In the estate planning and administration world, the last two years have been driven by political instability. It started following the November 2020 elections, and continued into 2021 with the various proposals to fund what is now known as the Infrastructure Investment and Jobs Act. Now, with the results in from the 2022 mid-term elections, it would appear that the period of political instability is behind us (at least until December 31, 2025). But as the period of political instability is ushered out, it seems it will be replaced by a period of economic instability. 

This article provides a refresher on key estate and gift tax rules (along with 2023 inflationary adjustments), provides a curated tour of topical issues in estate planning and administration, and suggests various planning techniques that should be considered as we enter this period of economic instability.

I. Estate/Gift Tax Rules and Inflationary Adjustments

The federal estate / gift / generation-skipping transfer tax exemptions are increasing to $12.92 million, effective January 1, 2023. This is an increase of $860,000 from the 2022 exemptions. Importantly, as part of the Tax Cuts and Jobs Act (TCJA), these exemptions are set to sunset effective January 1, 2026 to their pre-TCJA levels.

Continuing the theme of significant inflationary adjustments for 2023, the federal gift tax annual exclusion is set to increase to $17,000 in 2023, which is up from $16,000 in 2022 and $15,000 in 2021. Similarly, the enhanced federal gift tax annual exclusion applicable to gifts to non-citizen spouses is also increasing and will be set at $175,000 in 2023, which is up from $164,000 in 2022 and $159,000 in 2021. 

Inflation will also significantly increase the New York State estate tax exemption. As of the writing of this article, New York State has not published an official number, but the 2023 New York State estate tax exemption is estimated to be approximately $6.5 million, which is up from $6.11 million in 2022 and $5.93 million in 2021. 

II. New IRS Guidance on Retirement Plan Required Minimum Distributions Post-Death

Last year brought a number of significant changes to the intersection of estate administration and retirement plans, and a good amount of confusion. In order to understand these changes, and the confusion they created, some context is required.

The Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act) was enacted at the end of 2019, effective January 1, 2020, and in the context of this discussion, is applicable to decedents who died on or after January 1, 2020. The SECURE Act enacted major changes to rules related to individual and employer sponsored retirement accounts, and materially altered certain estate plans which included retirement accounts.

Before the SECURE Act:

•  if an owner/participant died before the required beginning date and the beneficiary of the account/plan was not a designated beneficiary, the entire account/plan was required to be distributed by the end of the fifth calendar year after the death of the owner/participant;
• if the owner/participant died after the required beginning date and the beneficiary of the account/plan was not a designated beneficiary, the entire account/plan was required to be distributed by (essentially) the end of the owner’s life expectancy as determined by the IRS; and
• if the beneficiary of the account/plan was a designated beneficiary, that beneficiary was historically able to take required minimum distributions (RMDs) based on his/her own life expectancy—the so-called “stretch.”
  

Generally, a designated beneficiary must be an individual or natural person, though there are exceptions for certain “look-through” trusts.

These rules changed with the passage of the SECURE Act, which eliminated the ability to stretch RMDs over the lifetime of most designated beneficiaries (individuals and trusts. As a result of the SECURE Act:

• if an owner/participant dies before his required beginning date without a designated beneficiary, the balance must be distributed “within 5 years after the death of the [owner/participant].”  See IRC §§ 401(a)(9)(B)(ii), 408(a)(6); 
• if an owner/participant dies after his required beginning date without a designated beneficiary, the balance must be distributed “at least as rapidly as under the method of distributions being used…as of the date of his death.”  See IRC §§ 401(a)(9)(B)(i), 408(a)(6); 
• if an IRA has a designated beneficiary, “subparagraph B(ii) shall apply by substituting ’10 years’ for ‘5 years’”, regardless of whether the owner had attained the required beginning date.  See IRC §§ 401(a)(9)(H)(i), 408(a)(6). In other words, the account must be distributed within 10 years after the death of the owner/participant.

There is an important exception to the 10-year rule, stated in Section 401(a)(9)(B)(iii), which allows distributions to be paid over a designated beneficiary’s lifetime if such individual qualifies as an “eligible designated beneficiary” (EDB). In other words, an EDB can withdraw the account over his remaining life expectancy, but a designated beneficiary only has 10 years. An EDB is a designated beneficiary who is also: (i) the surviving spouse of the owner/participant, (ii) a minor child of the owner/participant, (iii) a disabled individual, (iv) a chronically ill individual, or (v) an individual who is not more than 10 years younger than the owner/participant.

After the SECURE Act was enacted, practitioners believed that eligible beneficiaries of retirement plans who were not EDBs simply needed to withdraw their inherited IRA within 10 years of the owner/participant’s death.  This was based on a plain reading of the Code, which, combining two provisions, states: “the entire interest must be distributed within [10 years] after the death of the employee [/owner].”  In other words, it was believed that if a retirement plan owner/participant died on or after January 1, 2020, a designated beneficiary of that retirement plan was not required to take annual RMDs from that plan during the 10-year period.

On February 24, 2022, the Treasury Department issued Proposed Regulations with respect to the SECURE Act which, among other things, addressed the new 10-year rule.  With respect to owners/participants who died after their required beginning date, the Proposed Regulations provide that distributions must satisfy Sections 401(a)(9)(B)(i) and 401(a)(9)(B)(ii). To satisfy those Sections, the beneficiary must take annual RMDs beginning in the first year after the owner/participant’s death, and the remaining balance must be distributed by the 10th calendar year after the calendar year of the owner/participant’s death. No such annual RMD requirements apply to owners/participants who died before their required beginning date.

The Proposed Regulations created confusion among practitioners and panic among beneficiaries who inherited retirement plan funds and had not yet taken RMDs with respect to those funds. In response to numerous comments received on the Proposed Regulations, the IRS issued Notice 2022-53, which essentially states that Final Regulations will apply no earlier than the 2023 distribution calendar year, and that the IRS will not assert excise tax on a taxpayer who did not take an RMD in years 2021 and 2022 which otherwise would have been required by the Proposed Regulations.

III. Estate Tax Returns in Down Markets: Refresher on Alternate Valuation Rules                    

As we enter what may be a period of contraction in the global economy, alternate valuation will likely play a larger role in estate tax returns. Practitioners may not have thought about those rules since the last market contraction; therefore, a refresher is in order.

The alternate valuation rules, which were originally enacted in 1935 in response to the 1929 stock market crash, essentially provide that an executor may elect to value all property in a decedent’s gross estate six months after his date of death if doing so would decrease both the value of the gross estate and the estate tax payable. The six-month rule applies unless property is “distributed, sold, exchanged, or otherwise disposed of” within that six-month period. It is relatively straightforward to determine when probate property is disposed of for purposes of setting the alternate valuation date value, but it can be more challenging when applying this rule to assets that are included in the gross estate for estate tax purposes but are not part of the decedent’s probate estate (e.g., joint accounts, transfer on death accounts, beneficiary-designated assets, etc.).  Prior to the issuance of Proposed Regulations in 2011, practitioners were divided as to how these non-probate assets were treated for alternate valuation purposes, and whether various actions (e.g., transfer upon death, dividing an IRA into inherited IRA accounts, etc.) triggered the “distributed, sold, exchanged, or otherwise disposed of” language which fixes value for alternate valuation purposes.

The Proposed Regulations offer clarity on these issues. Under the Proposed Regulations, “[p]roperty is not considered ‘distributed’ merely because property passes directly at death as a result of a beneficiary designation or other contractual arrangement or by operation of law.” Examples in the Proposed Regulations further clarify that: (i) the transfer of a joint account with rights of survivorship to the survivor after death is not a “distribution” which fixes value at that date; (ii) the distribution of a beneficiary-designated asset to the named beneficiary after death is also not a “distribution” which fixes value at that date; and (iii) if the recipient of a non-probate asset sells or otherwise transfers that asset during the six month window, that transaction fixes value for alternate valuation purposes. 

Although the general rule states that Proposed Regulations are applicable only when finalized (absent a reliance statement), as a practical matter, there is perhaps little risk given that the current Code and Final Regulations are silent on the treatment of these non-probate assets for alternate valuation purposes, the Proposed Regulations represent the IRS’s own thinking on these issues, and the Proposed Regulations have not been withdrawn in the more than 10 years since they were proposed.  Of course, the question will be settled if the Proposed Regulations are finalized; this may occur as an economic contraction makes alternate valuation more relevant.

Practically, alternate valuation elections can be very simple or can be very complicated, depending on the type of assets. The inclusion of non-probate assets can require obtaining statements from beneficiaries to whom the assets were transferred to confirm sales and other relevant transactions during the six-month period. Return preparers should advise clients early of the potential for alternate valuation, the work and cost involved, and the uncertain result. 

IV. Estate Planning in the Current Political and Economic Environments

The current political and economic environments create exciting estate planning opportunities. 

As an initial comment, given the scheduled sunset of the federal gift tax exemption to its pre-TCJA level, clients who have not already utilized their entire federal gift tax exemptions should consider doing so before January 1, 2026. The contemplated economic retraction, and the associated decline in asset values, may enhance this benefit by allowing clients to transfer assets at relatively lower asset values.  Moreover, clients who have already utilized their federal gift tax exemptions in prior years should consider “topping off” those gifts with the additional inflationary adjusted exemption amounts.

As interest rates rise, estate planning techniques that thrive in low interest rate environments [e.g., grantor retained annuity trusts (GRATs), sales to grantor trusts, intra-family loans, etc.] may become less prevalent, although depressed asset values may make up for higher interest carrying costs.  Estate planning techniques that thrive in high interest rate environments [e.g., qualified personal resonance trusts (QPRTs), charitable remainder trusts, etc.] may become more prevalent, especially if high interest rates are paired with comparatively low asset values.

Finally, care should be paid to existing structures to ensure that clients are optimally positioned for the road ahead. For example, if a GRAT is underperforming, clients may want to consider freezing that GRAT (typically by utilizing a power of substitution) and rolling the underlying assets through another GRAT to avoid losses eroding future appreciation.

Nathan W. G. Berti, Esq., a second-generation estates and trusts lawyer, concentrates his law practice in all aspects of estates and trusts law. He helps a wide range of clients (primarily high-net-worth individuals and families, business owners, entertainers, managers and executives of investment firms, real estate developers and investors, and health care professionals) construct complex estate plans, often with a multi-generational, multi-jurisdictional (including international), and creditor protection focus. Nate also counsels fiduciaries and beneficiaries on all aspects of estate and trust administration, including contested matters. Nate takes a concierge approach to his practice. He regularly meets with clients outside of the normal workday, travels to their residences, social clubs, and more. He recognizes that his clients are busy people, and makes every effort to accommodate their schedules. Nate is a regular speaker on estates and trusts topics. In addition to his speaking engagements, he authors the estate planning chapter of the publication Taxation of Distributions From Qualified Plans, a leading treatise on the issue of taxation of IRAs and 401(k)s that is published by Thomson Reuters as part of its Checkpoint WG&L Tax Series.