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A version of this article first appeared in CNBC's Inside Wealth newsletter with Robert Frank, a weekly guide for high-net-worth investors and consumers. Sign up to receive future editions delivered directly to your inbox.
The increasingly tense presidential election campaign has triggered a wave of tax planning among super-rich investors, according to consultants and tax lawyers, especially in light of fears of higher inheritance taxes.
The scheduled expiration of a generous estate tax provision next year has taken on even more urgency, tax experts say, as the likelihood of a divided government or a Democratic president has increased. Under current law, individuals can send up to $13.61 million (and couples up to $27.22 million) to family members or beneficiaries without paying estate or gift taxes.
The benefit, along with other provisions of the Tax Cuts and Jobs Act of 2017, is set to expire at the end of 2025. When the law expires, the estate and gift tax exemption will be reduced by about half. Individuals will then only be able to give gifts of about $6 million to $7 million, and for couples, that amount will rise to $12 million to $14 million. Any assets transferred above these amounts will be subject to the 40% transfer tax.
Wealth advisers and tax lawyers said expectations of a Republican victory in the first half of the year have prompted many wealthy Americans to adopt a wait-and-see approach as former President Donald Trump seeks to extend 2017 personal tax cuts.
Vice President Kamala Harris has called for higher taxes on people earning more than $400,000.
With Harris and Trump virtually neck and neck in the polls, the likelihood that the inheritance tax benefits will expire has increased – either due to a blockade or due to tax increases.
“There's a bit more urgency now,” said Pam Lucina, a trustee at Northern Trust and head of the trust and advisory division. “Some people have been holding off until now.”
The expiration of the tax exemption and the reaction of the wealthy to it have far-reaching implications for inheritances and the trillions of dollars that will be passed from older to younger generations in the years to come. More than $84 trillion is expected to be passed on to younger generations in the coming decades, and the estate tax “cliff” will accelerate many of these gifts this year and next.
The biggest question facing wealthy families is how much to give in advance of an estate tax change and when. If they do nothing and the estate exemption amount drops, they risk having to pay taxes on inheritances over $14 million after they die. On the other hand, if they give the maximum amount now and the estate tax provisions are extended, they could end up experiencing “donor's remorse” – which occurs when donors have given away money unnecessarily out of fear of tax changes that never happened.
“When it comes to regret, we want to make sure our clients consider the different scenarios,” Lucina said. “Do they need a lifestyle change? If it's an irrevocable gift, can they afford it?”
Advisors say clients should be careful to make gifting decisions that are based on family dynamics and personalities as well as taxes. While it may make sense from a tax perspective to gift the maximum amount of $27.22 million today, it may not always make sense from a family perspective.
“The first thing we're doing is separating those who were going to make the gift anyway from those who never did and are only motivated to do it now because of the extension,” said Mark Parthemer, chief wealth strategist and regional director for Florida at Glenmede. “While this may be a one-time opportunity in terms of the exemption, it's not the only one. We want people to have peace of mind no matter how it turns out.”
Parthemer said today's wealthy parents and grandparents need to make sure they feel psychologically comfortable giving big gifts.
“They ask themselves, 'What happens if I live long enough to outlive my money?'” Parthemer said. “We can do the math and figure out what makes sense. But there's also a psychological component. As we get older, many of us become more concerned about our financial independence, whether the math tells us we're independent or not.”
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Some families also fear that their children are not yet ready for such large sums. Wealthy families who wanted to make large gifts in the coming years are under pressure to do so now because of the tax reform.
“Especially for families with younger children, the biggest concern is that the donor will feel remorse,” says Ann Bjerke, head of the Advanced Planning Group at UBS.
Advisors say families can be flexible with their gifts – for example, by giving to spouses first before passing on to children. Or they could set up trust funds that distribute the money over time, reducing the risk of “sudden wealth syndrome” for children.
But for families looking to take advantage of the estate tax window, now is the time. Transfers can take months to prepare and file. During a similar tax crisis in 2010, so many families rushed to process gifts and set up trusts that lawyers were overwhelmed and many clients were left in the lurch. Advisers say today's donors face the same risk if they wait until after the election.
“We are already seeing some lawyers starting to turn away new clients,” Lucina said.
Another risk of rushing is getting in trouble with the IRS. Parthemer said the IRS recently overturned a couple's strategy in which the husband used his exemption to gift money to his children and gave his wife money that she could regift using her own exemption.
“Both gifts were attributed to the wealthy spouse, triggering a gift tax,” he said. “You have to have time to measure twice and cut once, as they say.”
Consultants and tax lawyers said their wealthy clients are also calling them about other tax proposals from the campaign — from higher capital gains and corporate taxes to taxing unrealized gains. But phasing out the estate tax is by far the most pressing and likely change.
“Over the past month, inquiries about the [estate exemption]said Bjerke. “A lot of people were sitting on the sidelines waiting to implement their wealth planning strategies. Now more people are implementing them.”