Estate Taxes
Currently, estate taxes impact less than one percent of the U.S. population simply because the exemptions are historically high. In 2024, everyone can pass at death, tax-free, up to $13,610,000.00 (this amount may be lower if you gifted in excess of the annual exclusion amount in any year prior to death). If you have a taxable estate and you are charitably inclined, one of the options you have to lessen your tax liability is to donate some of your estate to charity.
Any amount you donate to charity reduces the amount of your estate subject to estate taxes. You can use this planning method to pass your estate to individuals with a lesser tax bill or even avoid the tax bill entirely.
As a very simplistic example, if you had an estate at the time of your death in 2024 that was valued at $15.0 million dollars, you would have a tax liability on $1,390,000 resulting in a $556,000 tax bill (tax calculation is 40% of the total assets in excess of the exemption). If you allocated the excess to qualified charities, you could avoid paying the estate tax altogether. You can also choose to donate lesser amounts and simply reduce the tax liability rather than avoiding it entirely. Obviously, you must discuss your individual situation with your team of professional advisors, but this is an option that works well for many people that have an estate tax issue and would like to incorporate philanthropic endeavors into their planning.
Irrevocable Life Insurance Trusts (ILITs)
For those who wish to avoid estate taxes without charitable planning, other options may better suit them. Irrevocable Life Insurance Trusts are a popular method of reducing an estate tax bill by transferring life insurance (which is a countable asset in the owner’s estate) to a trust prior to death. Life insurance is often worth considerably less prior to the death of the insured when the policy pays out. Moving the policy in advance, while the policy value is significantly lower than the death benefit, and structuring payments of the premiums through the trust using “Crummey powers” is an effective method of reducing the size of the taxable estate.
Spousal Limited Access Trusts (SLATs)
Spousal Limited Access Trusts (SLATs) are another estate tax planning tool that has gained popularity recently. The previously stated exemption of $13,610,000 per person exemption amount is an all-time high exemption because of a 2017 law that effectively doubled the exemption for the years 2018 to 2025. In 2026, that amount will revert back to 1/2, which is likely to be in the $7-$7.5 million dollar per person range. For married couples whose assets exceed roughly $15,000,000, many are concerned that they will go from not having a taxable estate in 2024 and 2025 to having to pay an estate tax bill of 40% on everything over the new lower exemptions. The couple might also not be ready to give up control or access to many of their assets to save estate taxes. For those in stable marriages, a SLAT may fit well. Essentially, a SLAT can function as an irrevocable grantor trust, quite similar to the classic family trust created under a revocable living trust, in which one spouse creates and funds the trust for the benefit of their spouse or spouse and children. The spouse creating the trust is using their estate tax exemption to fund assets into the trust, which results in 1) keeping future growth of the transferred assets out of their estate, 2) allows the couple to continue paying the taxes on those assets that are now outside of their taxable estate, 3) allows access within the couple through the beneficiary spouse to distributions from the trust and 4) use of the high gift and estate tax exemption before it (potentially) shrinks.
This tool is a very effective estate planning technique but is complex in both its creation and execution. Expect several meetings to chart out an appropriate design when considering a SLAT or similar irrevocable trust based planning.
Gifting Trusts
The annual exclusion from gift taxes is the (per person) amount you may give to individuals each year without reporting the gift to the IRS or reducing your lifetime exemption. The amount is indexed for inflation and increases in one-thousand-dollar increments. As of 2024, the exclusion limit is $18,000 and married couples can “gift-split,” effectively gifting $36,000 to each person. We often tell clients that their annual gift tax exclusion is a “use-it-or-lose-it” coupon: you don’t get to give more money in subsequent years for not using a prior year’s gift exclusion. Effective estate tax planning often uses some leveraging of the annual exclusion to remove assets from the taxable estate. In many cases, our clients may wish to take advantage of the annual exclusion but are not inclined to allow younger beneficiaries to squander the gift or wish to maintain some protections for the recipient against divorce, creditors, lawsuits and so forth. Transferring assets to a gifting trust, instead of directly to a beneficiary, can help maintain a level of control and asset protection over gifts while accomplishing tax goals.
Irrevocable Trusts - Generally
A quick explanation of irrevocable trusts may be helpful. These trusts come in many different flavors and can be quite confusing. However, it is important to note that irrevocable trusts can be includable in the Trustmaker’s estate (basis adjustment), excluded from the Trustmaker’s estate (no basis adjustment), or includable in the Trustmaker’s estate based on a formula (inclusion or exclusion based on the estate value and applicable exemption). Irrevocable trusts can make the Trustmaker liable to pay the income tax on the assets (often referred to as a “Grantor” trust), make the trust liable to pay its own income taxes (a “non-Grantor” trust) or make the beneficiary considered the income tax owner. Choosing an appropriate combination of powers is critical and is determined by the size and composition of your estate, your objectives, and your beneficiaries’ personal circumstances.
Income Taxes & Capital Gains Taxes
Unlike estate taxes, income taxes and capital gains taxes apply to a significant portion of the population, and it is a concern we discuss with many of our clients. This is another area where being charitably minded can provide you with options to lessen your tax burden through planning to include distributions to charitable entities that qualify under the IRS code.
There are different ways that you may have income or capital gains subject to tax in your estate after you have passed away. Pretax funds such as IRA, 401k, or 403b accounts consist of entirely taxable funds: every dollar withdrawn from these accounts is taxable. This unpaid income tax does not simply disappear after you have passed away. The recipient of the account will still be taxed. Often, we discuss with clients who are charitably inclined, which assets are most effective to give to loved ones and which assets are most effective to give to charities. We also discuss the relative income tax brackets of the client and the eventual recipients of retirement accounts to determine the most efficient timing for withdrawals.
Related Article: Planning for Retirement Accounts
You may have capital gains taxes on assets that have appreciated in value over time, such as stock or real property. These assets may receive a basis adjustment at your death (meaning the asset’s basis is reset to the value on the date of death), but the assets will need to be includable in your taxable estate (subject to the estate tax) to obtain a reset basis. Generally, gifts may remove an asset from your taxable estate but also transfer your basis to the recipient (often referred to as “carry-over basis”), which removes the opportunity for a basis adjustment. We consistently see a lack of coordination between estate and capital gains taxes that leads to less than optimum results. For instance, we’ll see assets in an irrevocable trust written to create estate exclusion (no basis adjustment) despite the fact that the couple does not have a taxable estate, or gifts of cash being provided to charities when there are low basis or retirement accounts available.
Just like many of the other planning techniques mentioned here, it is imperative that you consult with your professional team of advisors to implement a plan such as this. There are many requirements in how you allocate these assets and the language you use in your planning documents that, if done incorrectly, could result in more tax than necessary. Working with an experienced Estate Planning Attorney can help you ensure the tax planning will be effective when it is needed.
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