Wills and Trusts

Wyatt, Tarrant & Combs, LLP

The New Paradigm in Estate Planning

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The New Paradigm in Estate Planning

Given how large the Applicable Exclusion Amount will be in the future, it becomes clear that increasingly the focus of estate planning will move away from avoiding the transfer tax, and more focused on the income tax.  Much of the estate planning analysis will be about measuring the transfer tax cost against the income tax savings of allowing the assets to be subject to Federal and state transfer taxes.

If we were to summarize what the new “paradigm” will be for estate planning in the future, it might look something like this:

Estate planning will be more complicated and nuanced than in the past.  Estate plans will vary significantly based upon many more variables like:

(1)  Time horizon of the client (typically measured with reference to life expectancy).

(2)  Spending and lifestyle of the client, including charitable giving.

(3)  Size of the gross estate.

(4)  Future return of the assets.

(5)  Tax nature of the types of assets (for example, to what extent will a “step-up” in basis benefit the client and other beneficiaries?).

(6)  Expected income tax realization of the assets (for example, when is it likely that the asset will be subject to a taxable disposition?)

(7)  State of residence of the client.

(8)  State of residence and marginal income tax bracket of the likely beneficiaries.

(9)  Expectations about future inflation.

Estate planners will seek to use as little of a client’s Applicable Exclusion Amount as possible during lifetime because it will represent an ever-growing amount that will be available at death to provide a “step-up” in basis with little or no transfer tax cost.  This conclusion assumes that “zeroed-out” estate planning techniques like installment sales to IDGTs and or “zeroed-out” grantor-retained annuity trusts[1] (“GRATs”) can effectively accomplish sufficient wealth transfer requiring the use of a significant portion of a client’s Applicable Exclusion Amount.  Wealth transfer is not accomplished when a taxpayer makes a gift and uses his or her Applicable Exclusion Amount toward that gift, unless the gift is of discounted assets.  There is wealth transfer only if and when the asset has a positive total return (income + appreciation).  An installment sale to an IDGT and a GRAT transfers wealth in the same manner as a gift, except that those techniques only transfer the total return above a certain rate, like the applicable Federal rate[2] (“AFR”) or the § 7520 rate.[3]

Estate planners will focus more of the tax planning for clients on the income tax, rather than the transfer taxes.  In particular, it is likely estate planning will focus on tax basis planning and maximizing the “step-up” in basis at death.

Because the “step-up” in basis may come at little or no transfer tax cost, estate planners will seek to force estate tax inclusion in the future.

The state of residence of the client and his or her beneficiaries will greatly impact the estate plan.  In other words, if a client is domiciled in California, and his or her beneficiaries living in California, then dying with the assets may be the extent of the tax planning.  On the other hand, if the beneficiaries live in a state like Texas that has no state income tax, then transferring the assets out of the estate during the lifetime of the client may be warranted.  As a result, estate planners will need to ask clients two questions that, in the past, did not significantly matter:

(1)  Where are you likely to be domiciled at your death?

(2)  Naturally, at your death, your children, grandchildren, and other beneficiaries will be lovingly at your bedside, but where are they likely to be domiciled then?


[1] Trust that provides the grantor with a “qualified annuity interest” under Treas. Reg. § 25.2702-3(b).

[2] § 1274.

[3] § 7520.

Leave a reply. Please note that although this blog may be helpful in informing clients and others who have an interest in information privacy and security, it is not intended to be legal advice. The information on this blog also should not be relied upon to form an attorney-client relationship.

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