A window of opportunity opened in 2018 when the Tax Cuts and Jobs Act (TCJA) doubled lifetime tax exemptions for gifts, estates and generational leap to $ 11.18 million, from $ 5. $ 6 million. Factoring in inflation, the current exemption is $ 11.58 million this year, the highest ever.
While the change offers a major opportunity to pass on a substantial portion of your wealth tax-free, there is a catch: this is a limited time offer. This increase in the inheritance tax exemption is expected to end at the end of 2025, which means that the exemption will likely revert to what it was before 2018. In addition, the next US presidential election could accelerate the decline, because the challenger candidate has proposed important changes, raising taxes for the rich.
While many states have eliminated their inheritance taxes, only 17 states and the District of Columbia still have them – the estate planning landscape has changed dramatically over the past decade. In addition, the higher exemption presents a use it or lose it opportunity, and wealthy families should avoid taking a Set it up and forget about it approach. This is especially true for assets which can appreciate over time and helps ensure that the appreciation is not part of their taxable wealth. But remember: this area of wealth planning can be very complex, so we recommend that you speak with your financial advisor or tax specialist before making any decisions.
Consider donating assets to reduce inheritance taxes while you still can
As the inheritance tax increase and the gift tax exemption expire, the Internal Revenue Service has ruled that there will be no lifelong gift clawback. This means that donations made under the current exemption will not be subject to inheritance tax in the future, even if the exemption is reduced. Also, if you’ve already offered $ 5 million, consider donating up to an additional $ 6 million to preserve the $ 11.58 million exemption for your children and future generations.
Keep in mind that when you donate assets, to make a full donation for tax purposes, you are giving up ownership, control and use of those assets. If loss of ownership and control is an issue, married couples may want to consider a Lifetime Spousal Access Trust, or SLAT. A SLAT is an irrevocable trust created by one spouse for the benefit of the other. The settlor can indirectly benefit from this type of trust through his spouse’s lifetime access to trust funds.
When funding irrevocable trusts, beware of low cost asset donations. If the trust holds assets that appreciate when it is in the trust for long periods of time, the beneficiaries could face significant tax burdens. You can potentially avoid these problems by using alternate power provisions in the trust. With these power arrangements, the grantor can substitute or swap out of the trust low-cost assets that have appreciated over time for assets of equal value, such as cash or high-cost assets. This allows the value to remain the same in the trust and the settlor’s estate. An added benefit of using this technique is that those valued assets, now outside the trust, are in the estate and will be eligible for a base increase on death. This asset substitution may also allow the grantor’s beneficiaries to save capital gains tax, if applicable, which also makes it a prudent step for tax planning.
Take advantage of lower valuations and lower interest rates
Due to the COVID-19 pandemic and current market volatility, the valuations of many securities and companies have been affected, making this an opportune time to consider donating or transferring assets from your estate when the interest rates and asset values are low.
Lower valuations allow you to transfer more of your assets out of your estate using the annual gift tax exclusion or the lifetime exemption, thereby reducing your taxable wealth. The hope is that these assets will return to their original value and that any capital gain will be removed from taxable wealth.
In addition to low valuations, interest rates are at historic lows. Low interest rate environments can be particularly beneficial for intra-family loans. These loans can be an effective wealth transfer strategy, allowing family members to lend to each other without triggering a gift tax. These loans use the applicable federal rate from the IRS – which is currently at an all time high of between 0.14% and 1.12% – depending on the length of the loan. Intra-family loans work best when the borrowed funds are invested and the rate of return earned on the loan proceeds invested exceeds the loan interest rate. This allows appreciation beyond interest rates to pass to the borrower without inheritance and gift taxes.
Consider acting now to avoid the last minute rush
Plus, another reason to start now is that wealth planning using sophisticated techniques takes time. If you have more time to plan carefully today, you are less likely to run into any obstacles and challenges that might arise if you wait and end up rushing the process. When inheritance tax laws change, trust and estate attorneys often fall behind in cases, resulting in delays. Creating a thoughtful estate plan now can also help prevent planning errors, including triggering the Trust Doctrine or the Step Transaction Doctrine.
In addition to estate planning, affluent families should also focus on asset protection and distribution preparation, which complements tax planning. Asset protection and distribution planning allows you to protect your assets now and for future generations, giving you control of your money long after you’ve passed your inheritance down to your family.