As you may be aware, the current federal estate tax exemption is nearly $13 million, so that a couple may transfer almost $26 million worth of assets without incurring a tax cost. Those high 20 exemption amounts, while valuable for wealthy taxpayers, are so high that they have dissuaded many taxpayers from engaging in estate planning that could be very beneficial. That is for two reasons. First, estate planning should never only be about minimizing estate taxes, there are other valuable benefits that should be considered, even if your estate is substantially below the above figures. The second reason is that the above exemption amounts will be cut in half in 2026. Thus, while the tendency of many taxpayers is to “wait and see” what happens (wait until after the 2024 election, wait until late 2025 to see what the state of the law will be, etc.) that could be a costly mistake.
For very wealthy taxpayers, planning whenever feasible should be pursued because Congress can be fickle, especially with tax legislation. So, for very wealthy taxpayers the advice to pursue planning diligently has not changed, but the lesson for “mere” wealthy taxpayers introduced below, may apply and be helpful to consider.
Plan for Asset Protection Now: Estate planning should include addressing personal objectives such as planning for retirement and aging, structuring gifts and bequests to heirs to best help them, and not harm them, with the wealth transferred. Those objectives need to be addressed but are not necessarily relevant to more complex planning which many are putting off seeing what the law will be. An important planning goal for many is asset protection. That is structuring your assets so that if a malpractice or other claimant or creditors pursue your wealth, you will have barriers to endeavor to deflect them. A common asset protection technique is to create a corporation or limited liability company (“LLC”) to hold a business venture or real estate property. In that way, a lawsuit against the business or rental property may not be able to reach your personal assets outside the entity. Another very common asset protection benefit is to transfer assets to irrevocable trusts designed to be protective. The latter planning is often the same planning used to safeguard estate tax exemption. Thus, pursuing asset protection may entail identical steps to estate tax planning. As you can never know when you might be sued, asset protection planning must be implemented before you need it. Thus, if malpractice claims or other lawsuits could jeopardize your wealth, you should pursue that planning immediately. Waiting could jeopardize your wealth. If you are going to pursue that planning, you should simultaneously incorporate estate planning benefits and considerations into the planning steps. So, don’t wait to plan until 2025 when the potential for halving the estate tax exemption may be more certain. Plan now.
Plan for Income Tax Savings Now: Taxpayers are always seeking to find ways to reduce their income tax bill. Carefully planned transfers to irrevocable trusts may afford several ways to do just that. Those same irrevocable trust plans can also provide important estate tax planning benefits by locking in the exemption that might otherwise be cut in half in 2026. So, if you want income tax savings, why would you wait and lose years of tax benefits? If you are going to evaluate planning to use irrevocable trusts to save income taxes incorporate estate planning into whatever you do and do it now. There are several distinct ways you use your transfer of assets to irrevocable trusts to save income taxes (in addition to the estate planning benefits):
• Transfer assets to a non-grantor (complex) trust. That is the type of trust that pays its own income taxes. This could provide several immediate tax savings. First, if you live in a high tax state, such as California or New York, you could form the trust in a low or no tax jurisdiction like Nevada, Delaware, Alaska, etc. and immediately begin avoiding state income taxes in your home state. Secondly, if you name a broad class of beneficiaries the trustee can sprinkle or spray (distribute) income of the trust to whichever beneficiary has the lowest tax bracket. That can provide tax savings on a federal and state level, year after year. You might include charities as beneficiaries. Trusts can qualify for more favorable charitable contribution deductions then individual taxpayers can.
• If you transfer assets to a trust so that the assets are outside your estate, the trust can give an older family member who has modest net worth a right over those assets. This is called a general power of appointment (“GPOA”). On the death of that family member the assets over which they held the GPOA may be included in their estate and get a step-up in income tax basis. For example, you transfer stock you paid $10,000 for that is now worth $1 million to a trust for your spouse, children and elderly mother. The trust provides that your mother can appoint the trust assets to her creditors. She never does that. On her passing, the $1 million worth of stock is included in her estate. Because her assets are modest there is no estate tax. However, the assets still obtain a step-up in income tax basis to the market value of the stock. So, if you sell the stock afterwards, you will pay no capital gains. That could be $200,000 in income tax savings.
Deferring income tax planning until the reduction in the exemption in 2026 becomes certain may waste valuable income tax benefits. Why wait?
The Step-Transaction Doctrine Makes Planning Now Advantageous: There are several tax principals, referred to as tax “doctrines” that may serve to unravel planning you might seek to do. Here’s a simple and common example. A married couple wants to transfer assets to trusts to protect assets, obtain income tax benefits, or use exemption. Wife, a successful surgeon, is holding most family assets in her name. She transfers assets to husband, who a month later transfers those assets to a trust for the wife and children. The IRS may assert what is referred to as the “step-transaction doctrine” to collapse the steps in the plan. If successful, the planning would be treated as if the wife herself made the transfer to the trust and the purported transfer to the husband could be ignored. The results of that could be disastrous for the plan exposing assets to the wife’s malpractice claimants and including the assets in her estate.
Let’s change the facts a bit. The wife gifts marketable securities to the husband in late 2023. The husband has their financial adviser prepare a new investment policy statement and reallocate the assets into a quite different asset allocation. He withdraws a portion of the funds to buy that Harley he always dreamt about. In 2025, a different tax year and more than 12 months after wife transferred assets to him, he transfers most of the assets (sans the Harley) to a trust for wife and children. Not only has husband demonstrated his control and use over the assets involved, but there is what some would argue is a lengthy period between the gift by wife to husband and his later transfer of those assets to a trust for the wife. Many experts would argue that the time (bolstered by the control) involved should deflect a challenge by a creditor of the wife’s or the IRS 22 using the step-transaction doctrine. There seems to be enough independent economic events and time between the steps in the transactions. The take home point is that if you are going to plan time can be your friend bolstering the results you want, or it can be your enemy potentially undermining your hoped-for results by application of the step-transaction doctrine. So, why defer planning? Doing so might only increase the risks that the planning goals you have may not be realized.
The Reciprocal Trust Doctrine Makes Planning Now Advantageous: Unfortunately, to understand the importance of timing to your planning you must tackle, at least in general terms, another tax doctrine.
The reciprocal trust doctrine can be asserted by the IRS or a creditor to “un-cross” two trusts. That can unravel all your planning goals for the trusts. Here’s a simple and common example. Husband is an attorney and wife is a physician. They are both concerned about asset protection planning from malpractice claims as well as general suits (e.g., a car accident, fall at their home, etc.). So, husband creates a trust for his wife and their children. Wife creates a similar trust for her husband and their children. They each gift substantial assets, consisting of interests in a valuable rental property LLC they owned, to the trust they created with the anticipation that the assets in the trusts will be protected from their claimants and creditors. Then the husband is sued. The claimant asserts that they should be able to access the assets in the trust the wife created for the husband under the reciprocal trust doctrine. The claimant argues that the trust husband and wife created for each other were so similar that there was no meaningful difference in the economic position of the husband from before the plan was created until after the plan was created.
Let’s change the facts a bit. The wife creates her trust for husband and children in late 2023. She gifts both interests in the family real estate LLC, marketable securities and a life insurance policy on her life to the trust. The husband does nothing and has no plan. In 2025 the husband has their estate planner prepare a trust for wife, children and grandchildren. The trust has several significant differences from the trust the wife created more than a year and a half earlier. Husband gives wife a so-called “5 and 5 power” that gives her the right to withdraw the greater of $5,000 or 5% of the trust principal each year. The trust wife created for husband did not give him that right. Husband also gives wife a right to appoint trust assets among a class of family members. Wife’s trust did not give that right to the husband. Also, the husband adds his mother as a beneficiary of the trust (perhaps as part of a plan to grant a general power of appointment to endeavor to obtain a basis step up). Not only does husband’s trust have different assets and what many would argue are materially different rights, but there is what most would argue is a lengthy period between the creation and funding of the wife’s trust and the creation and funding of the husband’s trust. Many experts would argue that the time (bolstered by the different trust terms) should deflect a challenge by a creditor of the wife’s or the IRS using the reciprocal trust doctrine. The take home point is that if you are going to plan time can be your friend bolstering the results you want, or it can be your enemy potentially undermining your hoped-for results by application of the reciprocal trust doctrine. So, why defer planning? Doing so might only increase the risks that the planning goals you have may not be realized. If you are going to pursue asset protection planning with irrevocable trusts as described above, why not integrate estate planning considerations into it as well?
Last Minute May Not be Viable: You can wait until the last minute, say the end of 2025 to try to plan for the exemption that is to be reduced by half in 2026. While there may be some logic to it, it is not practical. In addition to the tax, asset protection and other reasons discussed above, planning just takes time. You will need a qualified appraisal of any business, real estate or other non-marketable assets you might wish to transfer. By mid-2025 appraisers may be so inundated with work that it may be difficult or impossible to hire one, or one may only be available at a bonus price because of the work demands. The same could well be the situation in hiring CPAs and attorneys. If you want to use an institutional trustee, which can be a significant benefit to bolster your planning, that takes time for any institution to review the trust and take actions. There have been similar situations in the past. In 2012 the estate tax exemption was $5 million and that was scheduled to decrease to $1 million in 2013. There was such a deluge of planning that many reputable firms in all the allied estate planning professions stopped taking clients in August or September. While that reduction did not materialize, there is no certainly that the 2026 reduction won’t happen. So, carefully consider how long you can delay. There is one final point. Planning done with a reasonable time frame and at a reasonable pace will be more thoughtful, more careful, and easier for you to absorb and hence understand. Even if you can get your planning done at the last minute, do you want subpar planning done so quickly no one has time to evaluate and explain options?
For many clients, but certainly not all, estate planning may make sense to begin now. For those that have already complete some measure of planning, reviewing and updating that planning is advisable. The inflation adjustments to the transfer tax exemption have added substantial increases and another is likely in 2024. Addressing the relevance of those increases to your planning, reviewing the operation and administration of your existing planning, is all advisable.
Please consider the above carefully. A review and update meeting can help us help you understand your options and the potential benefits of planning now. Contact us at firstname.lastname@example.org to schedule a meeting.