by James L. Cunningham Jr, Esq.
Do you need Advanced Tax Planning?
If you control over $5 million in assets, probably yes. These days controlling $5 million might just mean you own a house and have built up a nicely appreciated IRA. Indeed, you might have become “High Net-Worth” without quite realizing it—or realizing how your new status requires a whole new approach to your relationship with tax authorities.
Very wealthy families, say with assets over $50 million, have always understood the need for Advanced Tax Planning. These families have always found the best advisors and best lawyers to protect their wealth and figure out how to best pass assets on to future generations.
If you have over $50 million, it’s not hard to see the need for a complex strategy including things like a Dynasty Trust, Generation Skipping Trust (GST), Family Limited Partnership (FLP), Family Limited Liability Company (FLLC), Irrevocable Life Insurance Trust (ILIT), Grantor Retained Annuity Trust (GRAT), Private Annuity, and other structures that can protect against taxes today and on to the next generation.
Without Advanced Tax Planning, very wealthy families have always known that the government stands right outside the door, ready to take half or more of their wealth away. But some “white-shoe” planners will only work with families holding more than $50 million.
“Comfortably Wealthy” families, say with assets between $10 and $49 million, may have perceived this need, but often have a surprisingly difficult time finding good tax advisors—people who really understand things like “Intentionally-Defective Irrevocable Grantor Trusts,” charitable trusts, ways to use Irrevocable Life Insurance Trusts to escape taxes, ways to sell real estate without capital gains taxes—along with clever strategies to control property taxes and save their low Proposition 13 tax caps in California.
Comfortably Wealthy families may find themselves contacted regularly by investment advisors, insurance brokers, wealth managers, and the like—but may never realize how astoundingly few of these advisors offer a deep understanding of taxation. Indeed, I’ve seen plenty of “wealth plans” that completely ignored tax consequences.
As a result, families in the $10 to $49 million range rarely make sophisticated tax decisions that look forward more than a few years. Does that mean they regularly pay tens of thousands, hundreds of thousands, or even millions in unnecessary taxes? You bet.
Truth is, if you have over $10 million in assets, you could probably be using the same strategies as billionaires to protect yourself from taxes—if you had lawyers and advisors who knew how to implement them. Many people in this category may be earning upwards of $1 million a year. If so, certain advanced tax strategies become not just possible, but urgent.
In my experience, “High Net-Worth” families, who I will define as having assets in the $5 million to $10 million range, often don’t see themselves as “wealthy” at all, rarely perceive the need for truly Advanced Tax Planning, and mostly don’t look forward more than 12 months to their next tax bill.
Sure, these otherwise savvy people understand how things like IRAs defer taxes, but too often they don’t pay enough attention, do the serious math on Roths vs. Traditional IRAs, and often overlook things like FLPs and FLLCs to pass on assets.
As a result, these “High Net-Worth” families often get totally creamed by the IRS and state governments—without ever realizing it, and simply because they don’t perceive the need to look ahead and protect themselves.
What is “Advanced Tax Planning”? The phrase implies two distinct, but equally important approaches to one’s financial life.
For starters, “Advanced” means protecting against excessive taxation using sophisticated financial structures which have always been employed by very wealthy people. This means planning beyond the foundational, revocable Living Trust.
If you have $5 million or more in assets, why shouldn’t you benefit from the same tax strategies as people with over $50 million? It’s completely possible, and the benefits can be enormous.
But “Advanced” also means “planning ahead,” well beyond the next April 15th. It means looking forward to tax consequences five, ten or twenty years from now from actions you take today—not just for yourself but for your entire family.
Here at CunninghamLegal, we do lot more than traditional estate plans; we do intergenerational tax planning. That means we employ lawyers with specific degrees in taxation, and we look carefully at what’s good for you and your family both now, as well as far into the future.
Every “High Net-Worth,” “Comfortably Wealthy,” or “Very Wealthy” family’s situation is different. Some own businesses, some invest in real estate, some have blended families, some need protection against lawsuits—the list goes on and on. That means there’s absolutely no one-size-fits-all approach to tax planning or asset protection. And don’t let anyone tell you otherwise. No permanent life insurance strategy makes sense for everyone. No annuity. No LLC. There’s no shortcut around custom planning.
A tax-savvy lawyer or tax planner must understand everything about a client’s assets, their families, their goals, and their challenges before looking at possible structures to protect their assets. Anything less might lead to trouble, even decades down the road.
That said, let’s make a quick, but non-exhaustive list of potential strategies, with the hope of dispelling some of the mystery—keeping in mind that all strategies are subject to change or disappearance with the changing legislative landscape.
What perfectly-legal secrets have very wealthy people used to cut their taxes since the beginning of taxation itself? What “tax structures” can a law firm like mine build for you? Here’s a sampling.
You may think of charitable trusts only as a way for super-wealthy people to give away their money. Not true. Charitable trusts can be an important vehicle for reducing taxes, especially on highly appreciated assets as small as perhaps $1 million—and no, it’s not all about giving your money away. Structured properly, such trusts can pay you a continuous stream of tax-free income during your lifetime, and deductions from a donation can be spread across multiple years to control taxes overall. It’s a complex subject with many options, including the Charitable Remainder Unitrust (CRUT), Charitable Lead Annuity Trust (CLAT), Charitable Remainder Annuity Trust (CRAT) and more. Here’s a webinar we recorded on the subject.
There’s nothing simple about IRAs. Most people understand the basic concept of the traditional IRA, in which pre-tax money is socked away and allowed to grow before being withdrawn and taxed during retirement. But their knowledge ends there. Few people, and shockingly few of their financial advisors, do the full math, understand the tax options, or prepare heirs for the consequences of inheriting IRAs.
Your most important option may be the Roth IRA—a truly remarkable vehicle which allows you to pay taxes up front, but then create a tax-free investment fund for the rest of your days, and for years after you die. The long-term benefits of Roths can be enormous, but it’s vital to understand if, when, and how you should choose or convert traditional IRAs to Roths.
That math gets complicated, and no one should attempt one or more Roth conversions in any tax year without an expert involved. In some cases, creating an irrevocable IRA Trust will also make sense for you and your heirs. One of our webinars discusses issues in passing IRAs to the next generation. You’ll find a useful discussion on traditional vs. Roth IRAs in another webinar, where IRAs are compared to life insurance options, below.
Finally, consider signing up for our newsletter to receive a free download of the extensive chapter on IRAs from my book, Savvy Estate Planning. It’s a comprehensive look at the whole subject which you will find pretty eye-opening.
Retirement accounts are only one way to create tax-advantaged investments. Not enough people understand the important relationship between permanent life insurance policies and taxes. You can use a well-constructed policy to sock away cash and let it grow tax-free, then take carefully-planned loans from the policy tax-free, and pass the benefit along to your heirs tax-free over the course of a lifetime. The issues are complex (for example, insurance benefits may be subject to estate taxes but not income taxes), the timeframes are long, and you need professional help to do this right, but insurance can be a powerful tax-avoidance tool. We’ve recorded a full webinar on this subject, along with an in-depth comparison to an IRA strategy.
If you live in California, you can tap a powerful but little-known law that allows you to designate certain assets as “retirement assets,” both protecting them from attack by lawsuits and creditors, and potentially creating huge tax advantages for both families and businesses. In the words of CunninghamLegal partner TRUST-CFO, “Because the PRP Trust is ‘exempt,’ we are able to harvest unique tax exemptions against all items of tax, including active earnings, passive income and gain on sale of appreciated assets.” Creating and administering a Private Retirement Trust requires focused expertise. For more on this subject, see our webinar on PRPs and our asset protection overview.
If you buy and sell income-producing real estate properties, it’s vital to understand 1031 exchanges. When you sell a property, you can invoke Section 1031 of the Internal Revenue Code (26 U.S.C. § 1031) to fully defer your capital gains tax, as long as you buy a new property within 6 months. Do this right, and you can daisy-chain transactions to avoid capital gains on real estate through your entire life, while enjoying the benefits of larger and larger incomes. See our webinar on 1031s. In California, certain advanced strategies to also avoid property tax assessments under Prop 19 and Prop 13 may be available to people with children: see our current article on Prop 19.
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.
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.
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. Read more about Dynasty Trusts and Multi-Generational Planning here.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
If you believe your family could benefit from Advanced Tax Planning, let me invite you to contact us well before taxes actually become due!
You may also want to consider a Family Office at CunninghamLegal, where we truly manage your overall planning year-round in concert with your other advisors.
You can book an appointment for Advanced Tax Planning using the form on this page, by calling us at +1 866.988.3956, or by clicking here to schedule a free call with a client specialist.
We look forward to working with you!
Best, Jim
James Cunningham Jr., Esq.
Founder, CunninghamLegal
At CunninghamLegal, we guide savvy, caring families in the protection and transfer of multi-generational wealth.
