The burden of estate taxes can be hefty for individuals and families with significant assets. Advanced planning techniques can be used to alleviate estate tax liability.
Gifting is a common way to reduce your taxable estate and transfer wealth to family members. However, you must be careful to stay within the annual exclusion limit, which will reduce your lifetime exemption amount.
An effective estate tax strategy involves the transfer of assets to beneficiaries with a reduced or eliminated federal gift and estate tax liability. This often involves utilizing various complex systems, including leveraging valuation discounts.
Valuation discounts can reduce a gift’s value for calculating transfer taxes or even the amount of one’s lifetime exemption. For example, a family-owned business or real estate, like the power of attorney for real estate transactions, may be valued less due to a lack of marketability and control. These discounts can be leveraged with the use of trusts and other structures.
Be careful to consider the frequency, size, and recipients of any monetary gifts. You want to ensure you stay within the annual federal gift tax exclusion. Viewing the scheduled sunset of the historically significant basic exclusion amount (BEA) in 2026 is also essential.
This should spur careful planning now. Additionally, non-spousal heirs who receive distributions from traditional accounts can benefit from stretching those amounts over their lifetime to avoid an immediate tax bill.
Qualified Personal Residence Trust (QPRT)
Since current high exemption levels allow a greater variety of estate planning techniques, speaking with a trusted advisor about the right strategies is essential.
One of these methods is a Qualified Personal Residence Trust (QPRT). When properly structured, this type of trust removes your primary or secondary home from your taxable estate and freezes the value for tax purposes. Thus, any appreciation in the home’s value will not be subject to gift or estate taxes.
The grantor can still live in the house for a specified period, known as the “retained interest” or “remainder of life.” The property will transfer to beneficiaries at the end of this retained interest period.
A potential drawback of this strategy is that the grantor could die during the QPRT term, which would cause the residence to return to the taxable estate for tax purposes. As such, this strategy may only be suitable for individuals with a longer life expectancy.
Grantor Retained Annuity Trust (GRAT)
A GRAT is a way to transfer assets while minimizing gift tax. It’s commonly used with assets that have the potential to grow significantly in value over a short period. A Cummings & Lockwood LLC trusts and estates attorney can explain how these strategies can work with your unique situation.
GRATs work best when interest rates are low, as this lowers the IRS Section 7520 hurdle rate. The lower hurdle rate makes it easier to appreciate trust assets to outperform this hurdle rate and pass on a significant amount to beneficiaries free of gift tax.
GRATs are often used with illiquid assets, such as shares in startup companies or real estate. These trusts allow you to transfer these assets while retaining the right to receive annual annuity payments for a set term. When the annuity payment period ends, your beneficiaries receive the remainder of the trust assets outright or in further trust.
Depending on how these trusts are structured, the transfer of assets can remove them from your taxable estate while passing through income taxes to you (which may be at a lower tax rate). This strategy can benefit individuals who have a substantial appreciation for their real estate and want to avoid a potentially large estate tax bill at death.
Other options include a trust to hold life insurance policies, which provides immediate income tax deduction and a future death benefit to your beneficiaries free of federal estate taxes. A donor-advised fund also allows you to get an income tax deduction for money deposited into the fund and then dispersed to charity over time.
With the scheduled sunset of the TCJA’s historically high basic exclusion amount (BEA), thoughtful estate planning is now more critical than ever. We can help you develop strategies to preserve wealth and minimize estate taxes for your heirs.