Everyone has different priorities in estate planning, but the ultimate goals are usually similar. First and foremost, you want the assets to go to the person or entity of your choosing. For most folks planning wealth transfers in Florida, this means family, but including charitable gifts as part of an estate plan is not uncommon. Either way, you want to make sure that your assets are distributed to the correct beneficiaries and in the right amounts.
A good wealth transfer plan can also minimize the complexity of probate in Florida or avoid it all together. Florida living trusts, for example, can be a great way to keep your wealth out of probate and, as a result, out of the public record. Trusts are also an effective tool for one of the other important wealth transfer goals – asset protection. There are some important Florida asset protection limitations, but, for the most part, assets held in trust for a beneficiary are outside the reach of that beneficiary’s creditors.
And, of course, there’s Ben Franklin’s second certainty in life: taxes. When you transfer wealth, you want the recipient to be the principal beneficiary – not the taxman. To accomplish that goal, you need to consider the tax implications when deciding on a wealth-transfer plan. Fortunately for Floridians, the Sunshine State offers a friendly Florida tax structure for wealth transfers. But the IRS may still want its share.
In certain scenarios, transferring assets can actually result in less tax. Inherited property receives a step-up in basis for capital gains tax purposes. So, if you purchased shares in Widget, Inc., for $100,000 a couple years back, and those shares are now worth $150,000, you will owe capital gains tax on the $50,000 appreciation when you realize the gain. But if you instead bequeath the shares to your favorite niece, her basis will “step up” to whatever the shares are worth when she inherits them. And the gains accruing between the time you purchased the shares and the time she acquires them will be essentially tax free.
While reducing taxes on capital gains is certainly nice, federal estate and gift taxes traditionally dominate the wealth-transfer conversation. Due to a doubling of the estate tax exemption effective in 2018, the estate tax now affects fewer taxpayers than at any point in recent memory (other than the anomalous temporary repeal for the 2010 tax year). For 2019, only estates valued over a record $11.4 million will be subject to the estate tax. However, the estate tax exemption has, over its history, fluctuated significantly, and has been under $1 million within the 21st Century. So, even if you’re well within the current exemption, it’s a good idea to keep the estate tax in mind because there’s a good chance the exemption won’t always be so high.
The estate tax is assessed according to the amount by which the value of a taxpayer’s estate exceeds the exemption amount in effect for the year of the decedent’s passing. Importantly, though, the estate tax exemption has to be measured in conjunction with the gift tax. The two transfer taxes share the same exemption, so if you use the gift tax exemption during life, your estate tax exemption is reduced by a corresponding amount. A taxpayer who claims $1 million in gift tax exemption will have an estate tax exemption reduced by $1 million.
The gift tax exemption is cumulative over your entire life. Once you’ve used it all, it’s gone, and you have no more estate tax exemption (unless the government raises the exemption amount). But, each year, you receive a $15,000 gift tax exclusion per recipient. That means you can give assets worth $15,000 to both of your children every year without incurring any gift tax and without burning any of your gift or estate tax exemption. Married couples can combine their annual exclusions and give assets worth up to $30,000 per recipient each year tax free. Any gifts valued over the exclusion amount – other than limited exceptions for transfers to spouses, for the care of minor children, or to charity – must be reported to the IRS. The taxpayer can either pay the gift tax at the time or deduct the overage from the estate tax exclusion.
Up until 1976, wealthy families could avoid one or more generations of estate taxes by making “generation-skipping transfers.” Basically, taxpayers realized that, if they transferred wealth to their children, and then the children transferred the wealth to their children, the family had to pay two rounds of estate taxes. So, to reduce overall taxes, taxpayers gifted or bequeathed assets to their grandchildren instead. In response, Congress enacted the Generation-Skipping Tax (GST), which imposes a tax on any transfers to grandchildren or unrelated individuals more than 37.5 years younger than the donor. The GST also has an exemption linked to the estate and gift tax exemption.
Generation-skipping trusts, in turn, use the GST exemption to reduce cumulative estate taxes, but are also effective for many other wealth-transfer goals. By way of example, you could create an irrevocable trust in Florida and fund it with assets worth up to the amount of your available GST exemption. Then, you name your children as beneficiaries of the trust, with the residue to benefit the next generation (your grandchildren). An adult child can serve as trustee, but certain conditions must be met to ensure he or she never legally owns the trust assets. Specifically, the adult child can have a right to receive income from trust assets, but can only receive principal distributions subject to restrictions (e.g., for health, education, or subject to a third-party trustee’s approval). If the beneficiary becomes “owner” of the trust assets, then the assets are potentially subject to estate taxes on the beneficiary’s passing.
The beauty of a generation-skipping trust is that, once the wealth is in the trust and either (1) the GST exemption is applied, or (2) the GST tax is paid, the wealth will never be subject to estate taxes as long as it remains in the trust. The trust instrument can designate successive generations as beneficiaries – or the trustee can be given the power to appoint new beneficiaries, but no additional estate tax or GST will be owed – even if the trust endures for a century or more. For this reason, generation-skipping trusts designed to remain effective for more than two generations are often referred to as “dynasty trusts.”
Along with reducing transfer-tax liability, generation-skipping trusts also help keep wealth in the family. In fact, that is exactly what they are designed to do. If the first-generation beneficiary is bad with money or has aggressive creditors, the trust can protect the trust wealth from wasteful spending or creditor claims. Along the same lines, wealth held in a well-drafted generation-skipping trust is shielded from loss in a beneficiary’s future divorce. In sum, the grantor can provide for the support of his or her children while also ensuring future generations benefit from the wealth.
Florida is a great jurisdiction for generation-skipping trusts due to its friendly tax structure and prolonged Rule against Perpetuities. The trust won’t have to pay state tax on any income earned by trust assets because Florida has no state income tax. Likewise, Florida has no estate, gift, or inheritance taxes, so there won’t be any state tax liability when the trust is funded or when beneficiaries receive distributions. And, if you want to protect wealth for multiple generations, dynasty trusts in Florida can endure for more than 360 years due to Florida’s extended Rule against Perpetuities.
Transferring wealth isn’t quite as simple as it sounds. Whether through gifts, inheritances, or trusts, there are important legal and tax considerations to be weighed in any significant transfer. If you are thinking about preserving family wealth for multiple generations through a generation-skipping trust, or if you have other questions about the legal implications of a Florida wealth transfer, you should consult with an experienced Florida estate-planning attorney.
Steve Gibbs, Esq.