People who have been able to accumulate significant wealth are undoubtedly aware of the potential imposition of estate taxes. On the federal level, the estate tax carries a 40 percent top rate, and this is a very big slice.
The existence of this tax is especially disturbing to many people, because they see it as an instance of double taxation. After all, your estate is comprised of assets that you have left after you paid taxes all of your life. Why should a legacy that you are leaving to your loved ones be hammered down by 40 percent after you already paid so many taxes?
This question is a good one, and there have been legislative efforts to eliminate the estate tax. However, it is a fact of life at the present time. On the federal level, the exclusion is $5.45 million. The portion of your estate that exceeds this amount is subject to the estate tax.
The gift tax prevents you from giving gifts while you are living to avoid the death tax. The $5.45 million exclusion encompasses gifts and bequests. In other words, if you gave $5.45 million in lifetime gifts using this exclusion, there would be nothing left to apply to your estate. The entirety of your estate would potentially be subject to taxation.
Wealth Preservation Trusts
There are strategies that can be implemented to ease the burden. Trusts of various kinds are often going to be part of the plan, and we would like to pass along some basic information about three of them.
Generation-Skipping Trusts
If you convey assets into a generation-skipping trust, your grandchildren would be the beneficiaries instead of your children. However, your children could benefit from the assets that are contained within the trust throughout their lives.
After the death of the children, your grandchildren would inherit the remaining assets in the trust. This would be a taxable transfer, but there would be just one round of taxation instead of two.
Grantor Retained Annuity Trusts
When federal interest rates are low, you could potentially gain estate tax efficiency through the utilization of the zeroed out grantor retained annuity trust strategy. You would want to fund the trust with highly appreciable assets. As the grantor, you take annuity payments throughout the term of the trust, and you name a beneficiary who would assume ownership of any remainder that may exist after the expiration of the term.
If there is a remainder, the beneficiary would be receiving a gift that could be taxable. The IRS adds estimated interest accrual through the application of the hurdle rate, which is 120 percent of the federal midterm rate.
You do the math and take annuity payments that are equal to the entire taxable value of the trust. If these highly appreciable assets perform better than the hurdle rate, a remainder will exist after the expiration of the term. Remember, you took all of the taxable value, not all of the actual value. The transfer of the remainder to the beneficiary would not be subject to the gift tax.
Qualified Personal Residence Trusts
You could potentially transfer your home to a beneficiary at a significant tax discount if you were to convey it into a qualified personal residence trust. You don’t have to worry about leaving your home at first, because you decide on a period of time during which you remain in the home as usual. This interim is referred to as the retained income period.
You name a beneficiary who will assume ownership of the home after the term expires. Once again, the gift tax is applicable, though you removed the home from your estate for estate tax purposes when you conveyed it into the trust.
Since you are going to be remaining in the home for the duration of the retained income period, the beneficiary would not receive a gift for a number of years. The value of this type of gift would not be equal to the fair market value of the home when it was conveyed into the trust. This is taken into account by the IRS when the value of the gift is being calculated.
Ultimately, the beneficiary would assume ownership of the home at the end of the term, and the taxable value of the gift would be much less than the true market value of the property.
Attend a Free Seminar
If you would like to learn more about tax efficiency strategies and other estate planning matters, attend one of our upcoming seminars. These information sessions are free to attend,and you can click this link to see the schedule: Estate Planning & Elder Seminars.
Mr. Horowitz was awarded his Juris Doctor degree with honors from the University of Connecticut School of Law. While attending law school, Mr. Horowitz received the American Jurisprudence Award in Legal Ethics and the Nathan Burkan Award.
After graduation from law school, Mr. Horowitz continued his legal education at New York University School of Law where he received a Post Doctorate Law Degree in Taxation. He has also recently received a national achievement award.
Mr. Horowitz is admitted to practice before all the state courts in the State of Connecticut and the United States District Court.
Mr. Horowitz was selected for Super Lawyers in 2021, 2022 and 2023.
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