Tax hikes turn estate and wealth advisors into ‘triage center’ for the rich

Ever since Democrats unveiled their proposal to raise taxes on the wealthy, David Handler’s phone has been blowing up with pleas for help. But the trusts and estates lawyer at Kirkland & Ellis in Chicago has told most of those prospective customers to go away. The reason: He’s already working overtime to craft tax-saving moves for his existing clients before the year ends.

“Our office (or home offices) are like a triage center,” Handler said in an email. “My days are now booked by the half-hour, fielding calls and emails all day, plus trying to actually get the work done.”

Handler, who caters to high net worth individuals, isn’t an outlier. Other estate planners and financial advisors say their lines are ringing off the hook with calls from rich people flipping out about the emerging tax proposal. Adding to the scrum and the pressure: Many clients put off meeting with their planners and advisors in person last year — a key step of gaming out multi-million dollar wealth transfers to the next generation — because of the COVID pandemic.

Estate planners are inundated with requests from wealthy investors this year.

Bloomberg News

“This is what we have been inundated with since Sept. 13,” said David Pratt, an estate planning lawyer at law firm Proskauer Rose in Boca Raton, Florida.

Planning and ‘rumblings’
That’s the day when Democrats in the House of Representatives released their bombshell tax plan, a proposal that threatens to throw a major wrench into fancy moves used by rich investors for decades to legally escape taxes and pass on tax-free wealth to their heirs.

The $3.5 trillion spending and tax increase proposal is increasingly contested by some Democratic lawmakers, whose support is needed if it’s to become law. While it’s likely that some items, both on the spending and tax increase sides, will be pared back or scrapped, nobody knows precisely which tax increases might be downsized or fall by the wayside.

“As we draw closer to year end, there have been more questions than answers as new federal tax proposals continue to evolve,” said Alyson Nickse, a wealth advisor and partner at Crestwood Advisors, a registered investment advisory firm in Boston.

What’s clear amid the uncertainty is that financial planners have a world of potential tax pain to ponder. The long-term capital gains rate would rise to 25% from 20%. The top individual rate would climb to 39.6% from 37%. A 3% surcharge would hit individuals with modified adjusted gross income, a measure of taxable income minus certain deductions, over $5 million. Backdoor Roth conversions and mega Roth IRAs, two tax-free retirement account strategies popular with the wealthy, would go into the ash bin of history. A lucrative 20% deduction for small business owners would be curbed.

But it’s two proposals concerning steps to avoid taxes on substantial assets once they’re inherited that advisors are most worried about.

One proposal would effectively kill the use of grantor trusts, a staple strategy for the rich to shift million-dollar assets, such as life insurance, real estate and business holdings, out of a taxable estate, come 2022. Existing trusts would be “grandfathered” but face tight restrictions. The second proposal would slice in half the income levels at which the 40% estate tax would kick in, also starting next year.

Douglas Schneidman, an estates and trusts partner at law firm Sullivan & Worcester in New York who represents high net worth individuals, worries that the grantor trust noose could formally tighten before President Joe Biden would sign it into law. “Rumblings from Congress and the estate planning community suggest the effective date of the grantor trust rule changes could be the date of introduction of the (tax) bill and not the date of enactment (the signing date),” he said.

Pratt said that he has “worked under a lot of deadlines, but this is the first time I don’t know what the deadline is.”

Short and sweet
Most financial advisors outsource the legal part of estate planning to outside law firms. If affluent investors are worried and scrambling, so are their planners and wealth advisors.

“This year in particular, finding time with attorneys has been challenging, so it has required meeting outside of traditional business hours to get issues handled before year end,” said Kenneth van Leeuwen, the managing director of Van Leeuwen & Company, a wealth management firm in Princeton, New Jersey.

Some potential clients who get turned away aren’t even seeking fancy estate planning — just garden-variety documents with wills and beneficiary designations. Others want complicated moves. But even existing clients might not have their situations sorted by the end of the year (if that indeed is the deadline). “Discussions need to be short and decisions made quickly,” Handler said.

‘Cutting it really close’
Investors who want to transfer hard-to-value assets, like an interest in a private firm, to a grantor trust have to get an appraiser to value the stake for tax purposes. (A grantor trust is a kind of trust over which the owner, meaning the grantor, has control and pays income tax on its realized gains.) But Schneidman said that “many appraisers are warning that they cannot take on new projects at this juncture.”

Jennifer Jones, a wealth and estate advisor at Gratus Capital, an independent advisory firm in Atlanta, said that while the last three months of the year are “always busy,” this year “is trending much higher, partly because many people put off estate planning meetings last year because of the pandemic.” She added that several lawyers in the Seattle area told her firm recently they would not be able to meet with a new client until late November, “which would be cutting it really close to have something in place before year end.”

Window of opportunity
The House proposal says that a grantor trust set up on or after the so-called “date of enactment” — when Biden signs it into law — no longer escapes the 40% estate tax, and instead gets included in the trust owner’s taxable estate when she dies. While trusts already in existence would be “grandfathered,” any gifts to or transactions with the trust once the law is in place would become part of the grantor’s estate. And any gifts from the trust to beneficiaries while the owner is still alive would become taxable gifts.

That’s where the potential opportunity comes in. The idea, advisors and lawyers say, is to sneak some estate planning in before the ban would hit. “The window of opportunity is limited,” said Michael Repak, a vice president and senior estate planner at wealth management firm Janney Montgomery Scott in Philadelphia. “The window of opportunity is now.”

Much of the hysteria now swirling centers around a common type of trust known as a grantor retained annuity trust, or GRAT. This involves the grantor putting assets into the trust in exchange for annual “annuity” payments. Meanwhile, the assets appreciate in value. By making the annuity payments tiny, investors can “shift massive amounts of wealth (future growth) out of their estate without the impact of transfer taxes,” wrote Jeffrey Levine, the chief planning officer at Buckingham Wealth Partners, an advisory firm with broker-dealer services in St. Louis, in an Oct. 5 blog post.

The particular trick involves a so-called “zeroed-out” GRAT, in which over time, the annuity payments equal the value of the assets when initially transferred. When the assets appreciate, they can go to heirs free of estate and gift taxes. While zeroed-out GRATS survived a legal challenge by the IRS in 2000 that involved an heir to the Walton family fortune, they’d no longer be possible under the House tax proposal.

But advisors and estate planners say it still may be possible to set up some basic trusts before next year, as they would be “grandfathered” in.

The idea is to corral tax-free benefits for assets at historically high levels that would disappear come 2022. Currently, estate taxes apply once an individual has $11.7 million in assets ($23.4 million for married couples). The Democrats’ tax proposal would slice those exemptions in half, so around $6 million and $11 million, starting Jan. 1.

On top of everything, gift tax returns are due on Oct. 15. And so many planners are “turning away new clients or deferring them until later in the year,” Handler said. At the same time, existing clients “are unaware of the tight time frame and the extent of possible legal changes, and we have to advise them that the work might not be completed before the laws change.”