Ten Planning Strategies to Protect Family Wealth from U.S. Estate Taxes

Locksley A. Rhoden, P.L.
Charitable Remainder Trust, Family Limited Partnership, Foreign Trust, Insurance Trust, Irrevocable Trust, Land Trust, Private Foundation, Public Charity, Qualified Personal Residence Trust

With the Democrats taking control of the both the executive and legislative branch for the first time in a decade, President Biden’s tax policy ideas are anticipated to be enacted into law. Because President Biden’s tax plan is highly progressive, his expected tax policy changes to U.S. federal estate tax laws has motivated many wealthy individuals to revisit their family estate plans. Within his Tax Plan Proposal, Biden has proposed to (i) raise the top estate tax rates from 40% to 45%, (ii) lower current estate tax exemption thresholds, and (iii) adjust or eliminate the stepped up basis provisions in the U.S. Tax Code. Each proposed tax law change would significantly increase the potential federal estate tax liability exposure of qualified beneficiaries receiving inherited assets.

What Is the U.S. Federal Estate Tax?

The U.S. federal estate tax is a tax on the right to transfer property at death that ranges from 18% to 40% on the value of a U.S. taxable estate of a deceased person’s (decedent). The decedent’s U.S. taxable estate includes, but is not limited to, cash, securities, real estate, business interests, insurance, trust assets, annuities, and other equitable property titled in decedent’s name at death. The federal estate tax applies to those U.S. taxable estate assets in excess of the federal estate tax exemption threshold, i.e. the amount a decedent can give to heirs estate tax-free. This exemption amount has increased this year to $11.7 million per individual and $23.4 million per married couple. Because Biden’s tax plan will likely increase the highest federal estate tax rate and lower the exemption thresholds during his first term, many wealthy American families are likely to pay increased federal estate taxes if they die without effecting estate tax minimization strategies that limit their federal estate tax liability exposure.

Planning Strategies to Minimize Federal Estate Tax Exposure

With tax policy changes on the horizon and death rates climbing due to the COVID-19 virus pandemic, wealthy families are proactively planning to reduce federal estate tax exposure and avoid legal fees and costs of adminstration that arise during probate of family assets. In addition to preparing a Last Will, inventorying assets, appraising businesses, itemizing valuable personal property and making charitable gifts, here are ten planning strategies affluent families have successfully used to reduce estate tax liability exposure of their U.S. taxable estate:

1. SETTLE AND FUND A CREDIT SHELTER TRUST. Except when a surviving spouse is a non-U.S. citizen, lifetime gifts and bequests at death to a spouse, whether during life at death, are not subject to U.S. estate taxes. For this reason, when assets conveyed to a spouse by way of a credit shelter trust, the unlimited marital deduction is applied to prevent thier taxation. If the spouse’s marital trust can be funded up to the estate tax exemption amount, the spouse will receive the maximum amount estate tax-free and the balance of assets can be allocated to a separate subtrust trust for deceased spouse’s children and not be counted towards the surviving spouse’s taxable estate.

2. SETTLE AND FUND A FAMILY GIFTING TRUST. Either or both spouses can make a large one-time gift or annual gifts up to $15,000 in trust to any number of persons without reducing their $11.7 million lifetime exemption. For this reason, large gifts of assets can be made to children or grandchildren during life or at death without incurring tax liability. If both spouses maximize gifts to an irrevocable family trust for the benefit of a class of family beneficiaries, they can collectively remove $30,000 per person per year from their U.S. taxable estate or make a tax-free lump sum gift of cash above this amount up to the $7 million lifetime exemption.

3. CONVEY REAL PROPERTY TO A QUALIFIED PERSONAL RESIDENCE TRUST. The U.S. tax code allows homeowners to gift their personal residence into a qualified personal residence trust (QPRT). A QPRT is structured as an irrevocable trust for the benefit of the children-beneficiaries of the homeowner who retains the right to live in the property for a period of time. At the end of the trust term, the trust beneficiaries become owners of the property outright or via trust. Since children-beneficiaries do not receive a present interest in the property until the end of the trust term, the value of the property to the donor’s U.S. taxable estate is significantly discounted for federal estate and gift tax purposes and is removed eliminated altogether from the homeowners taxable estate at the end of the trust term.

4. SETTLE AND FUND AN IRREVOCABLE LIFE INSURANCE TRUST. Because the value of life insurance death benefits of a deceased policy owner is included from their U.S. taxable estate when they die, transferring ownership of an existing life insurance policy to an irrevocable life insurance trust (ILIT) during life will remove the death benefit value from the grantor’s U.S. taxable estate. The key is that the ILIT be structured such that the grantor is not the trustee nor beneficiary of the trust and does not retain any ability to withdraw cash value from the policy or change the trust beneficiaries at any point during the trust term.

5. ESTABLISH AND DONATE ASSETS TO A PRIVATE FAMILY FOUNDATION. If your family has philanthropic ambitions, creating and funding a private family foundation (PFF) will reduce the size of the foundation founder’s U.S. taxable estate and, thereby, reduce the potential U.S. estate tax liability. A PFF is a not-for-profit organization created by family members whom seek an IRS tax exemption that allows them to use family assets for charitable grantmaking. If properly funded at during life, gifted assets will be excluded from the donor’s U.S. taxable estate and generate an income tax deduction that can be carried forward for five years to offset donor’s taxable income.

6. ESTABLISH AND FUND A CHARITABLE REMAINDER TRUST. A Charitable Remainder Trust (CRT) involves a donor making an irrevocable gift of cash or other property to an irrevocable trust for the future benefit of a public charity or private family foundation after donor’s life. While the donor takes an income stream from the CRT for life, the charitable beneficiary of the CRT receives the remaining trust assets at the end of the donor’s life estate term. Upon funding the CRT with cash or property, the donor creates an income tax deduction and also removes the fair market value of those assets from their U.S. taxable estate.

7. PURCHASE A PRIVATE ANNUITY AND NAME A FAMILY TRUST AS BENEFICIARY. An annuity is a contract between an individual and an insurance company in which the individual transfers ownership of a cash or other equitable property to the insurance company in exchange for a fixed distribution of income over a period of time. Once the cash payment is made, the value of the cash of property plus any future appreciation in value, is removed from the owner’s U.S. taxable estate. Because Florida law specifically exempts judgment creditors from collecting judgment from the cash surrender proceeds of annuity contracts, if a third-party irrevocable trust receives the annuity contract surrender proceeds as annuity beneficiary, the annuity death benefit will avoid U.S. estate tax exposure and be protected from potential creditors of trust beneficiaries.

8. SETTLE AND CONVEY ASSETS TO A FOREIGN GRANTOR TRUST. Many international families are utilizing cross border trusts to leave assets to leave U.S. based property or other assets to U.S. naturalized resident or U.S. citizen family members. Because the federal exemption is so low for non-U.S. persons whom are non-resident aliens (NRA’s) for tax purposes that die owning U.S.-situated assets ($60,000 lifetime exemption threshold), NRA owners of U.S. based assets are establishing foreign grantor trusts to manage U.S. and foreign property for the benefit of U.S. and foreign beneficiaries. So long as U.S. trustees are utilized to distribute assets outright or in trust, U.S. assets owned by or to be inherited by a NRA spouse will remain out of their control and, as a result, not be included in the NRA‘s U.S. taxable estate.

9. DONATE REAL PROPERTY TO A LAND TRUST FOR CONSERVATION EASEMENT PURPOSES. A qualified conservation easement is a written agreement between a private landowner and a state or local government agency by which the landowner make an irrevocable gift of real estate to a land trust for the benefit of the government agency as trust beneficiary. The donated real property is typically restricted in use for environmental preservation or protection purposes such as creating a public zoo, park, beach or a land sanctuary for endangered animal and plant species. Along with leave a lasting family legacy for generations, the donor will remove the value of the donated land from their U.S. taxable estate. It will also create a significant income tax deduction equal to the property’s current fair market value that can be carried forward for several years and deducted against taxable income.

10. FORM AND FUND A FAMILY LIMITED PARTNERSHIP. A family limited partnership (FLP) is a management company owned by two or more family members and created to centralize ownership of the family’s business interests, real estate, financial investments and other equitable assets contributed the FLP. The primary purpose of creating a FLP is typically to create an enhanced level of creditor protection and plan for continuous management of family assets conveyed to the FLP. Gifting equitable assets to a FLP with future generation family member limited partners is a proven strategy to reduce U.S. taxable assets. This is because limited partners of FLP’s exercise no control over partnership assets and, as a result, the marketability and value of FLP limited partner interests is reduced.