Escaping Gift & Estate Taxes: Releasing Ownership While Retaining Control
Anyone looking forward to passing an estate over $3.5 million to their loved ones should seriously investigate advanced strategies to protect that estate from “death taxes” when they pass away. I say $3.5 million because some in politics have proposed dramatically lowering its current high threshold of $12.06 million (per individual) to the $3.5 million range. If you presently have $10 million or more in assets, the need is truly urgent.
Here’s the secret that wealthy families have always understood: As a high net-worth individual, your goal is to retain control of your assets and derive the benefits of those assets while you are alive, whether you “own” them or not. In order to reduce your own and your heir’s taxes it may well make sense to transfer ownership (but not control) to those heirs while you are still alive—and to structure ownership so they benefit properly when you die.
Imagine you own a big beautiful bus and you are driving it with your family in the passenger seats. You own the bus and are driving it: you not only control the bus you own it as well. Well, imagine further that you sign the pink slip over to the kids. Nothing else changes. You are still driving the bus (controlling it) even though your kids now own the bus. This is what wealthy families in the United States have done for generations.
The tools I am about to describe are all methods of driving the bus without owning it. The “bus” we build often involves a variety of irrevocable trusts, family Limited Partnerships (FLP) partnerships and Family LLCs. All of these are very different than the familiar Living Trust, which is a revocable trust in which the grantor remains the taxpayer.
Each of these tools applies only to certain circumstances—definitely not one size fits all. The below strategies for avoiding gift and estate taxes are discussed in detail in my webinar on high-net worth estate planning.
Beating the Limits
The context for each of the following tools is the same: The heirs of people with large estates face estate or “death taxes” of 40% (or more if they live in certain states). Under current federal law (2022), a person is allowed to pass $12.06 million on to the next generation without estate taxes. That’s $24.12 million for a couple. While you are alive, you are also allowed to gift up to $15,000 a year per individual recipient, tax-free. You can learn more about estate taxes in California in this article.
The below are all methods to beat these limits (i.e. federal thresholds), when needed to avoid gift & estate taxes—but again, keep in mind that the federal thresholds are expected to drop dramatically, along with the closing of loopholes in the coming years, making fast action imperative.
Intentionally Defective Irrevocable Grantor Trust (IDIGT or IDGT) to Reduce Gift & Estate Taxes
The strangely named IDGT is a method of either “selling” assets to an IDGT or gifting up to $11.7 million (under present law) to a loved one such as a child immediately, but in a way that they won’t have to pay gift taxes—and the assets or the growth (or both!) are also not subject to estate taxes when you die. An IDGT requires careful overall financial planning, and is not for everyone. Sometimes, the person making the gift is still liable for the taxes. This may sound like a really bad idea, but in reality it offers a way for the parents to pick up the kids’ tax bill – in essence making an additional tax-free gift to the kids. An IDIGT is a well-known and often-used strategy among sophisticated practitioners.
The Dynasty Trust, often unfortunately called a “Generation-Skipping Trust,” allows you to pass an asset worth up to $11.7 million (under present law) to your child, then through to a grandchild, by taking advantage of a little-known tax exemption: the Generation Skipping Transfer Tax Exemption. The net result of a well-structured Dynasty Trust is that you, your child, and your grandchildren can enjoy the benefits of that asset without any death taxes payable at your child’s passing. “Generation-Skipping” is a misnomer because in reality your child benefits as much as your grandchild.
Spousal Lifetime Access Trust (SLAT)
The SLAT is a method of transferring large assets, up to $11.7 million (under present law), outside of an estate to reduce the overall size of the estate and avoid estate taxes. In a SLAT, one spouse makes a gift into an irrevocable trust to the benefit of the other spouse (and possibly other family members). This removes the asset from the couple’s combined estate, and only the one spouse has control—and only the spouse who receives the gift can benefit from the SLAT. At death, the benefitting spouse can transfer the SLAT to a child without an estate tax. Special rules apply if spouses make SLATs for each other.
Irrevocable Gifting Trusts ($15K/year)
Every person can give another person $15K in one calendar year without triggering the need to file a Form 709 Gift Tax Return. That means you can give $15K each to your six grandchildren without tax consequences. If you try to go over $15K a year, your power to gift is limited by your overall lifetime cap of giving away $12.06 million (per individual giver) tax free—when you die, all those 709s are added up and your estate threshold is impacted. Importantly, if you want to make gifts to younger children, you may want to wrap these gifts in an Irrevocable Gifting Trust controlled by an adult. Gifting Trusts have advantages over UTMA and UGMA accounts for high net-worth families, including protection from creditors.
Qualified Personal Residence Trust (QPRT) for Homes & Vacation Homes
The goal of this Trust is to give away your home to your children but retain the right to live in it—removing the home from the estate and avoiding estate taxes down the line. It’s a bit of a complex undertaking. For example, the value of the gift is the value of the home minus the retained right to occupy the home up to 20 years rent free. After that, you have to pay rent. There are a lot of caveats, including the fact that you must survive the term of the QPRT (minimum 3 to a maximum 20 years) or the house passes back into the estate, despite the existence of the QPRT. Still, this could be an important tool for many families facing large estate taxes.
Irrevocable Life Insurance Trust (ILIT)
If you are the owner of a life insurance policy, the benefit paid on your death goes into your estate. If your spouse is a US citizen, they will not have to pay tax when they receive it. But if it goes to your kids, it will be subject to the death tax. An Irrevocable Life Insurance Trust can keep your insurance death benefit out of your estate and avoid this tax hit. As an example, a mother creates an ILIT with her son as the trustee. It’s the trust that holds the insurance policy on her life, not the mom, but mom contributes to the trust every year. As trustee, the son pays the life insurance premium and administers the policy. When mom dies, her life insurance benefit passes to the son 100% without any tax.
GRATs, GRITs, and Private Annuities
These are three variations on a common strategy for the intergenerational sharing of wealth to avoid taxes. A GRAT is a Grantor Retained Annuity Trust, an extremely powerful tool to minimize taxes on large financial gifts to family members. It’s a short-term trust designed to share profits on an investment you are expecting to increase rapidly in value. A GRIT is a Grantor Retained Income Trust, used to minimize taxes on large financial gifts to extended family members like nieces and nephews (not your children), while you benefit as well. A Private Annuity is an agreement where an individual transfers property to an “Obligor” (probably your child), and the Obligor agrees to make payments to the Obligee (Annuitant – you) on an agreed schedule. A Private Annuity makes sense when the underlying asset is expected to increase in value, and avoids both gift taxes and estate taxes.
Gifts Using Entities Including FLPs and LLCs
Wealthy families have long benefitted from the creation of Family Limited Partnerships (FLP) and Family Limited Liability Companies (FLLC). Assets are gifted into these entities, and shares are transferred to family members, such as children, while you keep control. For Gift Tax purposes, the value of the gift itself can be reduced under law because of the shares that are gifted cannot be sold and the holder of the shares cannot demand that income be distributed to them. LLCs can be effectively “daisy-chained” across generations to control tax consequences—a complex subject worthy of book-length discussion, but a possibility your family may wish to investigate deeply.
Evaluating and Combining Tax Strategies
I’ve only been able to give a brief flyover of the most common strategies available to people with assets over $5 million. I’ve left out numerous significant details, and each strategy must be evaluated against your own situation. Especially in larger estates, multiple tools should often be employed, and as perhaps you now realize, each tool requires careful consideration for long-term benefits and risks.
Certainly. as planners, it’s vital for us to understand everything about a family’s or company’s configuration, income, assets, challenges, and needs before beginning to create an efficient tax structure that can span generations.
Process & Costs to Build Advanced Tax Structures
Here at CunninghamLegal we’ve established some straightforward protocols for doing serious tax planning with families that own $5 million or more in assets. As part of that protocol, it’s vital for us to understand early if makes sense for both us and our clients to work together—possibly on a long-term basis.
Phase I: Deep Dive
For that reason, we begin with a “deep dive” into your information. We ask you to provide us with all necessary data, and we meet with you (virtually or in person) to understand your concerns and challenges, along with what’s important to your family or business. We charge a flat fee of $495 to make this initial “deep dive,” after which you and CunninghamLegal decide whether it makes sense to continue.
Phase II: Architectural Plan
If we both decide to move forward, then CunninghamLegal begins to work in much the same way a design/build firm would conceive and create a house for you. In this case, the “architects” are our lawyers, who create a blueprint to build new tax structures for your assets and income, using tools like those I discuss above. The cost for this “architectural plan,” which always includes several optional approaches, is generally $7,500. Often all the significant decisions can be made with you during a single meeting, but more meetings may be required.
Phase III: Buildout
In the third stage, we build out your new tax structure using the plan created by our legal architects. Here the costs are, of course, variable, but typically run from about $25,000 up to perhaps $75,000 for a large and complex estate. Always this includes a revision to your existing estate plan, along with creating all the necessary trusts, LLCs, PRPs, or other entities. It also includes working closely with your CPA, Financial Advisor, and others on your “A-Team.” If you have a $20 million estate, and this architectural plan can save your family $10 million over the next 10 years—not to mention protecting your assets for the next generation—we know the investment will be worthwhile.
Again and again, after our deep dive, our clients tell us they are astounded by “what they didn’t know they didn’t know” about their tax situation and the possibilities for minimizing it.
Because CunninghamLegal is a stable firm with a long track record, you can also be certain we will be able to handle changes to your plans and structures as needed over many decades to come. As a mid-sized firm with lawyers who work together as a team, you also know you will get both personal attention and access to a broad set of skills.