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Nothing to Fear but Fear Itself: Planning in the Current Environment

Carl Fiore, JD, LLM
Published Date:
May 1, 2023

As the calendar turns to 2023, taxpayers and their advisors face an uncertain future. Given a divided government for at least the next two years, it is not the usual suspect of potential legislation and sweeping tax changes that fuels this uncertainty. Instead, a declining market, the potential for recession looming, and increasing interest rates has left many taxpayers in a general malaise heading into the new year. However, while this overall economic downturn presents at least short-term challenges, it also creates certain wealth planning opportunities.

Before delving into some of the specific planning, it is necessary to outline the lay of the planning land, as well as to pause for some historical perspective. Beginning in January 2023, the gift, estate and GST Tax exemptions increased to $12,920,000 per person. In addition, the amount that can be given to a donee or trust for a donee’s benefit without using gift tax exemption — the annual exclusion — has also increased to $17,000. Rounding out these amounts, the annual exclusion for gifts to non-resident spouses has increased to $175,000 in 2023. On the interest rate side, the February 2023 rates used in various estate-freeze transactions, are as follows:

  • Short-term AFR Rate – 4.47%
  • Mid-term AFR Rate – 3.82%
  • Long-term AFR Rate – 3.86%
  • Section 7520 Rate – 4.6%

In comparing the current rates to the short-term, mid-term, long-term and §7520 rates from a year ago of .59%, 1.40%, 1.92%, and 1.6%, respectively, clearly there has been a significant increase. As a result, many interest rate driven transactions such as intra-family loans and installment sales (in the case of the AFR), and Grantor Retained Annuity Trusts (GRATs) and Charitable Lead Annuity Trusts (CLATs) — in the case of the §7520 rate — will not perform as well. However, this reduction in tax efficiency does not mean such transactions should be abandoned.

For the better part of the last 15 years, interest rates fluctuated between all-time lows, and near all-time lows. But in examining rates before the end of 2008, the beginning of the Great Recession, we see rates in line with current amounts. Furthermore, even with these increases, interest rates are still well below where they where through the 1980s, 1990s and earlier. That said, since the possibility of additional increases still exist, it would be prudent to lock in the above rates with some of the transactions mentioned above. Of course, this also speaks to the general state of the economy and depressed markets.

As a basic rule, it is better to transfer an asset when it is worth less. While straightforward enough in concept, this cold, mathematical calculation ignores the uneasiness of taxpayers and legitimate concerns about their wealth — i.e., “I’m worried I won’t have enough.” Some of the lessons of 2008 and thereafter are again instructive. By several measures, 2022 was Wall Street’s worst year since 2008; but as the economy recovered in the years after 2008, generally speaking asset values recovered and exceeded their previous values. While the timeline may be unknown, it is a fair bet that sooner or later most assets will recover and exceed their pre-2022 values in this case as well. From a wealth transfer standpoint, it is far better that this recovery happen outside a taxpayer’s estate. While no one can be sure how long markets will take to rebound, one thing that is sure — at least under current law, is that the exemptions mentioned above will go down.

Under the Tax Cuts and Jobs Act (TCJA), which doubled exemptions in 2018, those same exemptions are scheduled to be cut in half at the end of 2025. As a result, absent legislative intervention, the gift, estate and GST Tax exemptions will be reduced to the neighborhood of $6–$7 million per person (taking into account the inflation indexing) beginning in 2026. While it should be noted that since the estate tax was introduced in 1916 the exemption has never gone down (ignoring the no estate tax year of 2020), current law says what it says.

Promulgated in 2019, IRC Reg. §20.2010-1(c)(3) addressed the “clawback” concern if the exemption is in fact reduced. The regulations states that there will be no adverse estate tax implications if a taxpayer used all of his/her exemption during life, and then dies when the exemption is less than the amount previously used. This result is accomplished through mechanics specifying that if the above situation occurs, the exemption at death will be the greater of the actual exemption existing at that time, or the gift tax exemption used during life over the exemption at death — the so called “special rule.” With no fear of clawback and exemptions scheduled to be reduced in the not-to-distant future, combined with current depressed markets and potentially increasing interest rates, now is the time to focus on wealth-transfer planning.

As mentioned above, while it is easy to make the case for transferring assets now, concerns over having enough, particularly in a bear market, can present roadblocks to planning. Such concerns are often more acute for younger taxpayers whose wealth has just started accumulated. For many of these taxpayers, while they may not have a taxable under current exemption amounts, they very easily could by the time they die, and any estate tax would become due. It is therefore critical that any gifting plans take into account these realties.

There are several techniques of varying complexity and risk designed to deal with concerns over having access to gifted assets. While a complete list or detailed discussion of such transactions is beyond the scope of this article, the important thing to note is that with proper planning, these fears are not insurmountable. Also, before even discussing specific planning ideas, it is necessary to clarify the concern.

Often, it is not so much that a grantor wants access to value; it’s that the taxpayer wants access to cash. If the worry is cash, this concern can be mitigated without the need of complex transactions. For example, in most cases a grantor can simply borrow from a trust. If the trust is a grantor trust, this borrowing and subsequent interest/principal payments on the note will have no income tax consequences. Not only does borrowing give the grantor instant access to cash; the interest payments paid by the grantor to the trust also represent additional wealth transfers. When it is time to pay off the loan, that payment need not be in cash; instead, the loan can be satisfied with other property, including discounted assets to further augment planning. In the alternative, assuming a grantor trust is used to avoid any income tax issues, a taxpayer can substitute out cash for an asset of equal worth. Again, this substitution can be done with a discounted asset as part of additional planning.

As for specific transactions designed to provide access to cash, the first idea that comes to mind is the Spousal Limited Access Trust, or SLAT. Simply put, a SLAT is a trust that includes a spouse as a beneficiary. Since larger gifts are usually made to these trusts, they tend to be multigenerational GST exempt trusts as well. What is also a common component of this planning is for each spouse to set up similar trusts that include each other as beneficiaries along with descendants. While SLATS are now a common form of planning, the transaction is not without risk. Whenever both spouses are establishing these trusts, taxpayers and practitioners must be cognizant of the reciprocal trust doctrine. In this context, application of the reciprocal trust doctrine would “uncross” gifts to each trust so it would be deemed that one spouse made a gift to a trust that he/she was a beneficiary of, and the other spouse

did the same. Such a result could create estate tax inclusion issues, especially if the trusts are not established in a creditor protection state. To avoid this result, the trust provisions must be different enough so that they are not considered by IRS to have the same economics. The risk comes in because there are no guidelines as to what is different enough. That said, most practitioners are comfortable that changing certain specific provisions between the trusts (usually related to distribution standards and powers of appointments) and perhaps the timing of funding is sufficient to avoid this issue.

As a practical matter, the SLATs limitation is that in the event of divorce, or death of one of the spouses, the other spouse no longer has access to that trust. At the cost of increased risk, there are other techniques that provide direct access to trust assets; the most straightforward is a discretionary trust in which the grantor is also a direct beneficiary, sometimes referred to as a completed-gift asset protection trust. In PLR 200944002, IRS ruled that if such a trust was established in an asset protection state under appropriate law so that creditors could not reach trust property, the transfer to the trust is a completed gift and, at least in that context, there is no estate tax inclusion. However, the ruling also made clear it would not speak to other potential estate inclusion issues that could arise depending on other facts. As a result, it is not clear whether IRS would assert §2036 estate tax inclusion under some other theory such as an implied understanding between the trustee and grantor regarding distributions. Similar to the above approach but perhaps less risky is a trust where the grantor is not a current beneficiary, but an independent party such as a trust protector has the ability to add the grantor as a beneficiary in the future. Again, the full estate inclusion impacts of this transaction are unknown.

Another transaction designed to allow for full access to transferred assets is the Beneficiary Defective Inheritor’s Trust (BDIT)/Beneficiary-Deemed-Owned Trust (BDOT), which are different versions of the same concept. Without going into the specifics, these are trusts that are established and minimally funded (generally not more than $5,000) by someone other than the taxpayer, usually a parent or sibling. By utilizing §678, the trust is also designed to be grantor to the taxpayer, rather than the person funding the trust. The beneficiaries of this trust are the taxpayer and decedents. The taxpayer then sells an asset(s) to the trust for a note in a non–income tax recognition event because it is a grantor trust. Since the taxpayer is a beneficiary, he/she will have full access to the trust assets without being a direct grantor as is the case with the completed-gift asset protection trust. Again, without getting into the specifics, the risk here is that IRS could call into question whether such a thinly capitalized trust could support a sale of any substance.

It should also be noted there are a handful of transactions that focus on access to wealth concerns that may no longer be viable. In April 2022, proposed regulation §20.2010-1(c)(3)(i) was issued by IRS to target transactions that are designed to utilize gift tax exemption without actually giving anything anyway. These transactions include a gift of a promise to pay a donee (if the promise remains unpaid at death), transfers subject to certain powers retained by a donor that would create estate tax inclusion under §2036-2038 and 2042, transfers that intentionally trigger the artificial valuation rules under §§2701 and 2702 where there is an estate tax offset for the property that trigger those artificial gift value rules and is also included in the estate, and any transfers that would have been included in the proposed regulation but for the elimination of the subject property from gross estate within 18 months of death. If applicable, a taxpayer will lose the benefit of the “special rule” under the anti-clawback regulation mentioned above and potentially be subject to additional estate tax.

Once it has been decided a gift should be made and what the specific transaction should be, for married taxpayers the next question is how those gifts should be made tactically. Under the tax code, spouses making gifts have the ability to gift-split. In other words, if one spouse makes a gift, with certain exceptions, the married couple can choose to either treat that gift as coming from the donee spouse, or as coming from each spouse, one-half each. As the name suggests, if gift-splitting is elected, each spouse will use gift tax exemption and, if allocating, in most cases GST exemption, equal to one-half of the gift value. While gift-splitting has a variety of benefits, it may not be the best option under current law.

As mentioned, after 2025 the transfer tax exemptions are schedule to be reduced. For married couples, whether gift-splitting is elected can impact how the reduction is calculated. Under current rules, when the exemption is reduced, what is reduced first is the additional amount granted under the TCJA. However, under the same rules, taxpayers use their pre-TCJA existing exemption first. As a result, gift-splitting could jeopardize exemption. Assume married taxpayers each have $10 million of exemption and one spouse makes a gift of $10 million. If they elect gift-splitting, they each will be deemed to use $5 million of exemption. Because they will have used their pre-TCJA $5 million first, when the exemption is reduced, they will each be left with 0; however, if they do not elect gift-splitting, the donor spouse will have used $10 million and the non-donor spouse would be left with $5 million after the reduction.

Turning to the GST exemption, there are some unique planning opportunities in a down market relating to late allocations. For gifts made in 2022 to trusts intended to be GST exempt, values should be revisited when gift tax returns are prepared in 2023. While taxpayers are stuck with the value of property at the time of the gift for gift tax purposes, the same is not so for GST purposes. If the value of trust property has decreased from the time of the gift to the gift tax filing deadline, a late allocation could be considered. For example, if a gift is made to a trust on June 1, 2022 with a value of $1 million, its gift tax reported value is $1 million. If that property is only worth $500,000 in April 2023 and a late allocation is done right after the filing deadline (assuming no extensions), the GST allocation would only be $500,000.

Procedurally, to make the allocation, a 2022 gift tax return would be filed before the April filing deadline, electing out of any automatic allocation. Any time after the filing, depending on what happens with the value, a late allocation can be done on a “2023” gift tax return using the value of the trust property on that date. Of course, depending the asset(s) the trust holds, it can be difficult if not impossible to value the trust property, prepare, have signed and file the return on the same day. Thankfully, under Regulation Section 26.2642-42(a)(2), there is an election allowing taxpayers to value the trust assets as of the first of the month, in which case the return must then be filed before the end of that month. If the gift tax return is extended, the taxpayer must wait until after the extended due date and whatever the values are at that time for a late allocation. If gifts were not made in 2022, that does not mean taxpayers cannot take advantage of depressed values with a late allocation.

Any existing trust not currently GST exempt is a potential candidate for a late allocation. For example, if a taxpayer funded a successful GRAT, in most cases that GRAT remainder would be held in further trust. For technical reasons, generally speaking, GST exemption cannot be allocated to a GRAT so it is likely that remainder trust would not be GST exempt. If the value of the trust assets are depressed, as long as the trust terms are such that it would be appropriate for that trust to be GST exempt (i.e., it is multigenerational), then a late GST allocation would be advantageous.

As we forge ahead in uncertain times, we should not forget there are both opportunities presented by and techniques to mitigate risks of transfers in a down market. When properly navigated, taking advantage of depressed asset values and still relatively low interest rates can provide significant transfer tax savings for decades to come.

Carl Fiore, JD, LLM, is a managing director in the Andersen US National Tax office, where he focuses on gift, estate, individual, charitable and fiduciary tax consulting and compliance matters. Carl has significant experience with tax and financial matters affecting entrepreneurs, executives and other high-net-worth individuals. He has worked with numerous families and closely held businesses to develop and implement wealth maximization plans through the use of family entities, income tax planning, stock option planning, charitable giving strategies, and effective gift and estate tax planning. Carl has been published and interviewed in Trusts & Estates, The Metropolitan Corporate Counsel and The TaxStringer, and is a frequent speaker on tax planning matters. Carl is also a co-author of the Andersen treatise, Tax Economics of Charitable Giving. Before joining Andersen, Carl worked in the Private Client Services practice of Arthur Andersen, and as a trusts and estates associate at Capell and Vishnick. He can be reached at or 646-213-5125.