Peter, Paul, and Mary Should Make Large Gifts – Now!

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July 30, 2020

Peter, Paul, and Mary have done well for themselves. Each has a nice home, a seasonal residence, and a large IRA. Coincidentally, each also has an additional $11 million worth of real estate, savings, brokerage accounts, and closely-held business interests.

We advised Peter, Paul, and Mary that in 2020 each has a federal gift and estate tax exemption that allows him or her to transfer up to $11,580,000 free of tax. (The exemption is adjusted annually for inflation.) The exemption can be used while living or upon death, as long as the total value of both types of transfers does not exceed $11,580,000. Every dollar transferred while living or upon death in excess of the exemption amount is taxed at 40%.

We also advised them that these historically high gift and estate tax exemptions are scheduled to decrease to roughly $6 million in January 2026. That’s what the law says. In other words, the only way it won’t happen is if Congress passes a law to prevent it. Mary said she read that with $7 trillion or more of unplanned stimulus spending to deal with the coronavirus pandemic, it’s possible Congress could lower the gift and estate tax exemption before 2026.

Therefore, we advised Peter, Paul, and Mary that they should consider making large gifts to remove appreciating assets from their taxable estates while they can. Referring to the large current exemptions, Mary summed it up this way: “It sounds like we either use them or lose them.” Then Paul said what was on everyone’s mind: “Yes, but as much as I love my children, I’m not going to part with a big chunk of my hard-earned wealth just so they can save some taxes at my death.”

We explained to Peter, Paul, and Mary that they can make gifts to remove assets from their taxable estates but still have access to those assets if they need it. Here’s how.

Peter and Paul are each married and each has children. Mary is a widow and has children. Peter and Paul can create irrevocable trusts for their wives and children, giving preference for the needs of their wives, with special features that will allow Peter and Paul to have access to the trust assets if their wives were to predecease them. Mary can create an irrevocable trust for herself and her children under the laws of a state that permits a person to create an irrevocable trust (called a self-settled spendthrift trust) for his or her own benefit. Nevada and South Dakota are two of the leading states that provide for these types of trusts. We have established relationships with trust companies and attorneys in those states to be able to accommodate the needs of clients like Peter, Paul, and Mary.

Alas, Peter said he didn’t have time to think about gifts. Therefore, unless Congress changes the law, Peter’s gift and estate tax exemption will be reduced from $11,580,000 to roughly $6 million as of January 2026. By not using his large exemption before the change in the law he will lose almost half of it.

Paul decided to create the trust we recommended but he limited his gift to $6 million of stocks and bonds. Therefore, unless Congress changes the law, Paul’s gift and estate tax exemption will be zero as of January 2026 ($6 million minus the portion he used in 2020). Unfortunately, Paul didn’t accomplish much with this gift. If Peter decides to make a $6 million gift on January 1, 2026 (since he decided not to make any gift in 2020), both he and Paul will be in the same position. In other words, unless Paul makes a gift of more than $6 million, he’s not accomplishing anything with respect to using his larger exemption before the law change.

Mary understood the math perfectly. She decided to create the trust we recommended and transferred an assortment of assets to her trust worth $11 million. Therefore, unless Congress changes the law, Mary’s gift and estate tax exemption will be zero as of January 2026, just like Paul’s, but Mary will have removed an extra $5 million from her taxable estate free of tax.

As these examples illustrate, people with large estates, and people who expect their estates to continue to grow in value, should consider making large gifts to flexible trusts for the benefit of their immediate family (and possibly themselves) in order to use their historically large gift and estate tax exemptions before they are significantly reduced in 2026 (or sooner). If you have questions about how you might be able to take advantage of this type of planning, please contact an attorney in our Trusts & Estates Practice Group.

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