If you’re looking to transfer your wealth to your beneficiaries, some heavy tax roadblocks — by way of the Biden Administration’s proposed estate tax changes or Sen. Bernie Sanders’s proposed “For the 99.5% Act” progressive estate tax plan — could be in your way. But with careful estate planning strategies, you can limit their impact on your family.
Right now, the estate, gift, and generation-skipping transfer tax exemption is $11.7 million per person, or $23.4 million per married couple. That means your estate is exempt from the federal estate tax of up to 40% of the value of your estate if you leave no more than those amounts to your heirs.
However, without further action of any kind, the $11.7 million per-person and $23.4 million per-married-couple limit is slated to drop by more than half to $5 million and $10 million, respectively, come December 31, 2025.
And, if Sanders’s For the 99.5% Act is passed by Congress, that exemption amount could be lowered even more, to $3.5 million per individual and $7 million per married couple. In addition, the current 40% estate tax rate would jump up to 45% for estates valued under $10 million; 50% for estates valued over $10 million; 55% for amounts over $55 million; and 65% for estates valued above $1 billion.
What You Can Do to Prepare: Fortunately, there are some ways to bypass or reduce these estate taxes by planning ahead and discussing the right approach with your estate planning attorney.*
Transfers between spouses are not taxed, but taxes are imposed on a transfer to anyone else — even your children — of any amount in excess of the estate tax exemption, whether that amount is either $3.5 million, $5 million, or $11.7 million.
A transfer of assets by the first spouse to die to the surviving spouse may not have tax consequences if all assets are distributed to the surviving spouse. But once the surviving spouse passes away, the tax burden can be unnecessarily excessive.
For example, if Congress passes Sanders’s For the 99.5% Act, and a surviving spouse dies with a $7 million estate, the most her estate can protect from being taxed is $3.5 million. Unless the surviving spouse timely claims “portability” of the exemption not used by first spouse to die, the other $3.5 million would be taxed at 45% — meaning, a $1,575,000 tax payment would be made to the IRS.
There is a way to avoid taxation entirely if the spouses plan together when both are living. They can establish a Credit Shelter Trust (CST), which is also known as a bypass, family, or exemption trust.
Under this plan, each spouse establishes his/her own separate trust. In each separate trust, each spouse further divides their trust assets between a marital share and a family share. The family share of each trust (up to the entire estate tax exemption) is then “sheltered” in the family trust portion of the trust, while the remainder is held in trust for — or distributed outright to — the surviving spouse, who will not be taxed on any transfers from the deceased spouse.
Because assets placed in the family trust are separated from the surviving spouse’s estate, the assets in the surviving spouse’s estate can pass estate tax free to the beneficiaries at the death of the surviving spouse, so long as the estate’s assets total less than the estate tax exemption.
Accordingly, given the example above of a married couple with $7 million under the For the 99.5% Act, there will be no tax. How so? Because $3.5 million will be sheltered from estate tax by using the first spouse to die’s estate tax exemption, and the remaining assets will be protected by the surviving spouse’s estate tax exemption.
What if your estate is projected to exceed the estate tax exemption? For example, you may calculate that your assets that you pass at death will be $1 million more than the estate exemption. You can protect the excess assets by establishing an Irrevocable Life Insurance Trust (ILIT), to hold any life insurance policies you currently own or any policies your trust purchases directly.
Because the trust is irrevocable, and you are not the trustee or the beneficiary, the trust and the life insurance in it will not be counted as taxable assets at your death. With ample life insurance in the trust, the ILIT will be able to pay the tax bill for your taxable estate .
However, going this route means giving up control. You won’t be allowed to serve as trustee of the trust, which means you’re unable to directly control the assets in the trust. And, as it states in its name, this is irrevocable, so you will not be able to change or dissolve the trust; the only thing you can do is fund the trust by putting the policy into the trust. Depending on what you want to accomplish with the ILIT, our attorneys may be able to provide options to provide flexibility for the trust.
Like an ILIT, a Domestic Asset Protection Trust (DAPT) is an irrevocable, non-grantor trust. In a DAPT, a separate, third-party trustee — such as an attorney, banker or accountant — administers your trust, while you or your trustee may continue to work with your preferred financial advisor. Its purpose is to shield your assets by placing them beyond the reach of creditors.
But, unlike an ILIT, you have some direct input with a DAPT. Even though you surrender immediate control of your assets to the trustee, you can hold onto the power to direct your trustee’s investment decisions (though you can’t consent to or veto them); to veto distribution decisions (but not approve or direct them); and to appoint and remove trust advisors and trustees.
The DAPT was initially set up with high-earning professionals in mind — such as doctors, lawyers, professional athletes, celebrities, and anyone in businesses with high risks of lawsuits — as they could be at risk of a judgment in excess of liability insurance coverage that sought to collect against personal assets.
For example, if a physician is found liable for medical malpractice and is faced with a $50 million judgment, but her insurance coverage only covers $10 million, creditors will go after her personal assets to recover the remaining unpaid balance of the judgment (in this example, $40 million). Under the DAPT, the physician’s assets would be protected from creditors.
If you choose to go the DAPT route, it’s best to assess which assets you won’t need access to immediately and have those assets placed into the trust. In addition, be sure your state is one of the 17 where DAPTs are allowed (Michigan is one of them).
Giving a charitable gift is one of the smartest tax-saving strategies, as you can deduct part or all of your contributions on your tax returns (not to mention helping out a worthy cause). But there are estate tax advantages beyond the annual income tax part when giving to charity, as these two trusts show:
As an example of how these plans would work, let’s say Sanders’s For the 99.5% Act is signed into law. You have $5 million as part of the estate you plan to give to your beneficiaries, but only $3.5 million of it would be exempt from the estate tax. Instead of paying the estate tax, you could opt to use a CRT or CLT to earmark that remaining $1.5 million for charitable gift giving. That $1.5 million is now safe from being taxed, and it’s going where you want it to go (a charity) instead of where the government tells you it should go (its pockets).
The above options are just a few ways we can ensure your estate avoids unnecessary taxes. As the fate of estate taxes remains uncertain, and the For the 99.5% Act still up in the air, your estate plan shouldn’t be. Being prepared for any changes in estate tax is just one part of keeping and maintaining a trust, in order to make sure the money you plan to give to your heirs and beneficiaries are not hit with unexpected taxes.
The Estate Planning and Administration attorneys at Chapman Law Group are here to assess your current plan or set up a new one. We will see how we can take advantage of options that will maximize the assets available to you and your loved-ones and minimize the estate taxes paid to the IRS. Contact us today to learn more.
*NOTE: In addition to estate taxes assessable at death, additional transfer taxes are proposed that tax assets distributed to beneficiaries, transferred to trusts, or on “deemed sales” of the assets. Therefore, you should consult with Chapman Law Group to determine if your trust and estate plan will create tax liability when assets are transferred to your trust or distributed out of your trust or estate.
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