Planning Tools to Protect Your Estate


Note: This article is intended to provide information on various planning techniques and should not be treated as legal advice. You should always consult with your attorney and CPA as to how these planning tools relate to your individual circumstances.

The federal estate and gift tax are a unified tax. This means that you may use up your exemption through a combination of lifetime taxable gifts and amounts that pass as a result of your death.

At the end of 2017, Congress enacted the Tax Cuts and Jobs Act (“TCJA”), which was implemented in 2018. One of the most dramatic changes in the TCJA was an increase in the estate and gift tax exemption amount, from $5.49 million to $11.18 million per person, an amount that increases by inflation each year. The 2022 exemption is $12.06 million per person. For a married couple, this translates to a combined exemption of $24.12 million. However, under the terms of the TCJA, the exemption amount will automatically revert to pre-2018 levels (adjusted for inflation) on December 31, 2025. At that time, we anticipate the available exemption amount will be approximately $6 million per person.

The TCJA left in place the rules about annual exclusion gifts. Currently, you may gift up to $16,000 per person, tax free, on an annual basis, to as many people as you wish without incurring any gift tax liability.

Last fall, there were many discussions and proposals for changes to the estate and gift tax. These included accelerating the date on which the estate and gift tax exclusion amount reverts to pre-2018 levels, escalating the rate of tax (currently a flat 40%) as the size of the taxable estate increases, and eliminating the step-up in basis on inherited assets. Ultimately, none of these came to pass but it is important to know that these issues will continue to brew in the future, so it is important to stay on top of your planning.

A simple example of how the unified estate and gift tax system works is as follows: Let’s say you make a gift of $1 million to your child. The first $16,000 is covered by your annual gift tax exclusion amount; the remaining $984,000 is a ‘taxable” gift. Although you have made a taxable gift of $984,000, you will not actually pay any gift tax until you have completely exhausted your $12.06 million exemption.

One very important point to underscore: While you have a $12.06 million exemption right now, you will need to use the full amount prior to the end of 2025 if you want to get the full benefit of the entire exclusion amount that is currently available. After December 31, 2025, you will only have the pre-2018 exemption amount of $5.49 million (adjusted for inflation), and amounts gifted prior to that date will count toward the $5.49 million. Consequently, if you made a $7 million gift prior to December 31, 2025, you would have no exemption amount remaining as of January 1, 2026.

Keep in mind, while any gifts to your spouse qualify for an unlimited marital exemption, those gifts generally become part of your spouse’s estate for estate and gift tax purposes.
It would be great if we all had a crystal ball and knew exactly where this was going but, unfortunately, we do not. For single individuals with estates in excess of $5.49 million, or married couples with estates in excess of $10.98 million, you should take a serious look at planning opportunities that exist now, including using some or all of your exemption while the exemption is still $12.06 million per individual or $24.12 million per couple.

Here are some planning tools that you can consider:

  1. Make sure you are taking advantage of your $16,000 per person per year annual exclusion from the federal gift tax. You may make gifts of up to $16,000 each to your children, their spouses, your grandchildren, or other relatives or friends. If you are married and your spouse joins in the gift, you may gift up to $32,000 per person per year.
  2. You may gift five years’ worth of annual exclusion gifts ($16,0000 x 5 = $80,000) to a 529 plan. This will not only remove $80,000 from your taxable estate but will also remove the future appreciation on this money out of your taxable estate. Caveat: if you die within five years of the gift, a portion of it may still be counted in your estate.
  3. Consider making gifts of more than $16,000 per year per person. You will use up some of your exemption, but you will also get the appreciation out of your taxable estate. This is especially significant if you have assets that are likely to increase substantially in value. Additionally, if you use up your entire $12.06 million exemption while it is in place, you will not be penalized if the exemption amount reverts to $5.49 million at the end of 2025 or is legislated downward earlier.
    If you own assets in an LLC or other business entity, you may be able to significantly discount the value of any gifted interest in the entity, but this requires valuations and discount analyses, all of which take time, so start planning NOW if you want to do this.
    If your portfolio includes commercial real estate, you may be entitled to even higher discounts than normal, given the distressed market. In particular, do a forecast of your properties and tenants. Do you have any buildings that are vacant or with which you may be owed lease money that you will have difficulty collecting? Are market valuations low now? These issues can affect valuation discounts in our favor.
    You should examine partnership agreements, operating agreements, or shareholder agreements to ensure that they are structured to enable your estate to claim the largest available discount at your death.
    Some commentators are recommending that you add children or other relatives as co-owners on real property, using a discounted value if the gift is a gift of a minority percentage. This may be appropriate in some very limited circumstances, but keep in mind the following:
    1. You will not be able to sell or mortgage the property without the co-owner’s consent;
    2. The property may be at risk from the co-owner’s creditors, including a divorce judgement if the co-owner’s marriage ends;
    3. Depending on the relationship between you and the co-owner, your property taxes may uncap if the property is located in Michigan. There may be other tax consequences in other states.
    4. The co-owner will take your basis in the property for capital gains tax purposes, rather than getting a step-up in basis at your death as a beneficiary. If the property has a very low tax basis, this could result in significant capital gains when the co-owner ultimately sells the property.
  4. An irrevocable life insurance trust (“ILIT”). An ILIT can either be funded with a whole life or term life policy, depending on your needs. A whole life policy remains in place for your lifetime, while a term policy remains in place for a term of years. For instance, you may want to have a term insurance policy that remains in place during your working years in order to replace any income lost if you should die before retirement. You may want to consider a whole life policy if you are concerned about having sufficient liquid assets with which to pay any estate tax liability at your death.
  5. A grantor-retained annuity trust (“GRAT”) is a short-term trust (typically 2-10 years) into which you deposit assets with a likelihood of significant appreciation. The funds that you deposit are repaid to you in the form of an annuity paid over the term of the GRAT. The amount of interest that must be included in the annuity is set by the Internal Revenue Code Sec. 7520. For GRATs created in February of 2022 this interest rate is only 1.6%. Any appreciation or gain in excess of the annuity will be paid out to the beneficiaries of the trust (which can include another trust for the benefit of a beneficiary) with no gift tax consequence. We generally recommend short-term GRATs because, if you die during the term of the GRAT, the funds can be pulled back into your taxable estate. However, because the Section 7520 rates are so low right now, it may be worth the risk to consider a longer term GRAT in order to lock in the lower annuity rate.
  6. An intentionally defective grantor trust (“IDGT”) is another irrevocable trust option. Typically, would fund this trust in one of the following two way:
    1. You would transfer assets to the IDGT as a gift. To the extent the transferred assets exceed the annual gift tax exclusion amount, you would be using some of your estate and gift tax exemption.
    2. Alternatively, you would transfer assets to the IDGT in return for a promissory note which carries interest at a rate set by the IRS. You would fund the IDGT with assets that would be likely to appreciate faster than the rate of interest in the promissory note. Using this method of funding, there would be no “gift” for gift tax purposes because you have a promissory note for repayment of the transferred amount.
    3. In either case, you would remain responsible for payment of the income and capital gains taxes on the IDGT, which would enable you to further reduce your taxable estate while letting the assets in the IDGT grow, unreduced by any income or gains tax liability.
  1. A spousal lifetime annuity trust (“SLAT”) is a trust that you establish for your spouse (the “non-donor spouse”) and may also include other family members, such as children, as beneficiaries. The funds you transfer to the SLAT would be a gift for gift tax purposes and so would use some of your estate and gift tax exemption amount. The non-donor spouse can request distributions from the trust, typically to maintain his or her standard of living. This can provide an indirect benefit to you because distributions to help your spouse maintain his or her standard of living also benefit you. However, ideally, the assets would not be withdrawn but would instead be held in trust for the benefit of your children after both you and your spouse have died. Any amounts distributed to the non-donor spouse would become part of the non-donor’s spouse’s assets and, depending on the value of the non-donor spouse’s estate, could be taxable in the non-donor spouse’s own estate.

    A SLAT is a grantor trust, which means you (rather than the SLAT) would remain responsible for any income tax or gains liability on the SLAT’s assets. This can be both a benefit and a detriment. For instance, by paying the tax obligations of the SLAT you are removing more assets from your own taxable estate. However, this can be a problem if you do not have liquid assets readily available to pay the taxes. Additionally, you will want to include contingencies in the trust for what should happen if your marriage should end or your spouse should die before you. A SLAT cannot be funded with jointly owned property; the property must be solely owned by you. Finally, if your spouse should die before you, you would lose the indirect benefit of the SLAT.
  2. If you are charitably minded, you may (in addition to making outright gifts to a charity) consider a charitable lead trust or a charitable remainder trust.
    1. A charitable lead trust is an irrevocable trust that is established for a set period, for example, for the life of one or more individuals or for a set term of years. During the term of the trust, annual distributions will be made to the selected charity or charities, at a percentage rate selected by you. At the end of the term, the remaining funds will pass to the designated beneficiary or beneficiaries. In a perfect world, the assets of the trust would outperform the expectation, and your beneficiaries would receive more than originally calculated. In addition to getting funds out of your taxable estate, you would also receive a charitable deduction for income tax purposes for the amount calculated to pass to the designated charities.
    2. A charitable remainder trust is a tax-exempt irrevocable trust that pays an annuity or unitrust amount to you or your chosen beneficiaries, with the remainder passing to a charity or charities of your choice at the end of the trust’s term. You will be able to claim a charitable contribution for the value of the charitable remainder. You may donate highly appreciated assets to a charitable remainder trust and avoid capital gains tax when the property is subsequently sold.
  1. Finally, consider establishing a fund at your local Community Foundation. Your donation is tax deductible, your fund will continue in perpetuity, and you can structure your fund in any of the following ways:
    1. A donor-advised fund is a fund in which you (or the persons you designate) control the grants from your fund. You may select whatever charities you wish to benefit and designate the purpose for which a grant it to be used.
    2. An agency fund is a fund in which you pre-select the charities that you wish to benefit.
    3. A field of interest fund is a fund in which you specify certain areas of charitable giving in which you have an interest. The Community Foundation will then make distributions, on an annual basis, to charities that fall into the categories you have identified.
    4. A general fund is a fund in which the assets are unrestricted, and the Community Foundation can distribute the available funds in such a way as to provide maximum benefit to the geographical area in which the Community Foundation is located.

Many planning options, particularly those involving discounting, require significant advance planning time. Is there a chance that even when we get to December 31, 2025, Congress will simply vote to extend the current exemption indefinitely? Yes, of course. No one can say with certainty what will happen. But you should still be pro-active about planning so that, if necessary, you are ready to pull the trigger.

The IRS has finally issued Regulations for the SECURE Act which, among other things, governs the distribution of retirement plans payable to your trust at death. If you have an IRA, 403(b), 401(k), or other retirement plan that designates your trust as beneficiary, please contact us to update your trust language.