Little Potential for Adverse 2022 Federal Tax Legislation
Despite determined congressional Democrat efforts last year, the Build Back Better (“BBB”) bill failed to pass, even after most of its adverse income, gift, estate, and generation-skipping transfer (“GST”) changes were stripped out. This year, President Biden in his budget “Greenbook” reproposed many of those same adverse tax changes, plus others. Despite the continuing push for those changes, the failure of their adoption last year and the fact that even the stripped-down BBB bill has failed to pass so far this year, makes passage of those adverse tax changes this year seem unlikely. In addition, developments since last year further impede prospects for adoption of adverse tax changes this year, including: (1) growing opposition from Democrat members of Congress, particularly those facing re-election challenges that could give control of the House of Representatives to the Republicans, and perhaps the Senate too; (2) persistent high inflation; (3) continuing infections of COVID-19 and the recent outbreak of monkeypox; and (4) the continuing world economic upheaval resulting from the Russian invasion of Ukraine.
Despite those poor legislative prospects for adverse tax changes this year, taxpayers need to keep in mind that the clock continues to run down on most of the favorable income, gift, estate, and GST tax features of the 2017 Tax Act that they have been enjoying since 2018, because those features are due to expire and revert back to previous, less favorable tax law in 2026. In the estate planning world, critical among those changes is that the then-current inflation-adjusted lifetime gift, estate, and GST tax exemptions (for 2022, $12.06 million per individual and $24.12 million per married couple) will be halved in 2026.
In that context, it is important to keep in mind that advanced estate planning techniques designed to avoid or at least minimize federal income, gift, estate, and GST transfer taxes take time to understand, analyze, and plan for one’s specific situation, decide upon, and then implement. In addition, just like interest compounding, most of those techniques provide greater benefits the sooner they are implemented. Delays in doing so risk unanticipated developments that rapidly could alter the tax law landscape. Case in point: the COVID-19 pandemic, the scope of which previously was anticipated only by the epidemiologic and disaster preparation communities, that descended on the entire world seemingly suddenly in early 2020 and that has resulted in a continuing awful human toll, unprecedented multi-trillion dollar federal spending, worldwide business disruption, and now seemingly intractable inflation.
In short, the old phrase “the early bird gets the worm” especially applies to federal income, gift, estate, and GST tax avoidance planning now both as the clock continues to tick down to 2026 and because of the potential that countdown could be preempted by intervening adverse tax law changes that are deemed necessary to raise federal revenue even if the Republicans retake control of Congress and the White House. That might become necessary, for example, to fund the increased interest costs of the current and growing $30 trillion federal debt, which has more than doubled from a mere $14.6 trillion in 2017.
New Florida Community Property Trust Law
Married Floridians (and residents of other states who avail themselves of this Florida law) can now create Florida-sitused community property trusts. Florida, like most states, is a separate property state for marital property, as distinguished from the nine states that are community property states. Florida being a separate property state means that when the first spouse dies, appreciated property jointly owned by the couple in either tenants by the entirety (“TBE”) or certain other joint ownership forms only receives a tax basis step up equal to fair market value for the one-half of the property attributable to the deceased spouse’s interest.
In contrast, the same joint property owned by a married couple in a community property state receives a full fair market value tax basis step up at the death of the first spouse. In community property states, all property owned by a married person is deemed to be either the community property of both spouses or the separate property of just one spouse. In addition, property acquired during marriage is presumed to be community property unless there is clear and convincing evidence that it is the separate property of only one spouse.
The Florida Community Property Trust Act allows married couples to opt-in to community property treatment for assets held in such a Florida-sitused trust, provided the trust meets certain statutory requirements.
It is important to note that although Florida and some other states permit married couples to own property as TBE, this form of ownership has vastly different characteristics than property characterized as community property. Two of the main differences between TBE as separate property in Florida and as community property are that TBE provides rights of survivorship and creditor protection benefits not necessarily available with community property.
As to rights of survivorship, with TBE in a separate property state like Florida, when one spouse dies, legal title to the entire property immediately passes to the surviving spouse. Alternatively, with community property, in general, each spouse has the right to bequeath or devise his or her half interest in the property by will or trust as he or she wishes.
As to creditor protection, Florida law protects the TBE property from a creditor of either spouse, whereas with community property, one-half of it may be exposed to the creditor of one of the spouses.
Accordingly, with the different testamentary disposition rights and creditor protection distinctions between TBE and community property considered, the full fair market value tax basis step up at the death of the first spouse can now be obtained for such property held in a Florida community property trust. This could be a very valuable income tax avoidance technique for the right circumstances. Accordingly, married couples interested in a Florida community property trust should have a comprehensive discussion with their tax advisors about the pros and cons of this planning technique.
New Law Enhances Attractiveness of Florida-Sitused Spousal Lifetime Access Trusts (“SLATs”), but with an Important Caveat
A type of trust known as spousal lifetime access trust (“SLAT”) has been very popular in recent years while the federal gift, estate, and GST tax exemptions have been threatened with reduction, such as in the proposed, but unsuccessful, 2021 federal tax legislative changes and, as noted above, as is scheduled to occur when the exemption is halved in 2026.
A SLAT allows one spouse (the “settlor spouse”) during lifetime to create a trust for the benefit of the other spouse (the “beneficiary spouse”) while retaining indirect benefits of the trust’s assets and income through the beneficiary spouse’s enjoyment of them, but, significantly, also while consuming lifetime gift tax exemption of the settlor spouse before it is reduced. A law recently adopted in Florida and effective for trusts created on or after July 1, 2022, enhances the attractiveness of Florida SLATs by protecting a contingent reversionary interest in the trust for the settlor spouse (in effect, a contingent beneficiary interest) from his or her creditors if the beneficiary spouse were to die first. While several so-called domestic trust haven states already have had this favorable feature in their laws, with this new Florida law, married Floridians wanting a reversionary interest for the settlor spouse in a SLAT, which often is desired, may not have to form and operate their SLATs in those other states to obtain those favorable outcomes.
Nonetheless, as is often the case with tax laws, there is a potential shortcoming in this technique because it is not clear that a settlor spouse’s contingent reversionary interest in a new Florida SLAT would avoid inclusion in the settlor spouse’s estate when he or she dies, thus defeating the objective of consuming gift, estate, and GST tax exemptions with the trust’s funding. While that avoidance is available for certain lifetime marital trusts under existing Treasury Regulations, that same treatment has not yet been extended to contingent reversionary interest SLATs. Accordingly, as with all estate planning, taxpayers should seek the advice of competent legal counsel when considering employing this technique.
New Further Extension of Florida Rule Against Perpetuities Period
Another recently adopted Florida law that will become effective on July 1, 2022, is the further extension of the time a trust can exist. This time period is known as the rule against perpetuities (“RAP”) period, which is a longstanding trust law feature that historically was intended to prohibit accumulated wealth from passing indefinitely from generation to generation within a family and growing in value along the way. (The federal GST tax has a similar purpose by imposing a tax on the funding of trusts with amounts greater than the GST exemption that are designed to benefit multiple generations).
Until 2020, Florida’s longstanding RAP period was a mere 90 years; it then was extended to 360 years for trusts created after 2000 (for trusts that do not limit the RAP period to a shorter period). The new law extends the RAP period out to a whopping 1,000 years for trusts created on or after July 1, 2022. While even a 360 year RAP might seem absurd, and a 1,000 RAP even more so, such a long RAP does create the desirable aspect of trust continuity well out into the future (3022!).