Jessica Gibbs, CFP® [00:00:42] Welcome back to the Off the Wall podcast. I’m Jessica Gibbs, and I’m here with my co-host, Dave Armstrong.
David B Armstrong, CFA [00:00:47] Great to be back.
Jessica Gibbs, CFP® [00:00:49] And we have on Catherine Schott Murray today. Catherine is a trust and estate state attorney with Odin Feldman Pittleman, a law firm outside of D.C. She has over 18 years of experience. And, you know, I’ll say from a personal side, Catherine is one of my favorite attorneys to talk to because she explains things so clearly. So I’m really excited to have her on today to talk about, I think, a topic that is very much on everyone’s mind right now because it’s so in the news, right? Estate tax law changes, but we’re going to take a different approach rather than trying to speculate what’s going to happen, you know, trying to predict the future. We’re going to be talking about this from an angle that I think is probably more important. And it’s how do you think about your estate plan over time, given that what laws are today aren’t necessarily what they’re going to be when you actually pass away? So with that. Welcome, Catherine, to the podcast.
Catherine Schott Murray [00:01:49] Thank you both.
Jessica Gibbs, CFP® [00:01:50] So let’s just start with a baseline actually of tax law. As I said, very much in flux right now is very much in the news. And you even said to me things are even changing by the day. So, you know, several of these proposals obviously are geared towards personal income tax. But there’s also a lot of proposals right now that would impact estate taxes as well as types of trusts that are commonly used today. So can you give us a quick rundown of some of the estate changes that are on the table right now?
Catherine Schott Murray [00:02:21] Absolutely. So let me start with a brief overview of what the current law is and what’s changing and what’s actually being proposed to change in that current law. So from an estate and gift tax perspective, the exemptions that each person has are $11.7 million. That actually changed back in 2017 when we had the Tax Reform Act passed, which doubled the exemptions and they adjust for inflation each year. So that’s why it’s 11.7 this year. What’s being proposed is to go back to the pre 2017pre-2017 Tax Reform Act, which is a $5 million exemption adjusted for inflation, and that’s per person. So the anticipated exemption beginning January 1st, 2022, would be somewhere around $6.02 million per person that is exempt from federal estate tax. The percentage of estate tax above that exempt amount is 40%. So that’s one change. And those exemptions apply not only from an estate tax perspective, but also what you can gift during your lifetime and also generation skipping transfer tax, which is when you have gifts, direct gifts to grandchildren or future generations. So the anticipation is those exemptions will drop on January 1st, 2022, if the legislation is enacted. So that’s one of the major items that folks are looking at. Another item is relating to grantor trusts. So let me explain quickly what a grantor trust is, because I’m sure in the news people are talking about grantor trusts and the impact of grantor trusts. But some people are scratching their heads wondering, what is it exactly?
David B Armstrong, CFA [00:04:01] I’m scratching my head right now.
Catherine Schott Murray [00:04:04] Exactly. So there are revocable trust and there are irrevocable trusts in the context in which we’re talking. We’re talking about an irrevocable. So you can’t change it after you create it. Grantor trust. What does that mean? So I’m the creator of a trust. I’m the grantor. And I’ve decided to gift assets or perhaps sell assets to an irrevocable trust. I’ve made that gift. I’m moving those assets out of my control. I’m not going to have access to them anymore from a perspective of receiving distributions or having control over them. But I’ve retained the ability to be the deemed owner of those assets for income tax purposes. So as those assets generate income in the irrevocable trust, the income is allocated to me for tax purposes. So I pay the tax. But I’m not receiving distributions from that trust to pay the tax. And in paying that tax, I’m not making another gift. So I’m able to shift the assets out of my trust or out of my estate into this irrevocable trust. Pay the tax on it, not make another gift when I pay the tax. And therefore those assets in that trust can grow and appreciate for my beneficiaries. And it allows for that that transfer to the next generation or to a spouse. So that’s in a nutshell what these grantor trusts that everybody’s talking about right now in the news do. What’s proposed is basically to do away with that capability. And there’s a timing issue here. And the timing, at least when the House Ways and Means Committee came out with their proposals in mid September, was to say that any trust that is created and funded before enactment is actually grandfathered under the current rules that I just described. But if you do new transactions or you create new trusts or you make more contributions to an existing trust, that’s all going to jeopardize the estate tax benefits that you can’t really receive and some income tax benefits that you receive. So everybody is looking at this thinking all the planning that we’re doing. I can’t do if this legislation is enacted. Now, with that said, what came out just this week is the possibility that there may not be any grandfathering of existing grantor trusts. And so, again, people are scratching their heads wondering, well, what do I do? How do I plan? And it’s a complicated issue because a lot of folks are looking at these grand tour trusts. And it’s you know, some may say it’s for the super high net worth. But there are folks that are within that range of 10 to $20 million of total net worth. And they’re looking at these trusts or they have these trusts in place. So it really is a technique and a concept that a lot of people have looked at and have used. And right now they’re looking to the proposals are to eliminate the benefits.
David B Armstrong, CFA [00:07:10] Now, would that eliminate existing ones or just future ones?
Catherine Schott Murray [00:07:15] So the difficulty is there’s this concept of grandfathering that when the proposals first came out, seem to indicate that existing ones that had been created and funded before enactment of the proposed legislation. So the president has to sign on the dotted line would be grandfathered. So the current laws as they stand, would apply to the existing trusts. What came out this week, based on some conversations that some folks that I’ve listened to and some of the estate planners that are higher than me, you know, they’ve been doing this longer than I have basically said that the Ways and Means staff have indicated, well, maybe grandfathering wasn’t what we were thinking of. So we’re not sure, quite frankly, whether or not existing guarantor trusts will still be grandfathered. And that’s part of the Jessica, you mentioned the speculation. I just don’t have an answer right now. The thought is continue planning and we’ll see what happens because proposals are still being tweaked and written and there’s a whole process that these legislative proposals have to go through.
Jessica Gibbs, CFP® [00:08:21] Mm hmm. And just for reference, for those listening, we’re recording this on October 1st. So if you’re listening to this a few weeks out, things obviously may change. And I do just want to clarify one thing, Catherine, what you were describing as far as these impacts on grantor trusts, these do not impact people who have revocable trust. You were very clear about these are irrevocable trusts, as in you’ve given away the control and access to these funds versus a revocable trust where you are trustee. It’s like owning things in your own name during your lifetime, but it’s just meant to insure those assets past your heirs without going through probate and according to your wishes. So I just want to make sure that’s clear. If someone has a revocable trust and they’re wondering, is this me, do I need to call my trust in the state attorney? I think the answer is no. Right?
Catherine Schott Murray [00:09:07] That’s correct. And then one other item from a just a high level of one of the proposals are valuation discounts. So for all of your business owner listeners who are looking at exit strategies and exit transactions, the grantor trusts are very often used to shift a portion of their ownership. And what they do when they make that gift is they get a valuation and the valuation has lack of marketability and a minority interest type discount. Those valuations would also go that ability to discount and those valuation discounts would go away if this legislation is enacted.
Jessica Gibbs, CFP® [00:09:45] Yeah. And then just finally, to connect this to the personal income tax side, I mean, I think everyone’s aware, okay, you pay personal income taxes. Irrevocable trusts have their own tax rates. So I think when you’ve been hearing, okay, proposals about raising the highest personal income tax rate from 37% to 39.6%, that’s also impacting irrevocable trusts. And it’s interesting, for a trust, you only need about $13,000 of income to be in the highest tax bracket for an irrevocable trust. So that also is another consideration that’s on the table is is if you do have an irrevocable trust and that generates, you know, some income, you may be putting that trust into the top tax bracket, 39.6% under these new proposals.
Catherine Schott Murray [00:10:33] Not only is that ordinary income tax and its 12,500 adjusted for inflation. So you’re right, you know, 13,000 roughly puts you into a 39.6% tax bracket. But capital gains are proposed to go up from 20% to 25%. And then there is a proposal out there that for trusts and estates that have adjusted gross income over $100,000, there would be a 3% surcharge that is tacked on to that income as well. So just between the 39.6% and the 3% surcharge, you’re at 42%. And then you have the net investment that came out of the Affordable Care Act. So that 3.8%. So you’re now at almost 46.5% in tax at the irrevocable trust level, at a federal level before you even talk about state taxes.
Jessica Gibbs, CFP® [00:11:30] Well, which, you know, in the past where you were describing where the grantor pays the taxes, I mean, that actually if you had a very sizable state, you paying those taxes, that’s another way to lower your estate. Right. So there’s obviously higher taxes. No one’s necessarily in favor of that. But, you know, that was a tool that you could use to further lower your estate. But it sounded like, again, that tool may or may end up being taken off the table. So, I mean, these feel like a lot of big changes. But I think when it comes to estate law change is kind of something that is always happening. I mean, for fun, you know, let’s look at just the federal estate tax exemption amount and for fun, I pulled up. Okay, What has the amount been over the past 25 years? And it’s kind of just interesting. You look 1997, it was $600,000. And the actually the tax rate, what Catherine was describing, how much above 600,000? How much would that be taxed? It was 55% versus today, it’s 40%. You know, fast forward then to 2002, it was $1,000,000. 26. It’s 2 million. 2009, it’s 3.5 million. 2010 was kind of a weird year. It was like 5 million or nothing. And then 2011, it’s 5 million. And then what Catherine was describing, 2000, you know, 18, I bumped up to 11.18 million per person. I mean, so we’re going anywhere in the past 25 years from the estate exemption being 600,000 to over 11 million per person. So I think that just shows you, I mean, how much, you know, estate law changes over time. So with that in mind, Catherine, I mean, how can people embrace these changes? I mean, how should people be thinking about how to evolve their estate plan over time?
Catherine Schott Murray [00:13:15] It’s a great question because I always start when I sit down with folks talking about your goals and objectives. What are your goals and objectives from your estate plan? Let’s start there because folks shouldn’t necessarily be focusing just on tax law and trying to maximize what passes to the next generation. What are your goals and objectives? We have to, I remind my clients, focus on yourselves first. You have a long life ahead of you. So let’s you need to make sure that you have sufficient cash flow for your paying for your discretionary expenses. You want to travel. You want to be able to buy that second home. And these are conversations I know you all have on a regular basis from a financial management perspective, and I do it from the estate planning perspective of let’s not just start talking immediately about tax changes and what we need to do to maximize our use of our exemptions. Start with goals and objectives. Then we need to talk about the family dynamics. And what does that mean? Because I have a lot of conversations of, well, I don’t want to shift that amount in an irrevocable manner to the next generation who can’t manage it, that they don’t need that money. I don’t want to create trust fund kids, you know, I want them to be productive. And so there is an element of, again, going back to goals and objectives. What is your value system that you’re trying to project through your estate plan? And also, don’t forget about yourselves. Don’t forget about the fact that you may need long term care. You may want to stay at home during any significant illness or any decline. That’s going to take a large sum of money in order to keep you at home and provide for that 24 by seven aides or home health aides that come in and make sure that they’re there with you.
David B Armstrong, CFA [00:15:02] That’s such an important point, not just for trust in estate, but just across the planning universe. Is that one of the things that Jessica and I see all the time, and I suspect you do, too, is solutions in search of a problem. And the point about having to sit down and really assess what your goals and objectives is so important across all of the different spectrums of your financial life, whether it’s trust and estate or insurance or investments or planning or anything like that. If you’re not starting out with that question, that basic question, what are your goals and objectives? You’re really not tackling any problem that you have from the right perspective. So it’s really refreshing to hear you say that because that is one of our tenants, which is you’ve got to know what the money’s for in this case. What are your goals, objectives? What’s the money for in your trust and estate plan? And that’s just a really great point. I want every listener to take away, which is if you’re approaching solutions without identifying the problem, I think it’s backwards.
Catherine Schott Murray [00:16:00] Absolutely. And there’s part of the the goals and objectives also involve what are your charitable wishes. And a lot of folks in the conversations that I’ve been having recently, they want to see the impact of their charitable dollars. And so that’s part of, again, I’m sure you all are having the conversations. They want to make sure that they have the funds to make their charitable donations, and therefore they can see the impact of their dollars during their lifetime. And that’s going to impact what’s available, what may be left at the end of their lifetime after they’ve gone through that charitable planning, after they’ve gone through taking care of themselves or if they’re married, their spouse or if they have a significant other, their spouse. For those with disabled family members, their focus is on the here and now and not necessarily on, well, what are the tax laws doing? Because it does feel to a certain extent, every few years in the estate planning world, we all get spun up about the fact that the exemptions are going to change and tax laws are going to change. And then we go through this very busy season and they do change and everybody survives and then they change again a few years later. And you know, Jessica, I’m glad you talked about it, because I can remember all the ups and downs and ups and downs and ups and downs over the last 18 years of doing this.
David B Armstrong, CFA [00:17:20] Yeah, it’s such a great point because when people default and when we’re talking people in the planning process and we start talking about trust and say, I think everybody’s default mentality is okay, you’re talking about everything that’s going to be left when I die. I think that’s like a natural. And we see more and more people taking the approach that you just mentioned, which is not only do I want to identify where the money’s going to go after the second to die of a couple. I want to identify where the money’s going to go during my lifetime as well, because I would rather see my kids have use of the money and watch that, enjoying it while I’m alive rather than not ever get to see it when I’m dead. And we’re hearing that more and more. And that is a great example of why the planning process is so important, because if you’re trying to figure out how much money do I have, we always like to say money can really only go four places. You can spend it during your lifetime, and then after the second to die, it could go to friends and family, charity or the government. So if you can figure out what those four goals are for the money, we can cash flow plan for those things and show you how to allocate money to your family and to charity while you’re alive. So you see it during the benefit, as well as incorporate your goals and objectives for after you’re gone. And I think that’s a huge take away as well.
Jessica Gibbs, CFP® [00:18:33] Yeah, I mean, another way to think about what you just said, divorce rather than okay. Giving to your kids while you’re alive so that you can see them enjoy it and you can enjoy that. It’s also giving to your kids while they’re in their thirties or early twenties. And they really need that money versus when they’re in their sixties and they’re like already built up their portfolio and they really kind of don’t need that inheritance because they’ve built a portfolio for themselves. So just to add to what you were saying, Catherine, you know, one of the phrases we like at Monument, we like to say we use this mostly in terms of investing, but it does apply to us as well as don’t let the tax tail wag the dog. Right. So we like to think of that. You know, we mean by that is like, okay, don’t lie. You know, the fear of having to pay, you know, capital gains taxes on this investment that has grown, you know, drive your decision as far as like, I don’t want to sell this investment the stock because it’s not doing you know, it’s maybe not doing as well like don’t like the fear of paying taxes, you know, drive what your investment strategy is. But there’s obviously it’s applicable here. I mean, you may feel this desire to make all these really big changes before December 31st, 2021, because you want to save on taxes. But, you know, I would just add that taxes are just a piece. They shouldn’t be the driving factor in these decisions. I mean, I just love what you said. What is the original intent of your estate plan? What are your true goals? And, you know, the reality is, is, yeah, maybe your estate might have to pay some taxes, but you know, you’re still going to be able to accomplish the wider vision that you want. You know, saving on taxes, I don’t think is anyone’s, you know, primary driver in who they leave their estate to.
Catherine Schott Murray [00:20:16] Well, and don’t get me wrong. Those who have the goal of saving taxes and minimizing taxes, there is a sense of urgency right now from the perspective of these proposals, because there are changes that, if enacted January 1st, we have reduced exemptions. If those who want to make use of grantor trusts, it’s the date of enactment, which at this point is anybody’s guess. Again, that’s the president signing the legislation. And so we do have that question about grandfathering of these trusts. But there are those that we’re still moving forward with planning and the transactions to get it created and funded before any date.
Jessica Gibbs, CFP® [00:20:52] I guess to clarify what I meant, I meant like, okay, if you were already doing something in process, yes, go forth, try your best. And hopefully, yes, you’re right that things will be as of date of enactment and things will be grandfathered in. I meant more like if you’re listening to this right now and you’re all like, I need to talk to an estate attorney about setting up something. I don’t know what this is, but like, I need to do this grantor trust like and this was never part of your wider conversation. This was never part of your planning. And you’re just like, you know, feel this like urgency kind of out of nowhere. That’s where I’m thinking, okay, slow down a little bit. Are you doing this just because of headlines or are you doing this because it’s actually in keeping with your whole estate plan and your financial plan?
Catherine Schott Murray [00:21:34] Well, that’s why they have a team of advisers. That’s why they can pick up the phone and call you Jessica. Call you Dave. Call me and say, listen, I’ve seen this headline. What does it mean for me? And they can talk with their advisers. That’s what they should be doing from that perspective. That’s why they have a team.
Jessica Gibbs, CFP® [00:21:50] So we’ve talked about a lot of things that are up in the air. What options do you feel pretty confident, Catherine, that are going to stay in place that someone could use as tools to reduce their estate?
Catherine Schott Murray [00:22:05] Absolutely. So still, we have the ability during our lifetime each year to gift up to $15,000 to any number of different people. And if you’re married, the couple can gift up to $30,000 to each person that they decide they want to give to. And again, this doesn’t have to be a family member. It can be a friend. It can be a distant relative. So that is something that right now, at least in the proposals, there’s no appearance that it will be reduced or it will be eliminated. And folks use that very often because it’s an easy shift and it doesn’t require a gift tax return. And, you know, you can write a check on December 31st and you can write a check on January 1st. And it’s considered two different tax years, charitable giving, and still being able to make those charitable gifts. You can set up donor advised funds, you can set up permanent funds or endowments and make those gifts that during your lifetime becomes more of an income tax question because you’re making a charitable donation. And, you know, charitable donations typically are limited to a certain percentage of your adjusted gross income. But going to that what we discussed earlier, you get to see the fruits of your gift and the charitable impact during your lifetime. So I see those as two ways that people can continue to make gifts during their lifetime. You’re able to pay tuition directly, and it’s tuition. So if you pay the school directly, that’s a gift. But again, you don’t have to file a gift tax return and you don’t have to use your lifetime exemption. You can pay medical expenses directly and you don’t have to file a gift tax return for that. So those are ways where you can be giving and shifting monies to the folks that you want to have benefit during your lifetime.
Jessica Gibbs, CFP® [00:23:55] Yeah, we love donor advised funds here at Monument. We use them a lot. We’ve seen that very successful tour with our clients, both in terms of if someone has a big liquidity year, you know, because they’ve sold a business or some sort of event, you know, putting a large amount into a donor advice fund that year in order to get the full benefit of the charitable deduction in the year that they have higher income, but be able to space out, you know, donations to their favorite charities on their own timeline and actually invest in the donor advice fund as well if they wanted those assets to grow in order to make a larger transformational gift down the line. And then also, we’ve seen clients successfully use donor advised funds where they have highly appreciated stock that, you know, if they sold it, they would have a big capital gain. And sounds like this idea kind of isn’t in play anymore. But earlier this year there was talk of potentially making, you know, removing the step up in basis at death. So if someone were to leave highly appreciated stock to their children, their children potentially right now, they would get their basis would step up to the value of that stock when you know the parent passed away. But an idea that was floating around was not doing that. So a child would still have a very significant gain that they’d have to pay capital gains taxes on. So a tool around that is you could just donate that stock directly to the donor advice fund and sell it in the donor advised fund, because that’s a charitable entity. It’s tax free to sell that. So we’ve seen tools like that be really successful. We really love donor advice funds. I’m glad you shot those out.
David B Armstrong, CFA [00:25:28] It also pushes out the decision to which charity you want to donate it to down the road, too. So you don’t have to do all that research at once. You can say, I’m going to take this deduction right now. I’m going to donate this appreciated stock and I’ll figure it out later. A lot of flexibility there.
Jessica Gibbs, CFP® [00:25:43] Yeah. And I also like I think you kind of mentioned this before, we’ve seen clients be like, well, my estate plan is basically when I die, anything over the estate exemption amount, I’m donating to charity and then my estate will be the size of the exemption amount and I won’t have estate taxes and my heirs will inherit whatever is left. You know, we’ve seen people who have that as their their method of this is how I’m going to not have to see taxes. Another option to consider and we actually have a great episode. If you go back in the off the Wall catalog with Matthew Friedson talking about life insurance as a tool for covering estate taxes and how that can be used, though obviously the decision of how much to get is obviously tied to what the exemption amount will be and why you think the size of your estate may grow to.
Catherine Schott Murray [00:26:30] Well, and you have to be careful now with the guarantor trust rules because most irrevocable life insurance trusts are considered grantor trusts. And if those rules pass an additional contribution, which is effectively what you do with an irrevocable life insurance trust, as the insured makes a contribution to the trust of the premium amount. That could create complication if these laws pass going forward and bring the irrevocable life insurance trust back into the estate. So it goes back to that speculation and those moving parts and how fluid we are. You’re absolutely right. Life insurance in the past has always been used as a bit of a replacement or the ability to have it there, but it’s done so typically in an irrevocable manner so that it’s not counted towards the estate.
Jessica Gibbs, CFP® [00:27:17] Thank you for making that connection. I don’t think I had fully put that one together that basically, yeah, if you have a Irrevocable Life Insurance trust that owns a life insurance policy and even if it’s already been established but you’re making premium payments to it in the future, you’re making basically contributions to the ILIT that will then be used to pay a premium on a life insurance that may put it under these new rules. It’s not going to be under the grandfathered rules for grantor trusts. So thank you for clarifying that. That’s really helpful.
Catherine Schott Murray [00:27:50] Yeah. So there are a lot of folks who have these ILITs that are looking at ways to try and protect and preserve the benefits of having the eyelet going forward, particularly if we do have grandfathering.
Jessica Gibbs, CFP® [00:28:02] Okay. So to wrap up, let’s zoom out even more and just think about. Can you share from your perspective what are the most important things people need to consider before they go and meet with their trust in estate attorney?
Catherine Schott Murray [00:28:17] So I’ll go back to one of the other items I mentioned earlier, which is what are your goals and objectives? Some call it legacy planning and regardless of one’s estate. You want to think about legacy planning and what is the message that you’re passing on to the next generation? But even before that, you want to think about capacity planning because people are living longer, but they may not be living longer in a way in which they thought they would. There may be an event. They may, if they’re part of a couple. Their spouse may have died suddenly or died sooner than anyone anticipated. So I think you need to have the conversations and they’re tough conversations. Nobody really wants to have that conversation. They want to be able to live life and enjoy life. But you do need to have those conversations about how do I want to live my life? What happens if now we can’t determine all of the ifs? There are a lot of ifs, but you can hit some of the the higher points. What happens if there’s a death? What happens if there is a diagnosis? What happens if there’s a chronic illness and or at least have a general idea from the perspective of this is how I want to continue living and then talk about and this is the legacy I want to be able to leave. And those are conversations. I go back to the team. Have a team that supports you through those conversations and that dialog, whether it’s you, Jessica and Dave, whether it’s your estate planning attorney, the CPAs get involved, whether it’s all of us sitting around and making sure that you’re comfortable with the plan that you’re thinking of. And then there’s a question of do you communicate that plan to your kids or the folks that are going to help you implement that plan? And the answer is yes. To a certain extent, the more transparency you don’t need to get into dollars and cents, there should be no expectation from the next generation of anything, quite frankly. But if they’re going to participate in the decisions or if they’re going to participate in the care, they should understand who are the people that are part of the team and what are the tools that they have available to them to make the decisions and to implement the plan?
Jessica Gibbs, CFP® [00:30:23] Well, Catherine, that was excellent. Thank you so much for joining us on the podcast. Hopefully, maybe we’ll have you back in the new year and you can talk about, okay, what happened, how to move forward. So yeah, but I just again let’s hammer home the message of thinking about what are your personal broader estate goals, financial goals, legacy goals, and always making sure you’re thinking about your estate plan in that context, not in the context of what’s happening in the news. So thank you, Catherine.
David B Armstrong, CFA [00:30:56] Yes, thank you so much. This was really great. And I do look forward to having you come back on when there’s some more clarity around this current estate tax situation and any laws that come down the road.
Catherine Schott Murray [00:31:06] I look forward to having more clarity as well. Thank you both. It’s been great.
Jessica Gibbs, CFP® [00:31:11] Thanks.
David B Armstrong, CFA [00:31:12] Thanks.
