Estate, tax planning reminders and actions for holiday season

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As we embark on the holiday season and the end of another year, it is important to add a review of your estate and gifting plan to your list of things to do. The end of the year is always a good time to review your estate planning documents, gifting techniques, tax withholdings and tax elections, especially in light of the proposed income tax changes to fund President Biden’s agenda. Here are some considerations that you may want to review with your advisors: 

What’s new? 

The latest proposals for the Build Back Better Act would not change the current estate and gift tax exemption amounts or rates, or the rules concerning grantor trusts. Therefore, the frenzy to fund and potentially revise trusts as soon as possible has been alleviated for the time being. However, end of the year trust planning should still continue to be a priority for estate tax reasons because of the impending sunset of the estate tax exemption in 2026. On January 1, 2026, current legislation states that the federal estate tax exemption will be reduced from $11.7 million to $5 million (as adjusted for inflation from 2017) per person. In addition, there are income tax reasons to be concerned with because of the introduction of new income tax surcharges for high net worth individuals and non-grantor trusts. 

The proposed legislation would impose an income tax surcharge of 5% for individuals who have a modified adjusted gross income (“MAGI”) of over $10,000,000 and non-grantor trusts who have a MAGI of over $200,000. For those individuals who have a MAGI in excess of $25,000,000 and non-grantor trusts who have a MAGI in excess of $500,000, an additional surcharge of 3% would be imposed. Moreover, there would be a new 3.8% surcharge on active business income from pass-through entities for individuals who have a MAGI in excess of $400,000 ($500,000 for married individuals filing jointly). This would include any income from an active trade or business. Income from passive investments where there is no material participation is already subject to a 3.8% net investment income tax for certain high net worth individuals. 

Alternative ways to make gifts 

Besides gifting income-producing assets outright to family members in lower tax brackets, funding non-grantor trusts or gifting interests in family LLCs could be advantageous for those that are projected to be close or above the above mentioned income thresholds, if the surcharges are enacted into law. Both of these strategies have positives and negatives. The assets that are gifted to the trust or the value of the interests in the family LLC gifted to a family member will be removed from the grantor’s/transferor’s taxable estate for estate tax purposes. However, the income earned by the trust will be subject to a compressed tax rate. Carefully consider funding the trust with too many income-producing assets that will subject the trust itself to the new surcharges. In contrast, income distributed from a family LLC may pull the transferee into a higher tax bracket and/or subject them to the new active business income surcharge. 

Another type of trust that has become quite popular for gifting purposes is the spousal access lifetime trust (“SLAT”). A SLAT can be created for the benefit of each spouse and funded with cash, stock, or business interests. In order for the SLATs to work as intended, the terms of each SLAT must be slightly different (i.e., the trustees and dispositive provisions of the trust). The contributions to the SLAT will be removed from the respective grantor’s taxable estate for estate tax purposes. The SLAT can be treated as a grantor trust for income tax purposes so that the income earned by the trust will be picked up on the grantor’s income tax returns. A SLAT could be a beneficial strategy for someone that is not close to the new income cliffs but close to the estate tax exemptions. 

Standard gifts not to forget – annual exclusion 

Each person may gift up to $15,000 per year per donee ($30,000 if you split gifts with your spouse) in 2021. Any gifts that are made up to this annual gift tax exclusion amount will not be subject to federal gift tax and will be removed from your taxable estate for estate tax purposes. Cash gifts that are made directly to a donee are effective upon receipt. In contrast, checks must be deposited or cashed by the donee at his or her bank before the end of the day on December 31 for the gift to count for 2021. Therefore, if you are looking to make annual exclusion gifts, you should leave plenty of time for the checks to be cashed by the end of the year. 

Funding 529 plans 

The end of the year is also a good time to fund a 529 plan for younger children and grandchildren. While there is no federal tax break, up to $10,000 in contributions can be excluded on your New York state income tax return. The funds in a 529 plan are able to grow tax-free and can be used to pay primary, secondary, college and graduate school expenses for the beneficiary, amongst other purposes. 

Required minimum distributions 

For 2020 only, the mandate to take a required minimum distribution (“RMD”) from an individual retirement account or 401(k) was alleviated. This allowed retirement accounts to grow in value during the pandemic. However, RMDs must be taken in 2021 and subsequent years. If you have turned 72 years old in 2021, your first RMD must be taken by April 1, 2022, but if you are already 72 years old, the RMD must be taken by December 31, 2021. Therefore, to avoid penalties, you should ensure that RMDs are taken before the relevant deadline. You are required to pay income taxes on an RMD unless up to $100,000 of the RMD is made to a designated charity. This may be a good option for someone who does not need the distribution and is charitably inclined. It is important to note that income from an RMD still counts in determining whether such person exceeds the above mentioned income thresholds because the calculation of MAGI is done before any charitable contributions. Don’t forget, RMDs are not required from any Roth IRAs or Roth 401Ks. 

Charitable gifts 

For 2020 and 2021, an individual who itemizes can elect to deduct cash contributions made to qualified charitable organizations up to 100% of adjusted gross income (“AGI”). While most people will not want nor can afford to give away all of their income, this limited benefit is a tremendous tax break for those who can. Any charitable deductions that cannot be taken in 2021 can be carried forward for five years.

For an individual who does not itemize deductions, a deduction of up to $300 ($600 for married individuals filing joint returns) can be claimed for cash contributions made to qualifying charitable organizations. 

Health care proxies and powers of attorney 

Finally, if you have changed or are looking to change your domicile to or from New York, you should consider updating your estate planning documents to be governed under the law of the relevant jurisdiction, particularly your health care proxies and powers of attorney. New York has recently updated its statutory short form power of attorney and it is advisable to update to this newest form. 

Wishing you a wonderful holiday season and a prosperous and healthy new year! 

Stephanie T. Seiffert is a partner in Nixon Peabody’s Private Clients practice. She developed this article with Private Clients Associate Brian S. Roth.