Estate and Gift Tax Exemption Update Means Reevaluate but Don't Relax
On October 28, 2021, President Biden announced a “framework” for spending and tax legislation that was devoid of any reference to gift or estate tax changes, meaning that the exemption will likely remain around $12,000,000 per person or $24,000,000 for a couple in 2022.
This was a sudden and somewhat surprising twist in the legislative sausage-making process, since the House Democrats had just introduced a bill in September to cut the gift and estate tax exemption in half as of January 1, 2022.
While the President’s announcement is good news for many who would be affected by a drop in the exemption, I wouldn’t necessarily uncork your champagne bottles just yet. The exemption is still set to come back down in 2026 (with inflation adjustments, the 2026 exemption might be around $6,300,000 for an individual or $12,600,000 for a couple). Also, the final tax legislation could put the kibosh on many of the planning techniques that we now use to great effect.
Since the estate tax exemption is unlikely to change in 2022, I have backed off the suggestion I was making to a number of clients that they institute a spousal lifetime access trust, or SLAT, in order to make use of one spouse’s gift tax exemption. However, I am suggesting to many of our clients that they still consider a particular planning technique that Congress might try to crack down on here soon. I’ll give you a clue which one it is.
What planning tool, used by many of our clients, has also been used by a majority of the country’s wealthiest 100 individuals?
Any guesses? Are you actually reading slow enough to feel the suspense?
The answer is a grantor retained annuity trust, or “GRAT.” According to reports, over 50 of the country’s wealthiest 100 individuals use GRATs, or the same technique to shift wealth as our clients are using. Connoisseurs of GRATs include Mark Zuckerberg, Sheryl Sandberg, Phil Knight, Michael Bloomberg, Laurene Powell Jobs (Steve Jobs’ widow), Charles Koch, Leonard Lauder (the son of Estée Lauder), and Eric Yuan (the founder of Zoom Video Communications).
Since many of the wealthy individuals listed above have used GRATs with large amounts of publicly-traded stock, the media has watched and been able to report on these GRATs. As just one example of how well the GRATs have performed, Eric Yuan reportedly transferred $6 billion worth of Zoom out of his estate.
At this point, I can hear you saying, “Enough with the celebrity scuttlebutt. What’s the scoop with GRATs? What are they and why are they so beloved?”
Well they are prevalent because they’re extremely effective, yet relatively easy to understand and implement. The overarching goal, when setting up a GRAT, is to shift appreciation on assets out of your estate and over to your beneficiaries, free of any gift or estate tax.
Let’s take an example. Suppose you have an investment that today is worth $20,000,000, and that you think will go up in value. If you do nothing, and that investment grows by 15% over 5 years, the investment will be worth almost $33,000,000 at the end of that 5 year term. While that might be great news, the growth is going to add to your future estate tax bill to the tune of roughly $5,000,000.
If the investment is placed into a GRAT, however, the GRAT can pay you back the $20,000,000 with interest (paid back over 5 years at the current applicable rate of 1.4%, you’d receive $4,169,534 per year in the form of an “annuity”). At the end of that 5-year period, there will be over $12,000,000 left in the GRAT that can pass to your children free of any gift or estate tax, and they will have just slashed the estate tax bill by almost $5,000,000. If the investments in the trust continue to grow from years 6 to 10 at the same 15% rate, your children will have an investment valued at close to $24,000,000, and the estate tax savings will be closer to $9,000,000.
As an added bonus, since a GRAT can be structured so that no gift tax exemption is used, there is no danger in the asset underperforming. Put another way, if I gift $11,000,000 today, but the asset I gift falls to $8,000,000 in value, I still just used $11,000,000 of gift tax exemption to make the gift. That’s what, in legal parlance, I would refer to as a “double ouchy,” since your asset just dropped in value and you used up more exemption than the asset is worth. With the GRAT, though, if the asset underperforms, I simply get it back, there is nothing left in the trust at the end of the term, and I didn’t have to use any gift tax exemption. That “single ouchy” feature makes GRATs particularly attractive if you have a highly volatile asset.
The most common feedback I get from clients who have used GRATs are that (1) they are surprisingly easy to understand and implement, (2) since you are only shifting appreciation on assets and getting your initial contribution back from the GRAT, it’s not as scary as gifting millions of dollars off your balance sheet, and (3) they wish they had done it sooner. That last point cannot be understated. If your estate is worth $10,000,000 today, but might be worth $30,000,000 in another 5, 10, or 20 years, now is the time for us to talk and explore some options.
Generally, a GRAT can be set up and funded within a week or two of when I have an initial consultation with a client. If you are interested in discussing whether a GRAT might be worth including in your estate plan, please do not hesitate to contact me.