Estate Freezing and Gifting – Estate Planning In The Shadow of The TCJA Sunset

  • Estate Planning
December 4, 2023

Under the current federal tax code, the lifetime gift and estate tax exemption for an individual is $12,920,000 and $25,840,000 for a married couple. However, unless legislative action is taken to extend these exemptions, decedents who pass away after January I, 2026, will have effectively half of the previous exemption amount estimated to be around $6,800,000 for individuals and around $14,000,000 for married couples. This is known colloquially as the TCJA (Tax Cuts and Jobs Act) Sunset. However, it is possible to utilize the existing gift tax exemption in anticipation of the TCJA Sunset through the technique of “Estate Freezing”.

Estate Freezing utilizes a transfer in which the value of assets for gift and estate tax purposes is set at the time of the transfer, allowing any subsequent appreciation in value to be passed to beneficiaries without creating additional gift or estate tax liability. For example, an individual transferring an asset to certain types of trusts “freezes” the value of that asset at the fair market value at the time of transfer and is then applied against the individual’s lifetime gift and estate tax exemption. This general idea can take various forms which can be chosen based on the individual’s preferences and objectives.

There are many different types of trusts that can be utilized in Estate Freezing with various different benefits. The most prevalent type of trust for this purpose is a granter trust because, with a granter trust, the granter pays the income tax on the trust earnings, allowing the trust assets to appreciate tax free and providing essentially a tax-free gift to the trust beneficiaries by paying the income tax liability of the trust. A granter retained annuity trust (GRAT) is an irrevocable trust in favor of the granter’s beneficiaries that also provides for the granter to receive annuity payments from the trust. A granter retained unitrust (GRUT) is similar to a GRAT, except that the annual payment is recalculated based on a percentage of the value of the assets owned by the trust rather than a fixed annuity. GRATs and GRUTs are in effect for a limited term, during which time the granter retains control of the assets and enjoys the income stream provided. After the time specified, the assets are transferred to the beneficiaries. One downside of GRATs and GRUTs is that if the granter dies before the end of the specified term, the trust assets are counted in the granters’ taxable estate.

Another option is an intentionally defective granter trust (IDGT). An IDGT is an irrevocable trust structured to retain some characteristics of a granter trust, specifically that the granter pays income tax on the trust assets, but the trust is considered irrevocable at the time of the grantor’s death so the assets in the IDGT will not be counted in the grantor’s taxable estate, removing the term risk present in GRAT/GRUTs. However, IDGTs are considered more aggressive than GRAT/GRUTs and while the IRS has established the validity of GRAT/GRUTs, it has shown far more willingness to challenge IDGTs. There are additional potential tax benefits to utilizing the types of trusts described above and an experienced estate planner is recommended to walk you through these benefits on an individualized basis. It is also worth noting that estate freezing may be achieved without the creation of a specialized tax conscious trust; however, for estates above the exemption threshold there may be little reason not to take advantage of additional tax benefits.

Given the potential for the TCJA Sunset to occur, Estate Freezing is even more relevant. The IRS has given guidance that it will not retroactively impose gift and estate taxes to gifts made between 2018 and 2025. In practice, this means that gifts made prior to the TCJA Sunset will enjoy the doubled lifetime gift and estate tax exemption without risk of a clawback from the IRS. From an estate planning perspective, this strongly incentivizes those with potential estates that would exceed the post TCJA Sunset exemptions before January I, 2026 by freezing the value of the transferred asset and apply that frozen value to the current lifetime gift and estate tax exemptions ($12,920,000 for an individual and $25,840,000 for a married couple).

However, it is worth noting that there is no guarantee that Congress will allow the TCJA to sunset and any estate planner should consider their options with and without the TCJA Sunset. Additionally, while estate freezing has the benefit of setting the value of an appreciable asset, it may also bar beneficiaries from taking a stepped-up basis in the asset which could result in capital gains tax liability for the beneficiary. Ultimately there is no one­size-fits-all method to estate planning and each estate plan should be based on the individual’s objectives, asset mix, and personal circumstances. Luckily, there are many capable and experienced estate planners available to guide you through the process and achieve the best result for you and your beneficiaries.