Will Estate Tax Exemption Change In 2022?

It is possible the proposed clawback regulations from the Treasury may undermine the estate planning you’ve done to address the reduction in estate tax exemptions coming on January 1, 2026. These proposed regulations are not as severe as initially feared, but they do pose a threat to some estate planning, according to a recent article titled “Proposed Clawback Regs May Undermine Some Estate Planning” from Wealth Management.com.

On a positive note, if your estate plan includes a SLAT (Spousal Lifetime Access Trust) or a Self-Settled Domestic Asset Protection Trust (DAPT), the proposed regs shouldn’t prevent you from securing those exemptions, as long as they work with the other aspects of the planning. The proposed regulations are complex and may change the anticipated results of several other estate planning strategies.

When the Tax Cuts and Jobs Act of 2017 was passed, the federal estate tax exemption doubled from $5 million to $10 million, adjusted for inflation until January 1, 2026, when it ends. Some taxpayers made transfers, usually to irrevocable trusts, to secure the temporarily higher gift, estate, and generation-skipping (GST) exemptions. However, what’s not clear is what happens if the taxpayer who made these gifts dies after the higher exemption ends and the new exemption is considerably lower.

In most, but not all, cases, such gifts won’t be subject to a clawback. However, there are exceptions in the proposed new regulations.

The Treasury is concerned about gifts made where the taxpayer continues to retain control over assets. One example is funding a Grantor Retained Interest Trust (GRIT) so the gift would be deemed made of the entire amount transferred with no reduction for the interest retained because the value of the retained remainder would be zero.

A Preferred Partnership could also be structured that intentionally violated requirements under IRC regulations, so the equity the donor received in the entity would be valued at zero. The taxpayer would have retained a preferred interest and the trust would be set up so the entire value would be treated like a gift when family members acquired the common interests. The gift exemption would be secured and the Preferred Partnership interest would be included in the taxpayer’s estate, but the exemption would be preserved.

These types of transactions are the targets of the proposed regulations. Several types of transfers won’t benefit from the anti-clawback rule, so the lower exclusion at death and not the higher exclusion that was thought to have been secured will still be available.

Your estate planning attorney has been following the efforts of the Treasury to provide anti-abuse regulations. A review of your estate plan is always a good idea, but with these changes coming, it would be wise to evaluate your estate plan to see if any planning needs to be revised. There may be newer, better options.

Reference: Wealth Management.com (May 3, 2022) “Proposed Clawback Regs May Undermine Some Estate Planning”

Can I Protect My Inheritance from Divorce?

Even if divorce is the last thing on your mind, when an inheritance is received, it’s wise to treat it differently from your joint assets, advises a recent article “Revocable Inheritance Trust: Inexpensive Divorce Protection” from Forbes. After all, most people don’t expect to be divorced. However, the numbers have to be considered—many do divorce, even those who least expect it.

Maintaining separate property is the most important step to take. If you deposit a spouse’s paycheck into the account with your inheritance, even if it was by accident, you’ve now commingled the funds.

You might get lucky and have a forensic accountant who can dissect that amount and make the argument it was a mistake, as long as it only happened once, but the Court might not agree.

Long before the Court gets to consider this point, if your ex-spouse’s attorney is aggressively pursuing this one act of commingling as enough to make the property jointly owned, you could lose half of your inheritance in a divorce.

You might also try to mount a defense of the particular account or asset being separate property, by identifying the means of transfer. Was there a deed for real estate gifted to you from a parent or a wire transfer for securities? This information will need to be carefully identified and safeguarded as soon as the inheritance comes to you, in case of any future upheavals.

To spare yourself any of this grief, there are steps to be taken now to avoid commingling. Document the source of wealth involved as a gift or inheritance, maintain the property in a wholly separate account and consider keeping it in a different financial institution than any other accounts to avoid commingling.

Another way to safeguard gifts and inherited property against a 50% divorce rate is to use a revocable trust. Creating a revocable trust to own this separate property allows you to make changes to it any time but maintains its separate nature, by serving as a wholly separate accounting entity. The trust will own the property, while you as grantor (creator of the trust) and trustee (responsible for managing the trust) maintain control.

For a turbo-charged version of this concept, you could go with a self-settled domestic asset protection trust. This is a more complex trust and may not be necessary. Your estate planning attorney will be able to explain the difference between this trust and a revocable trust.

One clear warning: if you have already created a revocable trust to protect your estate and it is not funded, you may feel like it would be most convenient to use this already-existing trust for your inheritance. That would not be wise. You should have a completely different trust created for the inherited property, and this would also be a wise time to remember to fund the existing trust.

Using a revocable trust this way will also require customized language in your Last Will, as you’ll want standard language in the Last Will to reflect the trust being separate from your other marital property.

Reference: Forbes (April 13, 2022) “Revocable Inheritance Trust: Inexpensive Divorce Protection”