When the tax law changed in 2017, the benefits to taxpayers were expected to last through 2025. The favorable tax changes included an increase in the amount exempt from estate tax, from $5 million to $11 million per person, and a maximum capital gains tax rate of 20%. With the upcoming presidential and congressional elections, and calls by politicians to undo these favorable tax laws, our clients wonder what they should do now, before the tax law changes again.
Fortunately, there are many strategies that allow us to benefit from the current tax law, and to lower our taxes through already-proven techniques, before the law changes again. There is no new “magic button” tax remedy for Election Year 2020. Instead, tax lawyers can rely on “tried and true” tax strategies that have already proven to be effective and are available now. An added bonus: the IRS has stated that it will not challenge taxpayers who implement these tax strategies now, before the law changes.
On a basic level, one can simply gift up to $11.58 million worth of assets in order to remove the assets from one’s taxable estate at death. However, most people are hesitant to part with such a high amount, and they may not want their relatives to be enriched with such a windfall, simply to lower a tax at death. Instead, the following strategies contemplate lowering tax, while still controlling or benefiting from the asset during one’s lifetime.
How to Lower Your Estate Tax;
More to Your Beneficiaries, Less to the IRS
The goal here is to remove assets from the reach of the estate tax, utilizing up to the full current $11.58 million exemption (before it may be reduced to $5 million or perhaps $3.5 million after the election), while still controlling or benefiting from the use of those assets. This generous exemption is per person; a married couple may remove $23 million combined from estate tax. Here are some techniques to keep the assets in the family, and still remove them from estate tax at your death. Some have acronyms that lawyers, but probably few others, find to be cute.
This method to reduce estate taxes utilizes discounted transfers of interests in closely held entities (Family Limited Partnerships, LLCs, family corporations) to family members. Such “leveraged gifting” has been an extremely important, effective and common method used to reduce or eliminate estate taxes. As long as you retain your controlling interest (e.g., LLC Manager, General Partner), you will continue to control all assets within the entity, while still escaping the estate tax.
If you own a Family Limited Partnership (FLP), you can gift Limited Partnership (LP) interests (or membership interests in an LLC) to your heirs, and take advantage of discounting, to get even more out of your estate, tax-free. In some cases, as much as $46,000,000 worth of FLP interests can be conveyed to your heirs and escape the estate tax. FLPs also provide the additional bonus of excellent asset protection. It should also be noted that in the past, politicians have called for the elimination of such discounting benefits. Once again in this election year, discounting is in jeopardy of legislative repeal. However, until the tax law changes once again, leveraged gifting utilizing favorable discounting is a legal, available and very worthwhile strategy.
GRAT (Grantor Retained Annuity Trust)
GRATs are particularly effective for assets that you think will appreciate over time. The IRS sets a very low “hurdle rate” which in today’s COVID economy is at 0.4%, a historic low. (The rate was 2.2% in September 2019.) So long as the assets in the GRAT perform better than the IRS’s hurdle rate, they escape taxation.
If you contribute assets into a GRAT, you can receive a regular payment akin to an annuity over many years. When the trust term ends (from two to ten years), the appreciated assets pass to your heirs, are not considered part of your estate and will not be subject to estate or gift tax.
There are calls to eliminate GRATs, like discounting, after the election. However, GRATs are an effective and completely legal strategy, currently available for tax savings.
SLAT (Spousal Lifetime Access Trusts)
Spouses who are uncomfortable gifting significant monies to their heirs may instead set up trusts for each other and utilize the current $23 million joint exemption while still benefiting from the assets. The trust would provide distributions to your spouse (which would also benefit you) and would distribute the remaining assets to your heirs after your spouse’s death.
QPRT (Qualified Personal Residence Trust)
If you contribute your personal residence into a QPRT, you may still live in the residence for a term of years, and when the trust term ends, the home is removed from your estate while passing to your heirs, free of estate taxes.
ILIT (Irrevocable Life Insurance Trust)
If you own or control life insurance policies, the IRS deems the death benefit to be in your estate and subject to estate tax, even though you will never receive the death benefit during your life. If you contribute these life insurance policies to an Irrevocable Life Insurance Trust, you may remove the insurance policies from your estate. Your family members may receive the death benefit from the trust, free of any estate tax.
A Dynasty Trust allows for the preservation of assets for one’s immediate and remote descendants, along with offering asset protection from creditors, as well as delay of the estate tax bite for many generations. The trust can distribute income to beneficiaries, but principal is preserved, asset-protected and grows tax-free.
CRUT (Charitable Remainder Trust)
In addition to the loss of an $11.58 million exemption from estate tax, politicians are also calling for an increase in the income tax on capital gains from the current 20% to 39.6% (plus the 4.3% investment tax). This will affect taxpayers who own appreciated assets; if the law changes, they will pay double when they sell those assets. In addition, politicians are also calling for the repeal of the basis “step up” at death. (Under current law, assets passing at death are entitled to a “step up” to their current value, rather than their original value. This means, for example, that when the heir inherits and sells the inherited asset, the heir pays no tax. Such a “step up” in basis may be eliminated after the election.) To avoid this, taxpayers should consider a Charitable Remainder Trust. CRUTs are effective for both income tax and estate tax savings.
By contributing appreciated assets to a CRUT, the sale of these assets by the CRUT is exempt from all taxes; you are entitled to a charitable deduction; the trust makes regular payments back to you during the trust term; and at the end of the term, 10% of the assets pass to the charity, are not subject to income tax and are removed from your estate.
Some clients are availing themselves of the above strategies currently. Some clients are waiting until after the election on November 3 to see who wins, and which way the tax winds will blow. Even if final legislation may not be enacted until well into 2021, there are concerns that such legislation would be retroactive to January 1, 2021. The window from November 3 to December 31, 2020 is not wide.
These strategies are not only for the mega-wealthy. We have successfully utilized these strategies for clients of means at various levels who are concerned with leaving as much of their hard-earned assets for their heirs with as little as possible going to the IRS and state tax authorities. These are equally attainable goals with a $5 million estate as they are at $50 million. Moreover, these strategies are affordable, especially considering the amount of tax savings they offer.
Please contact us for more information.