Taxes are imposed on transfers, by gift or at death, above an applicable exclusion
amount which is indexed to inflation (currently $11.7 million for an individual).
With proper planning, it is possible for a married couple to use two exclusion
amounts. For example, an executor can make a “portability” election to transfer
any unused exclusion from a deceased spouse to a surviving spouse. Consult
your tax and legal advisors to determine the appropriate strategy for applying
the portability rules.
Explore wealth transfer opportunities
There are actions you can take to potentially reduce your future estate tax
liability and to maximize your lifetime gifting. However, make these decisions in
conjunction with your overall planning to make sure assets pass effectively and
efficiently and fulfill your wishes and the needs of your beneficiaries.
One action that may pass assets effectively and efficiently is paying medical and
educational expenses of your beneficiaries. Medical and education expenses paid
on behalf of anyone directly to the institution are excluded from taxable gifts and
are unlimited in amount.
Another possible action is an outright gift in excess of $15,000. While such
outright gifts are simple to execute and can reduce taxable estates, clients are
sometimes reluctant to use them due to a lack of control and concerns about
access once gifts are made.
Typically, families with significant taxable estates are strategic about how best to
use the annual exclusion and their lifetime exclusion gifting by utilizing advanced
strategies such as irrevocable trusts (e.g., irrevocable life insurance trusts, spousal
lifetime access trusts, intentionally defective grantor trusts, grantor retained
annuity trusts, charitable split interest trusts, etc.), transfers of interests in entities (e.g., family
limited partnerships and limited liability companies), and
other planning techniques. Modern planning techniques are increasingly flexible
and some may provide mechanisms to protect your beneficiaries while also
allowing you options for maintaining your own desired lifestyle. Given the
market volatility and low interest rates at time of publication, some of these
strategies may be that much more impactful at this time. As with any strategy,
there are risks to consider and potential costs involved. Discussions with your
advisors can help in the education of how these strategies work and the role that
depressed valuations of certain assets and low rates can play.
As mentioned earlier, changes could occur in the estate and gift tax system.
While changes to the exemption would require congressional action, other
changes could be done via regulation. One potential regulation change is the
elimination of marketability and lack of control discounts with family entity
transfers. These regulations were originally proposed during the Obama
administration in 2016 and subsequently shelved in 2017 during the Trump
administration. Any regulation on this could dampen the effectiveness of family
transfer techniques based on valuation discounting concepts.
A modern wealth planning approach goes beyond minimizing transfer taxes
and should incorporate income tax planning, asset protection, business
succession planning, and family dynamics considerations such as education of
heirs and beneficiaries to be financially fluent and knowledgeable about wealth
stewardship expectations and/or opportunities. Before implementing any wealth
transfer option, you should consider the trade-offs between lifetime transfers
and transfers at death.
Lifetime transfers usually result in the beneficiary assuming the tax basis in
the gifted asset equal to that of the donor at the time of the gift. This could
result in the unrealized appreciation being taxed to the beneficiary when he
or she ultimately sells the property, although any gift or estate tax on future
appreciation is usually avoided from the perspective of the donor. This typically
does not apply to assets with a built-in loss.
In contrast, if the transfer occurs at death, the beneficiary generally gets a new tax basis equal to the fair
market value at death, eliminating any income tax on the unrealized appreciation. However, income tax savings on
the asset may be offset by any estate tax imposed on the asset. Proper planning with your tax and other advisors
should consider the trade-off between income and estate taxes and help you maximize your results over the long
term. The right strategies to use will vary with the goals, assets, and circumstances of each family. As noted
earlier, this may not be a factor in the future since one of President Biden's tax proposals is the potential
elimination of step-up in basis to the fair market value at death.