I’m an estate planning attorney focused on asset protection and tax planning for high net worth clients. So if you like this video, go ahead and hit the like button, as well as subscribe to our channel, because we’re putting out new content all the time that I think will be really helpful, relevant, and probably different than a lot of the videos out there that are more focused on basic strategies.
Today’s video is going to be about an estate tax strategy aimed at potentially completely eliminating U.S. estate tax or, at the very least, significantly reducing it. There are many different strategies you can use, such as various trust planning and gifting strategies, with gifting being one of the most popular options.
One of the things you should know is that the IRS allows you to transfer a certain amount of assets during your lifetime and upon your passing without incurring estate tax. This amount, known as the exemption, changes from year to year. As of now, it’s 12.92 million dollars, but it’s set to go back down to around 5.5 million dollars, possibly higher due to inflation. It’s always a moving target. If the exemption is high, it benefits you; if it’s low, it’s more challenging. You can potentially run out of your exemption if you gift too many assets during your lifetime or upon your passing. So, it’s something to consider as you accumulate wealth over time.
One solution is to use a strategy called the Installment Sale to an Intentionally Defective Grantor Trust (IDGT). It’s a bit of a mouthful, but it’s an effective strategy. An IDGT refers to the tax status of a trust. When a trust is a grantor trust, it’s not taxed at the trust level. Instead, an individual is deemed to be the owner for tax purposes, so any taxable activity that happens inside the trust is reported on that individual’s personal tax return each year.
So, what can you do if you’re not gifting assets to a trust or to other individuals, but still want to remove assets from your personal taxable estate? One option is to sell your assets to a trust, which may be for the benefit of your kids or someone else. Alternatively, if one of your parents previously set up an irrevocable trust for your benefit and it has funds inside, you can leverage that trust to sell your own assets to a trust that benefits you, thus removing those assets from your personal taxable estate.
There are a lot of nuances to this, but let’s say you’re selling 10 million dollars of your own assets to the grantor trust set up for your benefit or for the benefit of your kids. You’re selling it at a potentially discounted rate. You can implement different planning strategies to reduce the value of your estate simply by using LLCs or limited partnerships and having a CPA perform a valuation. The way to reduce the value of those entities is to structure them so that the majority of the entity consists of non-voting interests, and you sell those non-voting interests to the trust.
When a CPA performs a valuation, because it’s heavily non-voting interest, there’s going to be a discount in value. So, let’s say you have a 10 million dollar limited partnership. After a valuation, maybe you’re able to get a 20% or 30% or even 35% discount based on the way it’s structured. Now, a 10 million dollar entity in assets is now worth, say, 7 million dollars. By freezing the value of that entity through the valuation and selling those non-voting interests to these trusts, you get them out of your own name and into the trust.
Because these trusts are grantor trusts, and you are responsible for the taxable activity, there is no income tax event that occurs when you sell an interest to the trust. This is because it’s essentially a transaction between yourself and the trust, which you are deemed to own for tax purposes. It can be confusing, but essentially, there’s no taxable event that occurs when you sell your assets to the trust.
Once inside the trust, these assets can appreciate in value outside of your personal taxable estate. They’re no longer in your name; they’re in the name of the trust. They’re able to grow, and when you sold those assets, you took a promissory note for the value, maybe at the discounted valuation provided by a CPA. So, rather than a 10 million dollar value, you now have a 7 million dollar note. The 7 million dollar note won’t appreciate in value like the assets you moved into the trust, and those assets in the trust will accumulate free of any estate tax.
It’s a very strategic and complex planning strategy, but when used in conjunction with gifts and using your exemption wisely, you can significantly reduce your taxable estate even if it’s well above the threshold. As tax laws continue to change, this is a strategy you’ll see used more and more. It’s something to think about with your tax attorney.
