The anticipation of new tax changes is a nail-biting experience for all taxpayers. For high-net-worth individuals, the changes can be even more stressful. Now that taxpayers know and can anticipate some of the upcoming changes, it’s time to prepare a plan to get through them.
Start With a Personal Financial Plan
As a high-net-worth individual, having a financial plan is key to preserving your legacy. In 2021, planning is heavily colored by the future decrease in the estate tax exemption amount. High-net-worth individuals should be aware by now that the current exemption is scheduled to decrease from $11.7 million for individuals and $23.4 million for couples to $5 million (adjusted for inflation). If your estate is going to be worth more than that amount, it’s recommended to start looking at shedding excess wealth.
Work with a financial planner or tax expert to determine how much money you think you’ll need to get to the end of your life. Give away your excess wealth today so you can reduce your estate tax burden in the future. If you’re going to give your money to your kids, charity, or another party upon your death, doing it now can alleviate a high tax burden in the future.
Figuring Out What to Give Away and How
Assets appreciate over time. If you’re planning for a post-2026 estate tax (i.e. you’re planning on dying after 2025), you need to prioritize what assets you’re going to gift now. Cash, unless invested, will likely remain at the same value until the estate tax exemption changes. Other assets, like real estate, are going to appreciate. So, if you’re going to shed assets, give away things likely to appreciate. This way you’ll be able to better reduce your future estate tax burden not only on the transferred assets, but the appreciation on those assets as well.
Once you’ve determined what to give away, you’ll have to decide how. This decision depends on who you’re giving your estate to. You can give your assets outright, in trust, or a variety of other ways. Discuss with your financial team and other stakeholders to decide the best way to distribute your wealth.
Here is a list of some popular estate planning techniques:
Family limited partnerships—These are great vehicles for transferring assets (including marketable securities) and then gifting the partnership units at a discount.
Grantor retained annuity trusts (GRATS)—This is a popular planning vehicle, especially in periods of low interest rates. One drawback, however, is the grantor must outlive the term of the GRAT for this to be effective.
Intentionally defective grantor trusts (IDGTS)—Benefits are like a GRAT, however there is no stated term that the grantor must outlive. In addition, the defective nature of the trust requires the grantor to continue to pay tax on the income generated, therefore reducing the grantor’s estate even further without being subject to gift taxes.
The Stepped-Up Basis
When appreciated assets like real estate pass through a decedent’s estate, heirs receive what is referred to as a “stepped-up basis.” For example, James buys a house for $300,000, he owns it for 30 years, and it appreciates to $1 million. He then dies and the house is inherited by his daughter Stacy. At that point, Stacy receives a stepped-up basis. If she sells the home, her basis for determining gain or loss is $1 million.
This is a common way people transfer their property and assets away without having to pay capital gains tax. Giving your assets away now will mean that your heirs will not receive the stepped-up basis upon your death. However, waiting to take advantage of the stepped-up basis is likely to come back to haunt you (or more specifically your heirs). The Biden Administration has also proposed doing away with the stepped-up basis altogether, although it was not included in the House proposal released Sept. 13.
Waiting for the stepped-up basis is like spending 40 cents to save 23.8 cents. If you transfer an asset now, it won’t be taxed in your estate (you’ll save on the 40% marginal tax rate). However, when your heirs sell the property, they’ll pay the 23.8% capital gains tax. Alternatively, leaving it in your estate until you die will subject the value to the 40% estate tax. However, your heirs will receive a step up in basis, therefore saving the capital gains tax of 23.8%. Hence, you’re spending 40 cents to save 23.8 cents.
The Uncertain Future
Today, we know the estate tax exemption amount is decreasing in 2026. What we don’t know is if it might decrease further, go up, or remain the same. More individuals than ever before have joined the estate planning discussion as talk of even lower exemption amounts spreads. Estates in the $10 million-20 million range face lots of indecision, while estates in the $5-6 million range are just entering the conversation.
If an individual has a $10 million estate today, doesn’t expect it to appreciate, and doesn’t believe Biden will lower the exemption amount further, there’s likely no action to take other than updating their living trust. If an individual expects their $10 million estate to appreciate, then there’s more planning and strategizing to do.
Estates in the $5 million-6 million range didn’t anticipate being at risk for the estate tax, but now must be prepared. In states like California, the high cost of real estate and rapidly rising home values put more people in this category for estate taxes. People in this category should connect with their financial planners to develop an effective strategy that fits with their goals and needs.
Regardless of estate value, it is wise to review the plans for your estate frequently with your financial advisors as tax changes like these occur regularly. It is important to ensure that your legacy is carried out according to your wishes and provides the most opportunities for your heirs. As the saying goes, the estate tax is really a neglect tax. If you neglect to properly plan, you will pay! Get in touch with your estate planning team and start preparing today.
This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.
Tim Tikalsky CPA is a tax principal with Sensiba San Filippo.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.
To read more articles log in.