I never was a Led Zeppelin fan, and hence I find fault with the song, “The Song Remains the Same,” both the lyrics and the vocals. Though history does repeat itself, the estate-planning song rarely remains the same. And as we enter 2023, quoting from excellent musician Sam Cooke, “A change is gonna come.” You’re no doubt saying, if you’re still reading this, “Please give me one more bad song metaphor.”1 As we enter into the discussion of our estate-planning focus for 2023, let’s consider this line from a not-so-famous John Lennon song: “Turn off your mind, relax and float downstream.”2 (He may not have mentioned estate planning expressly, but he was no doubt thinking in those terms.)
Two Most Effective Strategies
Certain aspects of the estate-planning song do remain the same. And two of them are the grantor retained annuity trust (GRAT) and the sales to grantor trust (STGT). Here’s a bold statement that I make without the slightest hesitation: The two most effective estate tax strategies since 1990 (1976 for the STGT) are GRATs and STGTs.
Really, but don’t we talk about discounted family limited partnerships (FLPs) all the time? That should be the first clue that there may be a problem. As discussed later, FLPs should still be considered in 2023, but often the focus will be on fixing improper administration or considering termination of the FLP. Even when FLPs succeed, their value is often overstated.3
Returning to STGTs and GRATs, was anyone other than me horrified at the proposed legislation in the House Budget Reconciliation Bill (House bill)4 in the fall of 2021? For reasons that aren’t completely logical, that House bill reminded me of the Monty Python skit in which the shop owner sells a parrot, a dead one, and then contends it isn’t dead. Apparently, it was “resting.” The House bill (had it passed into law) would not only have spelled angst and turmoil to GRAT and STGT planning, but also estate tax planning may have ended up like the dead parrot. Okay, a bit of a hyperbole, but it felt like that at the time.
Anyway, I think with a currently dysfunctional Congress, not a redundancy,5 we’re unlikely to see this kind of legislation any time soon. By the way, the grantor trust proposals and structures in the House bill were, to coin a legal phrase, idiotic in my view, and for those who are more erudite than me, those provisions were at best poorly thought out.
Therefore, for a period of time in the future, we can continue to go with GRATs and STGTs when the situation arises, which would include any operating company that: (1) has cash flow, could generate cash flow or can borrow to generate cash flow, OR (2) will likely appreciate substantially in value. Note the “OR”: either condition justifies these strategies. And if an enterprise has both, you now have a situation in which even a Barry Bonds performance-enhanced home run will be surpassed by the achievement lengths of these strategies.6
For a business with cash flow, given enough time and discounts in initial valuation, the entire value of the transferred interest is capable of being transferred with minimal transfer-tax implications.
Because a GRAT is statutorily authorized, it makes it hard for the transaction to have a negative result, except when the planning is so ridiculously offensive—see the fact pattern in Chief Counsel Advice 202152018—that the Internal Revenue Service steps in and say “no mas.” But follow the rules and be reasonable, and a GRAT will be a good friend.
That last phrase is understated: The GRAT and the STGT will be your two best friends.
Section 2701
Since it was passed in 1990, Internal Revenue Code Section 2701 has always had potential as an effective estate tax strategy, and a fair one, from a legislative perspective. From a purely quantitative standpoint, Section 2701 can’t and won’t be as transfer tax-efficient as a GRAT and an STGT. From a client comfort level, though, the strategy may be more attractive.
And now we have to digress a bit and talk about changing our thought process and definition of “estate-planning success.” In the recent decade, planners have evolved away from the primary thought of, “How do we minimize estate taxes” to a more holistic, “How do we benefit the family for generations to come.” We know that there are non-financial decisions that are paramount to many clients. And passing substantial wealth to future generations isn’t as wonderful as it seemed decades ago and with past generations.
In the 1970s, when interviewed about how much better his life must be because he became famous, Bruce Springsteen quipped, “You make more than $500 a day, you have more than $500 worth of problems.”7 Parents are cognizant of how important NOT leaving substantial, untethered funds to their children could be. Money can and does have potentially negative impacts on purpose and productivity. And purpose and productivity in one’s life, because those two energy sources often lead folks to valuing and respecting others, are important variables to quality of life and certainly principles that many of our clients appreciate.8
With Section 2701, a parent can actually have an IRC Section 2036-like retained interest without the full value of the transferred interest being included in the gross estate. We know Section 2701, and if I went into detail into that section now, you would be bored. But think about what it does. A company has a determined fair market value of $10 million.9 If the equity is restructured with a $9 million preferred interest and a $1 million common interest, and the preferred coupon is 4% or 5%, the common interest is transferred (using gifting credit) at $1 million and the company appreciates over 10 years to say $20 million, that’s $10 million transferred at no gift or estate tax cost. This is a great result, but not often used because Section 2701 is a bear to understand, somewhat delicate to administer and not as mathematically productive as a GRAT or an STGT. But, hey, the parent is able to retain their interest, while transferring appreciation. Clients have liked Section 2701 transactions that we’ve done. Ponder Section 2701 in 2023.
SLATs
Proceed carefully with the oft-discussed and used strategy in 2021 and 2022, spousal lifetime access trusts (SLATs). The SLAT is an effective strategy and valuable with the increased amount of the gifting scheduled to go the way of the passenger pigeon in 2025 (that is, the lifetime gifting credit is scheduled to return to lower levels).
But there are practical concerns that need to be discussed and navigated with SLATs. One concern is divorce. This can be navigated in different ways, but with 50% of U.S. marriages ending up in divorce,10 it’s an important discussion to have with your clients. In actuality, with a co-trustee that has a best interests distribution standard to a spouse, and decanting available, you may be able to plan around the difficulties that accompany divorce. But the reality is that no matter the planning, a SLAT and a divorce mix together about as well as borscht dissolved in vodka.11
With SLATs, these often aren’t happily administered either. Sort of like receiving the electronic gadget you always wanted, only to find out that you have to enroll in a Master’s program to understand how to actually use it.
And finally, with SLATs, not everyone (or anyone) is very happy giving away money, even to Generation 2, when those funds constitute a substantial part of their net worth. And this is true even when there’s the safety valve of the non-grantor spouse retaining an interest. We all do our own personal mental accounting, which has no relation to real accounting tabulation.
And while we’re talking about the lifetime credit, keep in mind the new amounts that will exist in 2023. With inflation at 100%, that new amount could be $10 million. Oops, that’s overstated; it will actually be an increase of $860,000 per spouse. But for those who set up SLATs before, perhaps it’s time to put more dollars into the SLAT associated with this $860,000 increase.
Speaking of a revisit, let’s dust off those partnerships we did 10 years ago, five years ago, five minutes ago. We’re all friends here, so let me ask you a question: “How’s the administration of the FLP going?” I know our clients often nod their head in approbation when you indicate, during the planning stage, that the “I’s” must be dotted and “T’s” must be crossed during the administration of the partnership.12 Many haven’t actually dotted or crossed anything during the life of the FLP, in a bad Section 2036(a)(2) implicating way.
Other partnerships exist to achieve estate tax discounts, when the estate tax credit was far lower than it is today. Those estates may be under $25 million per couple. They’re the Exxon Valdez of partnerships, waiting to run aground with unneeded estate tax discounts and thereby an accompanying loss of basis. Double ugh.13
In 2023, dust off those partnerships and consider terminating them to: (1) preserve the transfer-tax gain that’s been achieved, if the discount has been used in lifetime transfer strategies, or (2) remove the possible step-down in basis.
Intra-family Loans
Speaking14 of revisiting and terminating, dust off those intra-family loans too. Are any coming due? Guess what: Short and mid-term interest rates are ugly, relatively speaking versus the last decade. Keep an eye on these rates in 2023, and see if interest rates precipitously drop, sort of like used car prices in the last few months.
Also review the investments in trusts. We’ve been productive15 estate-planning beavers with the creation of trusts in the last 20 years. Are the investments in these trusts what we want them to be? Do long-term trusts hold 90% fixed income investments (sounds bad to me)? Or estate tax-free trusts low basis assets (also sounds like an oil tanker waiting to run aground)?
Continue to consider the effectiveness of grantor trust income tax planning, transferring or substituting high basis assets into estate tax-free trusts for the lower basis assets in those trusts.
Start-Up Companies
While we’re dotting I’s and crossing T’s, consider one of the low hanging fruits of estate-planning strategies.16 At the start-up time in a company establishment, transfer a portion—say 100%—okay—say 50%—into an estate tax-free trust for zero value. After all, there’s really no value in a start-up company, pre-funding. When you think of risk-return, there’s no greater risk (of fail) than a start-up company. And therefore, there’s no return potentially greater than with a start-up company. And if the value is zero when your client’s company is started, then the planner for no tax cost has potentially transferred what we know sometimes turns out to be millions (billions) free of estate tax. Do you think a long-term contingent fee based on tax savings down the road would be something to consider on these strategies? No legal fees to set up, just the contingent fee? The answer is yes, but it requires a bit of vision.17
Mobility
We’ve now reached the final thought to share for 2023: mobility. Our clients are often moving states. Out of Illinois, to avoid the horrible and incredibly stupid legislatively driven Illinois estate tax.18 And to California. Oops, California has really bad taxes too; good weather though. Out of there to Nevada. But Nevada is a desert. Let’s move to Colorado. Hmmm. There’s no water there and a few too many fires. Let’s go to Arizona, but that’s another desert. Oh well, you get my point. People move. And we need to have strategic alliances with our estate-planning siblings to work on planning when our clients move from one state to another to another. Keep in mind that estate planning, including counseling our clients on life matters in general, is 90% state-agnostic. Why give up clients when only 10% of their planning is based on new states of domicile? The year 2023 and going forward will continue to be a time of client mobility.
Happy Trails
I’m excited for 2023. Change is good. It’s refreshing, challenging, value added and important for us as planners to embrace. As we do every year, let’s greet this one with new opportunities, new adventures, new joy and increased happiness for our clients in their planning and in them relying on your wisdom. And so we leave with our final songwriter citation, Dale Evans: “Happy 2023 Trails.”
Endnotes
1. For the record, I sometimes regurgitate a bit in my mouth when I read other folks quoting songs…as if these artists are the Charles Dickens of our time; ugh.
2. From “Tomorrow Never Knows.” John Lennon probably wasn’t drinking coffee when he wrote those lyrics.
3. See, e.g., John M. Janiga and Louis S. Harrison, “Discounts vs. Step-Up Basis: Tax Rate Arbitrage Gone Bad (or Not as Good as Expected)?” Journal of Passthrough Entities (March-April 2014).
4. H.R. 5376 (October 2021).
5. Actually, it’s a redundancy.
6. Not that anyone is asking, but I think that Mr. Bonds should be in the Hall of Fame. Mr. Rose too.
7. The quoted portion is from memory listening to an interview at the end of the 1970s. I think this is about what he said but given that it’s been over four decades, a few words may be incorrect. Hey, you have to hide your love away.
8. Okay, I have no cite for that; anecdotal based on four decades of observing high-net-worth families.
9. That could be, on a sale now or a year later, $8 million, or $12 million; who knows what the market really brings?
10. True percentage or urban folklore? Paradoxically, likely a bit of both.
11. Gave it my best shot to come up with a combination that sounded disgusting.
12. Where did that dinosaur phrase come from? Did typewriters often not have dots for I’s, or horizontal lines for T’s, or in cursive writing, did the generations before us forget to dot I’s? Now that I think about this further, this is truly one of the dumber sayings ever, but it’s in our lexicon. To think this trite phrase has any meaning, we must have “drunk the Kool-Aid.” Ha, another silly expression in our vernacular. Nice job by society to create a legacy for Jimmy Jones, the guy associated with the poisonous Kool-Aid.
13. See supra note 3.
14. Does writing equal speaking? I think so, if you are reading this, I’m speaking TO YOU. Love the caps in emails, don’t you? Now people can scream at me in person, on the phone, and IN TEXTS AND EMAILS!
15. Reproductively speaking, as in multiple trusts being created.
16. Hope you’re going “hah, hah.” Low hanging fruit ranks up there with dotting I’s and the T thing as a ridiculous metaphor that should have been vocabulary-purged years ago. What’s low hanging fruit? Essentially, lemons that you can reach with your hands, and then use in the batch when you Drink the Kool-Aid.
17. And a long practitioner life expectancy.
18. Someone in the Illinois government must have drunk the revenue Kool-Aid in thinking that an estate tax was a net positive. However, there are so many people who leave Illinois for this reason that the Illinois estate tax is a big, big, big loser for Illinois revenue purposes. No one will accuse the government of being Big Thinkers, including the current Illinois state government. I specifically explained to them the revenue need to eliminate the Illinois estate tax. They listened to me about as well as my offspring listen to me; specifically, zzzzzzzzzzzzzzzzzzzzzzzzzzzzzzz.