Looming TCJA Sunset Provision Should Hasten Estate Tax Planning

Due to a sunset provision built into the Tax Cuts and Jobs Act, the federal exemption from transfer taxation (currently $13.61 million per person) is scheduled to decrease to approximately $7 million at the end of 2025.

While this might feel like the distant future, many strategies that could be utilized to take advantage of the current exemption require careful planning and can’t be completed at the 11th hour. The clock is ticking on the ability to shield millions of dollars from a crippling 40% tax rate.

The good news is the IRS has confirmed that taxpayers can use their higher exemption amount in 2024 and 2025 without fear of being penalized later.

This means high-net-worth individuals and families with unused exemption should strongly consider making one or more large gifts before the exemption drops. Assuming Congress doesn’t act to stop the sunset, a married couple can protect approximately $13.22 million more from estate tax today than will be possible after 2025.

For individuals and families that may be affected by the decrease in exemption, several planning steps should be high on their to-do list for 2024.

Redistribute Assets Between Spouses

Married couples contemplating large gifts should look now to see if assets will need to be shifted between them in order to fulfill their donative ambitions. This is particularly important when one spouse intends to fund a spousal lifetime access trust—a sophisticated estate planning technique in which the donor-spouse gifts assets to a trust that includes the other spouse as a permitted beneficiary.

With a SLAT, one spouse can use up all or most of their exemption, while the other spouse can continue to benefit from the trust assets—a tax planning win-win.

However, if funding the SLAT will require the beneficiary spouse to first transfer assets to the donor spouse, it’s imperative not to wait until the last minute to make the transfer. Due to the “step-transaction doctrine,” the IRS can argue that a trust established for the benefit of one spouse with assets previously owned by that spouse is a “self-settled trust,” with devastating tax (and other legal) consequences.

To minimize the risk, a married couple planning to fund a SLAT should act now if they need to redistribute assets. Putting a tax year (or two) in between a spousal transfer and the SLAT funding can dramatically minimize the risk of a step-transaction audit.

Be Mindful of Transfer Restrictions

Transferring ownership interests in closely held businesses can be a powerful way to leverage exemption, as the gift tax value of these interests is usually significantly less than their long-term appreciation potential. As a result, it’s often possible to transfer more closely held business interests for a given amount of exemption than would be possible with other asset classes.

Unfortunately, interests in private entities often come with restrictions that can limit or delay their transferability. To ensure smooth planning for the sunset, individuals and families should act promptly to address these restrictions, including obtaining any necessary consents and approvals.

Arrange for Valuations Well in Advance

Under applicable IRS regulations, the reported value for gift tax purposes of certain assets must be supported by a contemporaneous valuation performed by a qualified appraiser. This requirement applies to gifts of real estate, closely held businesses, and other hard-to-value assets.

Obtaining these appraisals can be time-consuming and expensive, and finding a qualified appraiser can be difficult. Individuals and families contemplating a pre-2026 gift that will require a valuation should leave plenty of time to arrange one. With the anticipated avalanche of gifting in 2025, those who wait until the last minute may find it impossible to find an appraiser who isn’t completely booked.

Build Flexibility Into Trust Agreements

Most estate tax planning strategies involve transfer of assets to an irrevocable trust, which generally can’t be modified or revoked. However, certain “strings” can be retained over the transferred assets. Consider building in some of the strings below to provide flexibility for changing circumstances:

Give the settlor a “swap power.” The settlor’s power to reacquire trust assets by substituting other assets of equivalent value is often included in a trust agreement in order to structure the trust as a “grantor trust” for income taxes.

This power, however, also provides the settlor with a string that can be pulled to regain control of the previously transferred assets. For example, the settlor could swap low-basis assets out of the trust and replace them with high-basis assets so the original assets receive a stepped-up basis upon the settlor’s death.

Structure the trust as a directed trust. With a typical trust, the trustee is responsible for trust administrative items, investments, and distribution of trust assets to the beneficiaries.

With a directed trust, an investment adviser can be appointed to direct the trustee regarding the investment of the assets, and a distribution adviser can be appointed to direct the trustee regarding their distribution. While the settlor generally shouldn’t be named as the distribution adviser, the settlor could be named as the investment adviser.

By serving as the investment adviser, the settlor retains a string (actually more of a rope) over how the previously transferred assets are managed and invested while held in the trust. Likewise, the settlor can name a family member or other trusted individual as the distribution adviser.

Together, these roles allow the settlor to retain significant influence over how the trust is administered.

Add a trust protector. Times change and so do tax laws, and even the most carefully structured trust can become ineffective as the years pass. To address this challenge, consider adding a trust protector. This “super trustee” can amend the trust, add or remove trust beneficiaries or fiduciaries, and even terminate the trust if conditions warrant.

Adding a trust protector can make your trust planning substantially more flexible and prevent buyer’s remorse in the event personal, financial, or legal conditions change.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

James R. Thomson is partner with Lathrop GPM’s trusts, estates, and legacy planning group in Minneapolis, representing clients in estate planning, estate and trust litigation, business succession planning, and charitable giving.

Edward H. Tully is partner with Lathrop GPM’s trusts, estates, and legacy planning group in Minneapolis, with focus on estate planning, business succession planning, and asset protection planning.

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