Estate planning amid economic and political uncertainty

Rising interest rates, a response to a year of inflation, continue to instill a level of uncertainty in the economy. The legislative outlook and Congress’s failure to enact a broad year-end tax deal will not make it any easier. Individual taxpayers have to consider these factors when engaging in near-term estate planning.

Inflation has the potential to affect succession planning, most obviously regarding its impact on asset values and future appreciation. Estate planning typically involves “freeze” strategies, which remove future appreciation of an asset from the estate. It is critical to understand the impact inflation may have on the appreciation of different types of assets. It is very inefficient to transfer an asset that loses value; therefore taxpayers should consider which assets may weather or even profit from an inflationary environment and assess which assets typically suffer in these periods.

It is equally important to consider the impact of interest rates. Many freeze strategies hinge on the ability of assets to appreciate faster than interest rates prescribed by the IRS. The rate in Section 7520 used to determine the present value of annuities and remainders has risen significantly over the last two years. Taxpayers should assess the impact to planning and what future rate changes could mean for specific strategies.

Taxpayers should also remember the current favorable estate, gift and generation-skipping transfer tax lifetime exclusions, which reached $12.92 million in 2023, and are scheduled to be halved beginning in 2026 without any new legislation. The IRS has issued helpful guidance allowing taxpayers to leverage the current exemptions without fear of future changes clawing back the benefit. The rules provide that the estate tax can be determined using the exemption amount allocated to gifts made during the increased exemption period or the exemption amount at the time of death, whichever is greater. Taxpayers who do not take advantage of the increased exemptions with gifts before 2026 could forfeit the benefit of the increased exemptions. And while not specifically tax legislation, the Inflation Reduction Act provided an unprecedented $80 billion in extra funding (reduced to $58.6 billion in the debt ceiling legislation) that will transform how taxpayers interact with the IRS and dramatically increase enforcement activity. The speculated impact is greater scrutiny and enforcement of tax return submissions.

Another factor to consider in estate planning is the theme that tends to reoccur in the annual Revenue Proposals. The Biden administration’s proposed budget calls for an increase in federal spending and an increase in taxes to fund it. The General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals (the 2024 Green Book) contains several changes that impact estate-planning strategies, including proposals affecting valuation clauses, discounts and deferral of unrealized gains. With a divided Congress, it is likely that none of the 2024 Green Book proposals will be acted on. However, such legislative proposals are important because they could be pulled from the shelf and enacted when the political climate is different.

Eliminate  certain valuation discounting opportunities - The proposal would replace Section 2704(b) of the Code, which disregards the effect of liquidation restrictions, and instead disallow discounts for lack of control or marketability for transfers of partial interests involving real or personal, tangible or intangible property, not including an operating trade or business to a family member. This valuation rule would apply only to intrafamily transfers of partial interests in property in which the family collectively has an interest of at least 25% of the whole.  For example, under the proposed change, if a family-owned real estate appraised at $1 million inside a limited liability company and wanted to gift a 10% member interest to a family member, the value of the 10% member interest would be $100,000. The proposal would also impose a consistency requirement related to promissory notes by providing that when valuing a note for federal gift and estate tax purposes, the discount rate may not be greater than the actual rate of interest of the note, or the applicable minimum interest rate for the remaining term of the note on the date of death.

Remove deferral of unrealized gains - Under the proposal, the donor or deceased owner of an appreciated asset would realize a capital gain at the time of the transfer. The amount of the gain realized would be the excess of the asset’s fair market value on the date of the gift or the decedent’s date of death over the decedent’s basis in that asset. In this instance, instead of deferring the gain tax to a later time and to the transferee, the transferor must pay the tax on the unrealized gain without receiving the funds from any sale to cover the tax.