Introduction to Advanced Gift Planning Strategies
January 21, 2022
A primary goal of many affluent families is to pass assets to their beneficiaries in such a way as to not lose significant portions of that wealth to gift or estate taxes. This is a crucial part of wealth management and estate planning. Thankfully, the current rules allow a lifetime exclusion of $12,060,000 worth of assets or monetary gifts to be transferred tax-free per person. However, many families may desire to leave more to their heirs and should implement specific gifting methods to ensure a lasting legacy. These strategies are best put into effect well before an estate is dispersed.
It’s important to understand that when you transfer an asset to a beneficiary during your lifetime, gift tax could be applied if the total amount gifted is higher than your remaining lifetime exclusion amount. This tax is evaluated on the date of the transfer and based on the fair market value at that time. Below you will find strategies to bequeath your heirs these same assets while possibly reducing the tax liability beyond the limit allowed by the IRS.
One of the most effective methods is a grantor trust, if such a strategy is implemented for a lengthy period of time. Grantor trusts allow for the transfer of assets out of the grantor’s estate while retaining ownership for income tax purposes. Depending on whether a revocable or irrevocable trust is established will determine who carries the liability for tax payments. In the case of an irrevocable grantor trust, the annual tax payments are made by the trust, while for a revocable grantor trust the tax payments are made by the grantor, further reducing the grantor’s estate. The primary consideration is to retain the ability to trade assets of equal value with the funds within the trust. This nullifies the requirements for income tax classification for the trust and leaves that burden on you instead of your beneficiaries, allowing the trust to grow and retain wealth. Because you pay the income taxes as a component of your annual tax burden, the funds will not be applicable as a gift tax liability in the future. It is equally important to note that treatment of grantor trusts can be changed by tax code in the future.
Creating a limited liability partnership is another potential strategy that employs what is known as a discount opportunity. The gift tax advantage comes into play because the asset is assumed to have less value at the time of transfer than it will once the partnership is dissolved and the funds are dispersed in the future. The inherent risk is that there might be changes to tax law concerning gifted assets in the future, nullifying the tax-specific advantages of this strategy.
Another notable approach is a grantor retained annuity trust (GRAT). This allows you to designate assets and pay the tax at the time of funding, therefore freezing the value at a specific tax rate and creating an opportunity for tax-free growth of the assets in the future. The trust pays out to you over a predetermined period of time, portioned and equivalent to the amount placed into the GRAT, but all remaining gains from growth within the trust will be given to your heirs, free of additional taxes. There are two vital considerations when setting up this strategy: You must remain alive for the term of the GRAT, and the assets inside the trust must appreciate over an IRS specified hurdle rate. If all criteria are met, this method could transfer more wealth, tax-free, than the two previous methods. Please visit our article on GRATs to learn more about these types of trusts and the tax benefits they offer.
Please keep in mind that it's essential to discuss each of these strategies with your Wealth Manager, as well as your estate and tax professionals before implementing, to be sure you’re following the best pathway tailored to your financial circumstances for gifting wealth to your heirs.
Sources:
https://www.sandhillexperience.com/blogs-1/estate-tax-planning-in-silicon-valley
https://resources.goldman.com/intro/advanced-gift-planning-strategies.html
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