Transfer taxes, such as estate and gift taxes, are highly political due to two main reasons. First, they contribute a small portion of revenue to the U.S. budget compared to other taxes like income and Social Security taxes. Second, only a small number of citizens are subject to these taxes, primarily the ultra-wealthy. These individuals are seen as “easy targets” for raising revenue due to their financial influence, including campaign contributions.
In 2021, several proposed tax laws were introduced aimed to overhaul the transfer tax system, but no significant changes were enacted due to the political sensitivity of the issue. However, regardless of current attempts to change the tax laws, statutory changes are scheduled to occur in the next few years. Therefore, it is essential to have flexibility in estate planning documents to ensure their effectiveness despite tax law changes.
Flexibility is also crucial in beneficiary designations for defined contribution plans, life insurance, and other assets included in estate plans. Recent changes in income tax laws require withdrawals from defined contribution plans over ten years in many cases. Considering the significant wealth held in these plans, it is important to assess whether controls, such as using a trust as a beneficiary, are necessary for non-tax reasons.
It is strongly recommended that you consider filing an estate tax return upon the first death of you or your spouse, even if the estate is not large enough to require it. This filing is done to make a “portability” election, transferring the unused exemption to the surviving spouse. Even without ongoing attacks on current exemption levels, the level is set to decrease by law in 2025.
To ensure flexibility, it is crucial to have systematic reviews of estate plans, especially when there are changes in your situation or tax laws. One way to create flexibility is by appointing a trust protector, who can modify trust documents based on your wishes and accommodate changes in tax laws. Trust protectors have various powers, such as arbitrating disputes, modifying the trust agreement, altering beneficiaries’ interests, and more.
Trust protectors can also assist in decisions related to pension distributions, considering the current requirement for full distribution within ten years of death. They can analyze the advisability of taking out defined contribution plan assets during your and your spouse’s lifetimes to potentially reduce overall tax rates. Additionally, protectors can prevent distributions to beneficiaries facing creditor claims or divorce proceedings.
In conclusion, understanding transfer taxes and engaging in modern estate planning involves considering potential tax law changes, beneficiary designations, trust protectors, pension distribution planning, portability issues, and state-level estate or inheritance taxes. It is important to stay informed about the estate tax laws of the state where clients reside and plan accordingly.
