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Trust Planning Strategies for Wealth Tax Increases

Trust Graphic for Wealth Tax Increase Strategies


Since the Tax Cuts and Jobs Act (TCJA) took effect in 2018, federal estate taxes have been deemphasized in estate planning. The TCJA more than doubled the federal estate tax exemption—from $5.49 million to $11.18 million. As a result, only about one in 1,000 deceased Americans have estates that qualify for federal estate tax, and only a small percentage of estate plans needed to address the tax.  Fans of low taxes welcomed the TCJA’s increased exemption. But—like it or not—there’s a good chance changes are on the horizon.  If the current Biden tax proposal is implemented, an individual taxpayer would be allowed—over the course of a lifetime—only $3.5 million in exempt gifts, generation-skipping transfers, and estate value. The tax code combines all three into a single lifetime exemption so that—for example—a taxpayer’s $100,000 exempt gift during life reduces the taxpayer’s eventual estate tax exemption by $100,000.  Thus, today’s topic of trust planning strategies for wealth tax increases is front and center when updating estate plans in Florida for most high net worth families and their estate tax advisors.

How Biden Administration Proposals Would Increase Estate Tax Liability?

For 2021, the federal combined estate-and-gift-tax exemption remains an inflation-adjusted $11.7 million. However, the historically high exemption sunsets at the end of 2025. So far, there doesn’t appear to be much momentum in Washington behind an extension.

As mentioned above, the Biden Administration has advocated reducing the federal exemption further—to $3.5 million. This would be the lowest level since 2009 and would dramatically increase the number of estates hit with the “death tax.  In addition to the changes mentioned in our first paragraph above, the Biden administration has also proposed increasing the top estate tax rate from 37% to 45%. And another proposal would eliminate the step-up in tax basis for inherited assets—which would make an estate or heir pay capital gains tax on estate assets that increased in value after being acquired by the deceased taxpayer. Taken together, the Biden proposals would result in a far larger percentage of estates paying estate taxes, and estates already qualifying under the current rules would pay considerably more.

Adjusting to a Lower Estate Tax Exemption

Federal Estate Tax ReturnWhile nothing in D.C. is certain, it pays to think ahead.  When people think about estate tax planning, usually using the spousal estate tax exemption with A-B trust planning is the initial planning option that comes to mind.  The spousal estate tax exemption includes portability in Florida and elsewhere and thus can be used with flexibility following a spouse’s death, and, thus, this is a very important estate tax planning tool, it is important to keep in mind that a conventional A-B trust in Florida does NOT lock in the exemption until the death of the first spouse.  So various approaches are being utizilized to lock in the exemption prior to 2026.

Under IRS rules, a taxpayer who claims an exemption under the current higher figure won’t be penalized if the allowable exemption shrinks in the future. That means a taxpayer can make tax-exempt gifts of up to $11.7 million in 2021, and, if the exemption drops to $3.5 million in 2022, the 2021 gift is still exempt.  You’re essentially “locking in” the higher exemption for the gifted wealth.

Using Irrevocable Trust Planning in General

Irrevocable trusts in Florida and elsewhere generally are one of the best tools for efficiently organizing assets to mitigate estate and gift tax liability—especially with potential tax increases looming. Wealth gifted to an irrevocable trust locks in the current high exemption and—just as importantly—removes the gifted wealth from a future taxable estate. If Congress lowers the estate tax exemption next year, wealth used to fund an irrevocable trust now is already exempt.

There are scores of different types of trusts that can accomplish a host of wealth-management objectives. The irrevocable trusts described below all potentially reduce estate taxes by removing wealth from an estate and locking in the current exemption. Each trust provides additional financial planning benefits and can be tailored to a grantor’s individual circumstances and goals.

Using Specific Trusts for Mitigating Federal Estate (Wealth) Tax Increases:  

Spousal Lifetime Access Trust (SLAT). A SLAT is an irrevocable trust created by a grantor spouse—with the other spouse named as the trust’s beneficiary. The tax code provides an unlimited marital deduction allowing transfer of wealth from one spouse to the other with no gift or estate tax liability. So, the purpose of a SLAT isn’t to avoid taxes on wealth transferred to the other spouse. Instead, the grantor spouse’s transfer to the SLAT removes the wealth—and any subsequent growth on that wealth—from both spouses’ estates.

When funding the trust, the grantor spouse applies the annual gift exclusion and lifetime exemption toward the transferred wealth. During the trust’s term, the beneficiary spouse can—but does not have to—receive distributions from the trust. When the beneficiary spouse dies, trust assets are distributed to secondary beneficiaries—usually children or grandchildren—outside of either spouse’s taxable estate. Alternatively, SLATs can be set up to remain effective for extended periods—supporting succeeding generations without exposing trust wealth to additional estate taxes at each generational level.

Irrevocable Life Insurance Trust (ILIT). An ILIT in Florida is an irrevocable trust created for the purpose of owning one or more permanent life insurance policies (like whole life or universal life). The insured grantor funds the trust with the cash needed for policy premiums—removing wealth from the grantor’s eventual estate. Upon the insured grantor’s death, the life insurance company pays out policy proceeds to the trust with no estate tax liability. The trustee either distributes the funds directly to beneficiaries or manages the money in accordance with the trust instrument’s instructions.

Grantor Retained Annuity Trust (GRAT). A GRAT is an irrevocable trust designed to reduce taxes on appreciating assets and to efficiently transfer family wealth to the next generation. When creating the trust, the grantor pays the taxes due on any assets transferred to the trust. Throughout the trust’s fixed term, the grantor receives regular annuity payments from trust assets. When the trust’s term concludes, the trust’s beneficiaries receive the remaining value with no tax liability. However, if the grantor dies during the trust’s term, the trust’s value becomes an asset of the deceased grantor’s estate.

Grantor Retained Unitrust (GRUT). GRUTs work similarly to GRATs. The principal difference is that annual distributions to a GRUT’s grantor are variable— calculated each year as a percentage of the trust’s value. Like with a GRAT, the trustee distributes the residue of trust assets to the designated beneficiaries—usually the grantor’s children or grandchildren—if the grantor is still living when the trust’s term concludes. Beneficiaries receive the remainder tax-free.

Generation Skipping Trust (GST). Generation skipping trusts mitigate the generation-skipping tax (also abbreviated GST)—a federal tax on gifts to recipients more than 37 ½ years younger than the gift-giver. Congress passed the generation-skipping tax to prevent taxpayers from bypassing a generation of estate taxes by gifting wealth directly to grandchildren. Like the gift tax exemption, the GST exemption is linked to a taxpayer’s lifetime estate tax exemption.

When funding a generation-skipping trust, the grantor either pays the transfer taxes or claims the exemption for the wealth transferred to the trust. A grantor can name successive generations as beneficiaries or authorize the trustee to name future beneficiaries. Once placed in a generation-skipping trust, wealth is not exposed to estate taxes as long as it remains in the trust—allowing wealth to avoid multiple generations of estate tax.

Charitable Remainder Unitrust (CRUT). With a CRUT, a grantor can both benefit a chosen charity and enjoy valuable tax benefits. The irrevocable trust has a fixed term during which the grantor receives regular distributions measured as a specified percentage of the trust’s total value. When the term ends, the trustee distributes the remainder to the charity.

A CRUT removes wealth from a taxable estate and reduces capital gains tax liability on appreciated assets because the grantor does not have to pay taxes on the trust assets at the time of funding. The grantor may also receive a tax deduction based on the present value of the charitable gift. Charitable Remainder Trusts (CRTs) and Charitable Remainder Annuity Trusts (CRATs) are close relatives of CRUTs—varying in how distributions to the grantor are measured.

Charitable Lead Trust (CLT). A CLT works like a CRT or CRUT but in reverse. The designated charity receives the regular distributions during the term of the trust, and the trustee distributes the remainder to a named beneficiary—usually children or grandchildren of the grantor. Along with benefiting a cause favored by the grantor, a CLT reduces estate or gift taxes due for trust wealth when it is ultimately received by the next generation. The grantor can also receive a current tax deduction for the value bestowed on the charity.

Remember that the above mentioned trust planning strategies for wealth tax increases are considered advanced planning and should only be implemented with the involvement of experienced high net worth estate planning attorney in Florida as well as other tax advisors (such as CPAs) who focus on high net worth planning.

Steven Gibbs, Esq.

2 comments… add one
  • Michael. Dahlen September 8, 2021, 10:16 am

    Any initial consultation fees? Can planning be done online?

  • gibbslawfl September 8, 2021, 11:06 am

    Hello Michael, thanks for connecting and yes all planning including notary services can be done through video conferencing. We offer a 15 minute introduction at no cost and appointments can be booked by phone 239-415-7495 or on the website home page top right. If you need a longer consultation, the best rates are offered by booking on the website and selecting either 1 hour or 30 minutes.

    We look forward to hearing from you.

    Best, Steve Gibbs, Esq.