With looming changes to estate and gift tax, it's time for elder and special needs law attorneys to brush up on a few tax basics.
While the first half of 2021 remained in pandemic mode, the wide availability of the COVID vaccines, along with a new political landscape after the 2020 elections have turned Congressional attention to other matters affecting the country and taxes are certainly high on the list.
In particular, there have been several proposals regarding changes to the estate and gift tax, including lowering the estate and gift tax exemption from the current $11.7 million to $3.5 million. The lower exemption could result in the estate and gift tax affecting more Americans than it has under the higher exemption, creating a challenge for elder law and special needs practitioners whose tax planning skills have become a bit rusty, or for younger practitioners who have never had to deal with tax issues as part of their planning.
Third-Party Special Needs Trusts
While many practitioners may not be well versed in estate and gift tax, most elder law attorneys and special needs planners are at least familiar with special needs trusts and many practitioners use them in their practice. In particular, third-party special needs trusts are often created to allow friends and family to make gifts to a beneficiary with special needs who is receiving means-tested public benefits. While practitioners are careful to draft trusts that will ensure compliance with state and federal requirements for exclusion as a countable resource, they frequently fail to discuss gift tax issues with potential donors. With a $15,000 annual exclusion limit and an $11.7 million estate and gift tax exemption, this oversight is a “no harm, no foul” issue. However, with changes in the estate and gift tax likely coming, this may not always be the case.
It is critical to remember that only gifts of a present interest qualify for the $15,000 annual gift tax exclusion. Transfers to trusts, including special needs trusts, are generally considered gifts of a future interest that don’t qualify for the annual exclusion. Therefore, individuals making gifts to third-party special needs trusts should be reporting such gifts annually on Form 709. While the estate tax exemption remains at $11.7 million, reporting these gifts would not result in an estate or gift tax liability for the donors. However, should the estate and gift tax rules change, then such a failure to report may have real tax consequences, which could result in significant penalties.
Practitioners have several options with respect to such gifts. One option would be for the family to use an ABLE account for gifts. Since the eligible individual is deemed the owner of the ABLE account, transfers to an ABLE account qualify for the annual exclusion. Another option, similar to the ABLE account, would be for the person with the disability to create a first-party special needs trust, so that the gifts can be made directly to the person with the disability (which will qualify for the annual exclusion) and then transfer the gifts into the first-party trust. Since only $15,000 a year may be transferred into an ABLE account, a first-party special needs trust may be a better option if the gifts are large and from multiple donors. Of course, with any ABLE account or first-party special needs trust, any funds remaining at the beneficiary’s death are subject to a Medicaid payback provision.
A better option may be to include a Crummey power in a third-party special needs trust. A Crummey power allows a beneficiary to make an immediate demand to withdraw the property placed in trust, making the gift a present interest rather than a future interest. While a release of a power of withdrawal is a gift or uncompensated transfer, it is not clear (but many think it is unlikely) that the lapse of such a power of withdrawal is not considered a gift if the lapse is limited to the greater of 5 percent of the contribution or $5,000. In addition, it appears that the IRS believes that the lapse can apply to each contribution made by separate contributors. This would allow multiple contributions to be made to the same trust without recourse against the beneficiary. Indeed, while it is important to analyze the gifts made by grantors to a trust from the perspective of the grantor, it should also be inherent in the practice of an elder law and special needs planner to analyze gifts to a trust from the perspective of the beneficiary. While the IRS may not treat the lapse of a right to withdrawal as a gift, SSI or Medicaid may impose a transfer penalty on the beneficiary that would counteract the purpose of the trust. However, it may be possible to name another beneficiary of the trust in order to avoid an effect on public benefits.
For many elder law attorneys and special needs planners, the Crummey v. Commissioner case has been long forgotten since the estate tax exemption was increased to such a high amount that it no longer affected a large majority of the population. However, with proposed changes to the estate and gift tax looming, it is likely time for elder law attorneys and special needs planners to review those tax basics to ensure that they are advising clients and their families on all aspects of planning.
26 CFR §25.2503-3.
Crummey v. Commissioner, 397 F. 2d 82 (9th Cir 1968).
Rev Rul 85-88, 1985-2C.B.201.