The Current Estate Tax Exemption Might Not Last Long

Clients seem complacent about the federal estate tax since President Trump’s Tax Cuts and Jobs Act of 2017 increased the exemption to $11.4 million. A married couple, therefore, may shield as much as $22.8 million from the estate tax.

A lot of clients are quoting Mad Magazine’s Alfred E. Neuman, “What? Me worry?”

But don’t get too complacent.

That 2017 law sunsets in 2025, and may, in fact, be overturned sooner depending upon the results of the next general election.

If you read Bernie Sander’s proposed estate tax act bill, for example, the federal exemption would be lowered to $3 million. Further, his act would limit lifetime transfers to only $1 million before imposing gift tax. Under current law, you can consume your entire estate tax exemption during life as taxable gifts before having to pay gift or estate tax. Bernie’s law would make it that much more difficult to minimize the estate tax by making lifetime transfers.

While no one knows whether Bernie Sanders or any other similarly minded Democratic hopeful will win in 2020, and we also have no idea whether a new tax law would be forthcoming given the makeup of the House and Senate. It’s safe to say that there’s a voting block interested in wealth redistribution.

The current federal estate tax was enacted, in part, during the beginnings of our country’s industrial age to curb what was then viewed as economic inequality. Then-President Theodore Roosevelt (a Republican) was encouraged by wealthy families, the Carnegies among them, to enact the tax to curb the creation of an “elite, ruling class” made up of trust beneficiaries.

Sound familiar to today’s headlines?

The thought that the pendulum may quickly swing towards a harsher estate tax isn’t outside of the realm of possibilities. Is there anything that you can do about that now?

The answer is “Yes!”

While the federal exemptions remain high, you might want to consider advanced estate planning techniques that consume your exemptions now, prior to any changes in the law. One of the most common objections to making these gifts now is that the transfers must largely be irrevocable, meaning that they cannot be undone, and that in many circumstances the one who transfers loses the ability to use and enjoy the assets during his lifetime.

But there are exceptions to all these rules. There are certain kinds of trusts that you could create where you retain certain income rights for your lifetime. Further, if you are married, you can create marital trusts for your spouse that consume your current exemptions. They would pass on to your children upon your spouse’s passing estate and gift tax free.

Until recently, one concern about using your exemptions before the law changed centered on whether the IRS would “claw back” the gifts at your death if they were made during a time that the lifetime exemption was higher, but at your death would have been taxable. Recent proposed Treasury Regulations issued by the IRS appear to put that concern behind us. The IRS has indicated that it does not view current law as allowing “claw backs,” meaning that if you implement advanced estate planning techniques now, even if the exemptions should decrease, the IRS would not try to include those transfers in your estate upon your demise.

Lifetime transfers have a host of issues to consider, including whether you wish to retain the income or use of the assets transferred, who may serve as trustee, whether a technique would allow you to “leverage” your exemption, how your loved ones benefit and whether you could shield the trust assets for successive generations.

These are not issues that you should consider with someone who is not a wills, trusts or estates specialist. The Florida Bar deems board certified attorneys as specialists; no one else can use that title. In order to become board certified an attorney must demonstrate special skills in the area of law, pass a test, and take many hours of continuing, high level educational credits. A board certified attorney must become re-certified every five years.

Nevertheless, you have an opportunity now that may or may not be around much longer. If you have wealth above the $3-5 million range, it makes sense to visit your estate planning attorney sometime soon to consider your options.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Co-Signing Loans for Children and Grandchildren

“Ed” telephoned me the other day with a problem. “Craig” he said, “I have a bank coming after me for $200,000. Does my revocable trust offer me any protection?”

I was surprised to hear that Ed was in financial trouble. As it turns out, it wasn’t Ed who caused the bank problem. I learned that Ed’s son, “Bruce” purchased a home five years ago, when Bruce was employed. In order to help Bruce qualify for the mortgage, Ed cosigned and personally guaranteed the mortgage note.

You can guess what happened. Bruce lost his job. Bruce then fell behind with his mortgage payments. Ed decided not to help Bruce with the mortgage payments, which turned out to be a mistake since Ed co-signed the loan. The home was foreclosed. Since the value of the home hasn’t significantly increased, the foreclosure sale of the home brought an amount less than the outstanding balance of the mortgage. The bank therefore obtained a deficiency judgment against both Bruce and Ed.

Since Bruce doesn’t have any assets, the bank is seeking recourse from Ed. The first I learn of this mess was Ed’s call to me asking whether his revocable trust somehow protects him against the bank. I advised Ed that his revocable trust does not offer any asset protection because he can freely do with the trust assets as he pleases. A revocable trust is simply another form of ownership. Since Ed can freely spend and consume his trust assets, they are not protected against creditors.

Because of Bruce’s inability to pay the mortgage, Ed’s credit rating could also be adversely affected by these problems.

Ed’s dilemma highlights an issue that many parents of adult children should consider before co-signing notes, and that is to determine what the worst-case scenario looks like, and whether that scenario could be financially devastating.

In addition to the monetary losses Ed may have incurred, there could be gift tax repercussions to the guarantee Ed signed. While an old Tax Court case held that an agreement to guarantee the payments of another’s debts does not constitute a completed gift for purposes of the gift tax rules, the IRS position has in the past been that when a person guarantees the payment of another’s debts, the guarantor transfers a valuable property interest, and therefore a completed gift has occurred.

A controversial 1991 Private Letter Ruling, for example, held that a guarantee is a completed gift, although no guidance was provided suggesting what the value of such a guarantee might be. The IRS cited a Supreme Court decision Dickman v. Comr., a 1984 case that held a parent’s agreement to guarantee payment of loans conferred a valuable economic benefit to the child; as without the guarantee, the child may not have obtained the loan or would have had to pay a higher interest rate.

This controversial ruling has since been withdrawn without IRS comment. However, the IRS may maintain the position that if the child defaults on the loan and the parent repays amounts under the terms of the guarantee, additional gifts are made to the extent that the parent is not reimbursed by the child.

With today’s $11.4 million gift and estate tax exemptions, making a taxable gift might not result in any estate taxes. The current exemptions sunset in 2025 absent any further action by Congress, and it is entirely possible that following the 2020 general election the tax law changes anyway.

In Ed’s case this could constitute additional heartache. Not only may he be required to step in to cure the deficiency on the mortgage foreclosure, he may also lose some of his lifetime gift tax exemption.

The bottom line is that one should tread cautiously when cosigning or guaranteeing family obligations.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.