As we head into a new year and a change of administration in Washington, advisors should be discussing several estate planning considerations with their clients. 
The pandemic-driven financial crisis has caused massive increases in government spending, adding to a historically high federal deficit. Under any circumstances that might be expected to lead to tax increases. But with Joe Biden as president, a Democratic majority in the House and possibly in the Senate as well, it seems inevitable. New legislation may eliminate many of the Trump tax reforms, including the revised lifetime gift exemption.
The Tax Cuts and Jobs Act of 2017 raised the lifetime exemption from $5 million/person to $11.58 million for the 2020 tax year, meaning that a married couple could gift more than $23 million without paying any gift or estate taxes on those bequests. If the amount were lowered back to the $5 million range, it will have a big impact on estate plans.
With that possibility in mind, some advisors, myself included, are working with older high-net-worth clients to maximize their ability to give assets away without penalty. That means sitting down with the client, going through their holdings, and deciding which discretionary assets, such as real estate or business assets, they can gift without disrupting their own lifestyle or retirement plans.
But aside from outright gifts, there are other ways that advisors can work with their clients to see that more of their wealth winds up in the hands of their heirs than with federal or state governments. An irrevocable trust or an intentionally defective grantor trust is one way to shelter discretionary assets that can be passed on to future generations.
In such a situation, the parents would be the architects of the trust, but it exists outside of their estate with a professional advisor or trusted friend as the trustee. When the grantor’s heirs come of age, the trusteeship can be transferred to them. For example, a family with four children could set up a trust that benefits each child equally. But over time that can be split into four sub-trusts that each of the original beneficiaries can pass down to their own children and grandchildren. In some states, such trusts are perpetual and can exist for as many generations as the assets survive. Others have time limits, but even those can last for several generations. For example, in California the time limit is well over 100 years, so advisors should consider which state they encourage clients to incorporate their trust.
When considering which assets to put into the trust, select those with a high probability for growth or that can generate a significant income stream. Undeveloped real estate is an ideal asset for this strategy. It will have a relatively low value when granted to the trust, but once developed it becomes a much more valuable asset that exists outside the parents’ estate.
Historically low interest rates give advisors some additional tools for creative estate planning in the form of intra-family loans. It’s extremely common for parents to lend money to their adult children to buy real estate and to transfer money out of their estate.The applicable federal rate, which is published every month and is the interest rate families have to adhere to when they lend money, is less than half a percent. For many wealthy clients it makes a lot of sense to make intra-family loans, using these very low interest rates to transfer assets out of their estates.
Here’s a hypothetical scenario taking advantage of the current high exemption level and the low interest rates to lower the tax bill. Let’s say the asset was a partnership worth $50 million and the parents would like to leave it to their adult children, but only have $20 million left on that $23 million lifetime exemption. They can gift what they are allowed under the exemption and then sell the remaining shares to their children in exchange for a promissory note held by the parents. The interest on the note would be very low and earnings from the partnership could be used to repay the loan principal.
If the parents should die with a note remaining in the estate, the note will have to be appraised to determine its current value, which is likely to be at a huge discount to its face value. For example, if it was a $10 million 30-year note, fixed at 1.31%, the valuation discount on that might be as much as 70% making it worth $3 million instead of $10 million.
Advisors should address these strategies well in advance of consulting with the client’s estate attorney. Advisors know their clients, understand the ins and outs of their financial situation and through careful financial planning have gained their trust. It’s a relationship where clients feel more comfortable discussing their concerns than in a conference room with a high-priced lawyer who bills by the hour. You can save clients a lot of time and money by doing the up-front legwork before bringing in the legal professionals.
There’s no telling what the next session of Congress will produce, but if your clients are concerned about possible changes to the tax laws, this is a great time to meet with them about creative options in estate planning.
Michael Winn is a co-founder and managing partner of Audent Family Wealth Advisors, an Audent Capital Partners company, where he leads the estate planning and business succession-pre-event planning practice. Winn has spent over 25 years working with business owners, real estate families and entrepreneurs on succession, exit, transition and estate planning matters.
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