California Probate - Law Offices of Janet Brewer Blog

2020 Offers a Temporary Increase in Exemptions from Estate and Gift Taxes: Why You Should be Taking Advantage of This Limited Time Exclusion

The Tax Cuts and Jobs Act was signed into law on December 22, 2017, and it continues to provide extraordinary opportunities for those who are planning for their estate. One of the most significant benefits gained through this Act was the temporary increases in exemptions on gift and estate taxes.

Changes in the Act

Currently, transfers of property that occur during one’s life or upon death in excess of the gift and estate tax exemption limit – which was $5,490,000 - are taxed at the federal rate of 40%. However, the Act doubled this exemption amount for a limited amount of time. Between January 1, 2018, and January 1, 2026, the federal estate, gift, and generation skipping transfer exemption amount is set at $11,180,000. This exemption limit is doubled for married couples.

This change means that individuals can leave a lot more of their wealth and assets to family members without incurring a tax rate of 40%. But it is crucial to understand that these exemption limits are only temporary; without another statutory change, the limits will revert to $5,490,000 after the January 1, 2026 deadline has passed.

Despite this, the IRS announced that individuals who use the exemption between 2018 and December 31, 2025, will not be adversely affected when the exemption reverts to its former level. They have determined that there would be no ‘clawback’ of gifts made by individuals during the defined period, even if the lifetime exemption amount is subsequently decreased.

There were no changes to the provisions that allow gifts of any amount for health care or education to be excluded from the gift tax. These payments must be made directly to the educational institution or medical provider, though.

Benefits of Estate Planning Now

Due to the changes made in the Act, estate planning activities, and asset transfers that occur during this time can be incredibly advantageous for families who are trying to keep more of their assets. And it is far better to consider taking action sooner rather than later to ensure that securing these benefits isn’t put into jeopardy by another legislative action.

For individuals who have previously reached the $5,490,000 gift tax or generation-skipping transfer tax exemption, they now have the opportunity of gifting another $6,090,000 (or double this in cases of married couples) to family members. Individuals can also bestow gifts within these limits to grandchildren or more distant descendants without incurring the 40% tax rate.

The increase in federal exemptions provides individuals with opportunities to retain more control of their assets for generations to come. In addition to this, the annual exclusion gifting amount has remained steady in 2020 at $15,000 per donee (or $30,000 per donee if spouses split gifts), which remains subject to indexing in future years.

The increase in the exemption amount open opportunities to employ several techniques that can maximize a family’s control over its wealth, including:

• Allowing those who have previously reached the limit to double their amount of gifts, including those made to generation-skipping trusts.
• Selling assets to intentionally defective grantor trusts (IDGT), which allow the grantor to continue making tax-free gifts to the trust.
• Creation of a Dynasty Trust, which is a perpetual trust that is intended to last for many generations, usually beyond the individuals’ lifetime.
• Making intra-family loans or cast gifts to operate as a prepayment of existing loans from senior family members.
• Employing a Grantor Retained Annuity Trust (GRAT) to remove appreciation from your taxable estate.

Considerations for Estate Planning

While it is clear that undergoing estate planning activities and transferring any additional wealth and assets now is one of the biggest actions you can take to make a positive impact on your family’s financial future, there are several other considerations to keep in mind.

The federal exemption is the only one impacted by this change; state tax law can vary from state to state - some of which altered their existing gift and generation-skipping transfer limits, while others didn’t. If you are uncertain about your state gift tax limits and rates, you should contact an estate planning attorney for more information.

But perhaps the most significant thing to remember is that the increased exemption limit is temporary. It has an expiration date, and while it may seem like you have plenty of time to reduce your taxable estate, it’s important also to realize that one-quarter of the allotted time for this temporary change has already lapsed. While you had eight years to make changes on January 1 of 2018, you have less than six years left to take action. If you haven’t done so already, it’s time to begin or expand upon your estate planning activities to ensure that you are optimizing your transfers of wealth.

Turbocharge Estate Planning with Intrafamily Loans

By pairing intrafamily loans with trusts, wealthy families are turbocharging their estate planning strategies. One business owner hit all the right notes when he sold a $30 million family limited partnership to a trust. Tax rules currently permit illiquid shares in a family partnership to be transferred to a trust at a discount of about a third. This was an extremely efficient way to transfer ownership of the business to his children. There’s no gift tax because the transaction is treated like a sale. The former business owner got a note from the trust in return for the sale, and the interest payments of a few million dollars provides him with cash for living expenses. It must be said that this is a highly complex strategy and requires the assistance of an experienced estate planning attorney.

The win-win in this scenario, as described in a recent issue of Barron’s, “How Family Loans and Trusts Can Create Big Wins,” doesn’t stop there. That note has a fixed value, no matter how big the underlying asset grows. So the business owner’s net worth remains frozen. The asset does not have to appreciate much to make this low-cost loan work for all involved. In the meantime, his business, now worth $250 million, is growing tax-free inside the trust for the benefit of his heirs. The savings are a mind-boggling $40 million to $60 million in estate taxes today, and, should he lives to his actuarial age, a lifetime savings of more than $100 million.

With low interest rates, families with taxable estates can benefit from structured trusts and intrafamily loans. Not that these intrafamily loans have their own rates and rules – the rates on intrafamily loans allow parents to lend their children cash at rates far lower than a comparable commercial loan. Plus, they can be part of a broader wealth-transfer strategy.

For instance, an aging millionaire can fund a trust for his children’s benefit with a $100,000 gift. He then loans it $900,000 at the allowable 1.82% interest rate for five years, which the trust invests. The trust makes regular payments on the loan and then repays the principal in full at the term’s end. Any investment gains over that extremely low interest rate are tax-free in the trust for the next generation – it’s all legal and great planning.

There are added benefits for using this trust – the oddly named intentionally defective grantor trust. It’s considered an irrevocable complex trust for estate-tax purposes (the assets transferred to it are out of the individual’s estate) and a grantor trust for income-tax purposes. By paying the income taxes on the trust’s income, more is left for the next generation.

Be sure that the loans are just that: they are loans. If they’re determined to be gifts by the IRS, you could owe gift tax at 40% (but the annual gift-tax exclusion is $14,000, and the lifetime gift-tax exemption is $5.43 million). Make sure it’s a loan with the proper documents, terms and interest rate. Payments must be made on time. When you’re planning your wealth transfer, consider a loan and a trust, but do it right with the help of a qualified estate planning attorney.

Reference: Barron’s (September 26, 2015) “How Family Loans and Trusts Can Create Big Wins”

You Can't Take it With You: Giving Now Reduces Tax Liability

There is a grain of truth in every cliché and that is particularly true of these two:

• Money. . .You can’t take it with you; and
• It’s better to give than to receive

In the context of estate planning, I encourage all of my clients to consider these old adages.   Whether you are extremely wealthy or only moderately so, it’s important that you enjoy the fruits of your labor while you are alive because after you are dead, you have absolutely no use for your money.  And you certainly won’t be able to enjoy it from the grave.

The larger your estate, the more estate taxes your heirs pay

Now, you may be thinking about your heirs and the fact that you want to leave something for them to enjoy once you’ve passed on.  That’s a common consideration for just about all of my clients.  But here’s the kicker.  The larger your estate, the more estate taxes and gift taxes your heirs will have to pay after you die.  So, spending some of your money now will actually benefit your heirs by reducing their exposure to estate and gift taxes.

Gifts up to $13,000 per year are tax free

What if I told you there is a way to benefit your heirs and other loved ones now, before you die, and simultaneously reduce their exposure to estate and gift taxes?  Well, there is and it’s by giving while you are still alive.  Under current law, you can give any person up to $13,000 per year, without paying taxes.  You can also give an additionl $1 million collectively to all of your heirs without taxes [assuming you’re a US citizen – if not, see my articles on international estate planning].

Example

Let me illustrate.  Suppose you have 3 chldren and 7 grandchildren.  You can make annual gifts to them of $130,000 ($13,000 x 10).  If they’re married, you can double that amount.  Let’s assume you also decide to give them an additional one-time gift of $100,000 each ($100,000 x 10 = $1 million).  You will have given them $1,130,000 without paying any taxes.

Assume that instead of giving them $1,130,000 that you die in 2011 with an estate worth that amount.  Because of the way that the estate tax laws work, they will pay approximately $53,300 in estate taxes and receive only $1,076,700.

Think about it. . .if you leave your heirs $2 million dollars when you die, they will receive only $1,565,000 if the estate tax comes back as scheduled.  So, it just makes sense to give as much as you can afford to give while you are alive.  By giving now, you benefit your heirs while at the same time reducing your estate, thus reducing your heirs’ tax liability.

Gift tax rate expected to jump to maximum rate of 55%

In fact, I advise some of my clients to give more than $13,000 per year.  Considering that the current gift tax is relatively low (35%), now is a perfect time to give more than you might ordinarily give and to simply pay the tax.  Next year the gift tax is expected to jump to a maximum rate of 55%; therefore, it just makes sense from some clients to give more than $13,000.

GRAT facilitates asset transfers

In addition to making $13,000 gifts, you can use other estate planning techniques to reduce exposure to tax liability.  One such technique is the grantor-retained annuity trust (GRAT).  The GRAT allows you to transfer assets that you expect will appreciate in value into a trust and to receive periodic payments from the trust for a minimum of two years.  Appreciation or gains in the assets placed in the trust go to the trust’s beneficiaries tax-free (caution: as they say in certain circles “some restrictions apply”)..

There is a strong possibility that the laws governing GRAT’s will soon change, making them far less beneficial for avoiding tax liability.  If this speculation is correct, Congress may extend the minimum terms to ten years and make the distributions taxable.

Consider the intra-family loan option

Another option that I advise my clients to consider is the intra-family loan.  The interest rate on intra-family loans is set by the government and currently stands at 0.53% for loans of three years or less.  However, if the government believes that the “loan” is really a gift, it will be taxed as such if it exceeds the $13,000 limit.  Therefore, it’s important to treat the loan as a loan by putting it in writing and requiring strict adherence to its terms including on-time payments and imposition of late fees when payments are not made on time.