts need to be carefully drafted to achieve the desired result, so it is critical to work with an attorney familiar with such gifts.

 

Including flexibility in planning is always important, but it can be particularly important when tax laws may change. There are many different planning strategies that can create flexibility or limit the amount of a transfer beyond those outlined above. It is critical to work with qualified professionals when choosing and implementing the planning that is best for you and your family.

Caroline McKay is a senior wealth strategist with CIBC Private Wealth’s Boston office, and has 13 years of industry experience. In this role, she works closely with relationship managers and clients to develop and implement estate and wealth transfer strategies as part of the firm’s integrated wealth management process.