Keep calm and read on.
This post is NOT political. I recognize that people can have a good faith difference of opinion on how and when to raise revenue, cut government spending, balance the budget or run a deficit, and use tax policy to stimulate the economy or influence other market forces.
I will only editorialize this much: I believe that family-owned businesses make a unique, positive contribution to society and the economy and that they should be given special recognition and consideration in all tax policy decision making. I believe this concept offers a space in which both political parties can agree.
In the meantime, part of my job, as a family business lawyer, is to work with my clients' accountants and the tax lawyers in my firm to help my clients operate their business, and plan for its succession, in a manner that is tax efficient, based on the tax law as it exists today and based on how we anticipate it might change from time to time.
Here are my thoughts on whether senior generation owners should transfer family business interests or other wealth to the next generation before the end of 2020 in anticipation of possible changes to federal transfer tax laws in 2021. It depends. Read on.
What is happening?
That's a good question. As I understand it, we will not know which party controls the Senate until the runoff election for the Senate seats in Georgia, which will happen after the end of 2020. Therefore, all we can do is continue to speculate about whether and how tax law will change in 2021.
What might change?
If Congress and the President agree to changes to federal transfer taxes (i.e., gift taxes and estate taxes), these are the primary elements that could be affected:
● Transfer Tax Exclusion. Many people view this as the biggest issue. For our purposes, let's say that the "transfer tax exclusion" is the total amount that you can pass free of transfer taxes, during lifetime or at death, to your children and other descendants. (Estate assets passing to a spouse or charity are not subject to transfer taxes.) Currently, the transfer tax exclusion is $11,580,000 (or double that amount, i.e., $23,160,000, for a married couple). Some lawmakers advocate reducing the transfer tax exclusion to as low as $3,500,000.
● Transfer Tax Rate. Currently, the transfer tax rate is 40%. In the past it has been as high as 55%.
It is possible that legislative changes to federal transfer taxes in 2021 could be made effective, retroactively, to January 1, 2021.
What should you do now?
The optimal strategy for you to pursue before the end of 2020 will depend primarily on the size of your "estate," as well as your age and health.
For example, if you have wealth well in excess of $11,580,000 (or $23,160,000 for a married couple) and if you are already retired, you may want to take full advantage of your ability to transfer wealth to your children and other descendants to the maximum extent free of transfer taxes under current law before the end of 2020.
In contrast, if you are younger (e.g., not yet retired) and healthy, and if your wealth does not substantially exceed the present transfer tax exclusions, then you may want to take a less aggressive approach to wealth transfers. It is important that you preserve enough wealth for yourself to continue to enjoy the standard of living you desire for the rest of your life (including a comfortable cushion for contingencies).
If you have a life expectancy of more than 20 years, you may have time to transfer wealth to your children and other descendants more gradually, using strategies that are not as dependent on the amount of the transfer tax exclusion. In the meantime, you may be able to use life insurance to address your potential estate tax liability in case you die before completing your lifetime wealth transfers.
If you fall somewhere in the middle of the two examples above, there are strategies that you could use to transfer wealth before the end of 2020 but preserve a financial safety net for retirement. For example, you could create a trust for your descendants, but name your spouse also as a beneficiary. You could sell assets to a trust in exchange for a self-canceling installment note or private annuity (see below). Your family business could establish a deferred compensation plan or other retirement benefit for you.
What can you do later?
If you don't use your full transfer tax exclusion before the end of 2020, and if the exclusion is reduced in 2021, there still may be a number of mechanisms that you can use to address your potential estate tax liability. Here are a few examples:
● Annual Exclusion Gifts. Using annual gift tax exclusions, you can gift $15,000 (or $30,000 for a married couple) per year, per recipient, free of transfer taxes, and these gifts will not reduce your available transfer tax exclusion.
● Grantor Trust. If you transfer assets to an irrevocable "grantor" trust for your descendants, you can pay the trust's income taxes each year, and that payment is not treated as an additional gift, even though it confers an obvious economic benefit on the trust and its beneficiaries.
● Life Insurance. If an irrevocable trust holds insurance on your life, the trust can receive the death benefit free of estate taxes. The death benefit can be used to pay estate taxes on your other wealth.
● Grantor Retained Annuity Trust, Self-Canceling Installment Note, or Private Annuity. You can transfer assets to a trust for your children and, in some cases other descendants, in exchange for an instrument that will pay you an income during a period of years or until your death, leaving no value to be taxed in your estate.
These are just some examples. I plan to describe these mechanisms, and others, in greater detail in future posts, particularly if the federal transfer tax law changes in 2021.
If your circumstances warrant using your maximum available transfer tax exclusion before the end of 2020, it may be prudent to do so. Do not, however, impoverish yourself in a panic to avoid transfer taxes. If the tax law is changed in 2021, stay calm, but then get to work with your legal, tax, and financial advisors to use the tools that remain available to address your potential estate tax liability, consistent with your own financial needs in retirement.