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Alert

Estate and Tax Planning 2023 Update: Act While You Can

Although the IRS is now on high alert for wealthy individuals, new and existing planning opportunities are available, such as tax-free gifts and other advantageous planning.

By Jennifer Jordan McCall, Matthew Perotti

Alert

By Jennifer Jordan McCall, Matthew Perotti

Takeaways

Wealthy individuals and families should take note of recent announcements by the Internal Revenue Service regarding its concentrated focus on high-income taxpayers, as well as new transfer opportunities of renewable energy credits available to individuals, estates and trusts.
In light of the looming reduction of estate and gift tax exemption amounts, now is the time to address estate and tax planning updates and to consider the use of the gift and generation-skipping transfer exemptions.

10.18.23

The 2023 taxation climate presents challenges—as well as opportunities—for wealthy individuals and families. This September, the Internal Revenue Service (IRS) announced its concentrated focus on high-income taxpayer compliance, while in June the IRS and Department of the Treasury released guidance that allows individuals, estates and trusts to benefit from certain new transfer opportunities of renewable energy credits. With the scheduled sunset of the all-time-high unified estate and gift tax exclusion amounts, as well as the IRS taking harsh positions against high-income earners, now is the time to consider opportunities for estate and tax planning. Very often, these opportunities to save tax will include making gifts to children, including in trust for them, and using the generation-skipping transfer (GST) exemption to make the potential transfer tax savings on that gift last through many generations.

Planning with the Looming Decrease of Estate and Gift Tax Exemption Amounts
The estate and gift tax exemption amounts are set to decrease at the end of 2025. Currently, an individual can make transfers by gift during life, and bequests at death, up to an aggregate of $12.92 million, with that amount increasing to $13.44 million in 2024, without incurring gift or federal estate tax. Similarly, the federal GST exemption is currently $12.92 million, increasing to $13.44 million in 2024. On January 1, 2026, these amounts are scheduled to “sunset” and revert back to the 2017 amount of $5 million, adjusted for inflation. Although the time frame for sunsetting may be extended depending on political and economic factors, it would be prudent to take advantage of the opportunities available now by utilizing the exemption amounts in excess of the projected 2026 exemption amounts, in case the exemptions are reduced as scheduled in 2026 (or possibly by changes in the law before then).

In light of the looming reduction of estate and gift tax exemption amounts, consider some of the following opportunities during the remainder of 2023:

  • Complete gifts now to use available exemptions, particularly GST tax exemption for gifts into a long-term dynasty trust. In light of the pending decrease of the estate, gift and GST tax exemption amounts and taking into consideration the proposed effective dates, it may make sense for those individuals who have exemptions available to make gifts prior to year-end 2023, and before the uncertainties inherent in election year 2024.
  • In connection with making gifts in 2023, giving a fractional interest in the property (such as an interest in an LLC or real estate) may prove beneficial as the value for gift tax purposes may be reduced by certain discounts, such as a discount for lack of control and/or lack of marketability.
  • Consider a spousal lifetime access trust (SLAT) to take advantage of the current high gift and GST exemptions, while retaining some access to the trust assets at the spousal level.
  • Consider giving to an irrevocable “grantor trust” that includes a power to reimburse the grantor for income taxes paid. A “grantor trust” means the grantor, not the trust, is treated as the owner for income tax purposes. The grantor pays all income taxes attributable to the trust income, which allows the trust assets to grow without reduction for income taxes.[1] Grantor trusts can be drafted to permit a trustee to reimburse the grantor for income taxes paid; however, until recently it was an open question whether such a power in a California grantor trust would cause negative estate tax consequences to the grantor. This is because prior announcements from the IRS stated that a power to reimburse a grantor for income taxes paid does not cause inclusion of the trust in the grantor’s estate if certain requirements are met, including that applicable state law must not subject the trust assets to the claims of a settlor’s creditors. Effective January 1, 2023, the California Probate Code clarifies that a trustee’s power to reimburse the grantor for income taxes paid does not create a beneficial interest that would allow the settlor’s creditors to reach trust assets.
  • For those who are charitably inclined, consider charitable planning such as charitable remainder unitrusts (CRUTs) and charitable lead annuity trusts (CLATs).
  • For individuals and families who do not have a significant amount of estate and gift tax exemption available but wish to reduce their overall estate, consider a sale to a trust in exchange for a promissory note. If structured properly, since the transaction is a sale, it will not be treated as a taxable gift, and the assets sold to the trust will be excluded from the estate of the grantor/contributor. The note becomes the replacement asset of grantor/contributor, effectively transferring the appreciation on the asset to the trust.
  • If you own Qualified Small Business Stock (QSBS), consider gifts to one or more irrevocable trusts to take advantage of substantial exclusions from federal income tax on capital gains. Gifts of QSBS continue to be eligible for the exclusion on gain, and the transferor’s five-year holding period “tacks” to the transferee. The gifted shares to irrevocable trusts that are appropriately structured will be eligible for a separate exclusion (up to the limitation amount) in addition to the exclusion that continues to be available for eligible shares retained by the transferor.
  • For individuals who have used their lifetime gift exemption but still have unused GST exemption, consider a late allocation of your remaining GST exemption amount to an existing GST non-exempt trust you have previously created. Alternatively, consider setting up a new two-year grantor retained annuity trust (GRAT) before the end of 2023 so you can apply your unused GST exemption to the GRAT remainder interest prior to January 1, 2026.

The foregoing is solely for illustration purposes. You should reach out to your legal advisor before undertaking any tax or estate planning to determine if it is appropriate for your situation.

New Tax Credit Planning Opportunities for Individuals and Families
Beyond the planning above, individuals and families should be aware of certain new tax planning opportunities. In June, the Department of the Treasury and IRS released guidance on Internal Revenue Code (IRC) Section 6418, which provides taxpayers a new way to monetize certain energy tax credits. The guidance included proposed regulations relating to the transferability of tax credits under IRC Section 6418. Specifically, Section 6418 allows for the sale of tax credits solely for cash to unrelated taxpayers, and such payment does not constitute taxable income to the transferor (and is not deductible by the transferee). Prior to the enactment of Section 6418, investors typically accessed renewable energy tax credits by investing in so-called “tax equity” partnerships—which were only workable for more sophisticated investors due to the costs and qualifications under such partnership arrangements. Now, with the new rules, monetization of renewable energy tax credits has been made more accessible to a broader range of investors, including partners of a partnership and individuals. Unfortunately, limitations exist. For one, the “passive activity” limitations, applying to individuals, trusts and estates (but not corporations), make such transferees subject to IRC Section 469, only allowing them to utilize purchased tax credits against tax liabilities associated with passive income generated from other sources. For more information on this topic, please refer to our prior alert.

Newly Focused Aim by the IRS on Wealthy Taxpayers
In September, the IRS announced its focused aim on high-income earners to “identify sophisticated schemes to avoid taxes.” Bolstered by its funding from the Inflation Reduction Act (IRA) of 2022 (P.L. 117-169) and equipped with artificial intelligence and machine-learning technologies, the IRS employed three key initiatives. First, in its “High Wealth, High Balance Due Taxpayer Field Initiative,” the IRS has committed dozens of revenue officers to focus on taxpayers with total positive income above $1 million and more than $250,000 in recognized tax debt. Second, the IRS deepened its compliance efforts related to ongoing discrepancies on the balance sheets of partnerships with over $10 million in assets. Finally, the IRS has expanded its program focused on monitoring returns for partnerships with greater than $10 billion in assets.

At Pillsbury, we are careful to observe current tax rules, both under statutes and case law, so that our clients can be confident that our planning does not cause IRS concern. On the other hand, it is important to be aware of this increase in IRS scrutiny to the extent that individuals or families have participated in such planning outside of Pillsbury.

Summary and Recommendations
The IRS is on high alert for wealthy individuals. Despite this, individuals have new and existing planning opportunities available to make tax-free gifts and do other advantageous planning. For example, long-term GST-exempt “dynasty” trusts provide a valuable (and potentially fleeting) opportunity to avoid transfer tax on substantial assets across multiple generations. Your Pillsbury team is available, as convenient on your end, to address estate and tax planning updates appropriate for you and your family.

Pillsbury’s Trusts & Estates team advises individuals, families, family-owned businesses and charitable foundations in the planning and administration of complex trusts and estates, and in U.S. and international estate, trust and tax planning. Our lawyers develop cutting-edge, customized transfer tax and estate plans, utilizing trusts, wills, various entity structures, such as partnerships and LLCs, and domestic and cross-border plans, to preserve and enhance our clients’ wealth for current and future generations. Serving clients globally, we maintain a strong bicoastal presence in the U.S., particularly in San Francisco, Silicon Valley, Los Angeles, New York, Washington, DC, and Palm Beach, Florida.

[1]   The state in which a taxpayer resides should be taken into account when considering whether use a grantor trust or a non-grantor trust. For example, in California, a priority may be to reduce high state income taxes. In that case, one may prefer to have a non-grantor trust (treated as the owner for income tax purposes) set up in another state without income taxes, such as Delaware or Wyoming.

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Trusts & Estates
These and any accompanying materials are not legal advice, are not a complete summary of the subject matter, and are subject to the terms of use found at: https://www.pillsburylaw.com/en/terms-of-use.html. We recommend that you obtain separate legal advice.

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