Affairs of Estate

As the reality sets in of all that was and was not included in the generational tax reform legislation that was signed in December, one thing is clear: this is a terrific time to reconsider your agency perpetuation and estate plans.

As you are probably aware, the legislation doubled the lifetime exemption from gift or estate tax to $11.18 million per person or $22.36 million per couple. What you may not know is this is a “use it or lose it” benefit, as the exemption is slated to decrease back to the pre-2018 level ($5 million per person or $10 million per married couple) in 2026. So what can you do to take advantage of this windfall?

First, dust off your business succession plans, which may be sitting on your shelf, because, well, let’s face it, no one likes to think about winding down or dying. And you should be considering whether this might be the right time to gift some of your ownership interests (or other assets) to the next generation. Failing to take advantage of this tax-advantaged window would be a lost opportunity, especially when planning sooner generates significant additional tax benefits by removing both assets and their appreciation from your estate.

For those who take full advantage of the increased cap before 2026, you need to prepare to navigate the potential uncertainty should the exemption cap revert to 2017 levels. Worst case: the estate tax ultimately would be calculated on the remaining estate plus the extra amount gifted during this window. Proper planning can minimize or eliminate this potential consequence.

For those implementing a gifting strategy now, this allows you to make gifts as tax efficient as possible. A number of techniques allow discounting of the transferred assets so you can “stuff” the $11.8 million or $22.36 million (or some lesser amount) with the most value possible. To take advantage of these discounting opportunities, you should look for assets you own that are ideal for discounting. One of the most ideal is interest in closely held businesses, such as privately owned insurance brokerages.

If you have children or other potential heirs who have joined the firm and you transfer minority interests in the firm to them, those interests can—if properly structured—qualify for a minority discount as well as a lack of liquidity discount. These combined discounts can be as high as 40%-45% of the current fair market value. A $1 million interest transfer could be valued at as low as $550,000 for calculating the gift tax exemption. Use of such discounting strategies allows you to get the most bang for your buck from your tax exemptions, and interests can be transferred outright or in trust.

There are many advantages to using trusts to hold business interests and other assets, including asset protection and centralized management. Many do not want their children to receive assets outright immediately, or sometimes ever, because they are worried the child will not know how to manage them or may lose them for some reason. Keeping the assets in the family line is another common concern. Trusts address all of those issues and can be tailored with great specificity to suit each person’s concerns and personal situation.

In addition to these benefits, some jurisdictions—Delaware, South Dakota, Nevada and Florida, for example—allow the trust settlor or others selected by the settlor to retain certain powers over trusts created there and can also be structured to avoid state income tax, which is a significant benefit.

Because the current 40% estate and gift tax rate is now not significantly higher than the maximum combined federal and state income tax rates, you must do proper income tax planning at the same time as your estate planning. Assets held by you at your death will receive a “step-up” in value to the property’s value at your date of death. So if your children or other recipients of assets at your death want to sell the assets they receive from you soon after receipt, there will be little to no income tax on those assets. In deciding what to transfer and what to give away, it may make sense to hold on to highly appreciated assets so they receive a basis of their fair market value at your death.

The recent changes to the individual income tax laws are also important elements of current estate planning. There are certain planning techniques that can be considered to offset the loss of the state and local tax (SALT) deduction for individuals. In high-tax jurisdictions, the loss of the SALT deduction can lead to significant increases in personal income tax. The use of multiple trusts to hold real property and increased charitable gifting can help to mitigate additional income tax liability.

One technique that combines estate and income tax planning is “upstream planning,” which involves using your extra gift exemption to create a structure that will benefit your children and future generations but will be included in a senior generation family member’s (say, your father’s) estate. If your father’s assets are minimal, the inclusion in his estate of the value of your gift will not cause any estate tax liability for him. But the inclusion will allow the tax basis of the assets to be stepped up to the fair market value at the time of your father’s death.

The bottom line is that there are many unique planning opportunities out there now to use in planning for the transfer of your assets and succession of your business interests. Now is the time to jump on this!

Tractenberg chairs Steptoe’s Private Client Practice. btractenberg@steptoe.com