5 Estate Tax Planning Techniques


4 minute read

5 Estate Tax Planning Techniques

Taxpayers currently have a historic window of opportunity to reduce future transfer taxes. The federal gift, estate and generation-skipping transfer (GST) tax exemptions – collectively referred to as the "federal exemption" – are $11.7 million per person. Thus, a married couple can transfer an unprecedented $23.4 million free of federal transfer tax.

But the window may be closing. Under current law, the federal exemption is scheduled to be reduced by 50 percent on January 1, 2026. Furthermore, President Biden proposed reducing the federal exemption to $3.5 million per person during his campaign.

That means now is an opportune time to evaluate your estate tax planning strategies. Here are five to consider:

1. Use Exemption During Lifetime
The federal exemption can be used either during lifetime or at death. There are two advantages to using the federal exemption during lifetime. First, a taxpayer who makes substantial gifts before the federal exemption is reduced may be able to take advantage of the temporarily increased federal exemption. For example, if a taxpayer makes lifetime gifts of $11.7 million but the federal exemption is later reduced by 50 percent to $5.85 million, the taxpayer will have taken advantage of $5.85 million of federal exemption that otherwise would have been lost – with potential federal estate tax savings of $2.34 million given the current 40 percent federal estate tax rate.

Second, when assets are transferred during lifetime, any appreciation on the gifted assets accrues outside of the taxpayer's taxable estate, potentially resulting in even greater estate tax savings. Additional information about the lifetime use of federal exemption is available here.

2. Employ Intentionally Defective Grantor Trusts
An intentionally defective grantor trust, or "IDGT," is a trust that is not included in the grantor's taxable estate for estate tax purposes, but is considered to belong to the grantor for income tax purposes, meaning the grantor is personally responsible for paying any income taxes attributable to assets owned by the IDGT. This is a very attractive feature from an estate tax planning perspective, as the grantor's payment of the IDGT's income taxes is not considered a taxable gift. This in effect lets the grantor transfer value out of his or her estate without using any exemption. Furthermore, the IDGT's status as a grantor trust means the grantor can sell assets to the IDGT without creating a realization event for income tax purposes.

3. Make Gifts to Spousal Lifetime Access Trusts
For married couples, a spousal lifetime access trust, or "SLAT," can be an ideal vehicle to receive lifetime gifts. Traditionally, lifetime gifts have been made to children or to trusts for their benefit. However, many couples are unwilling to transfer $11.7 million (let alone $23.4 million) to their children during lifetime.

A SLAT, on the other hand, is created by one spouse for the current benefit of the other spouse, generally with children only as remainder beneficiaries. This lets the beneficiary spouse "access" the trust assets, while still providing a vehicle that allows the appreciation on the gifted assets to escape estate taxation. As an added bonus, a SLAT is a form of intentionally defective grantor trust.

4. Take Advantage of Annual Exclusion Gifts
The Internal Revenue Code provides that a certain amount of gifts – currently $15,000 per donor/per recipient/per year – is excluded from being counted against the transferor's estate/gift tax exemption.

When spread over multiple recipients and multiple years, the impact of annual exclusion gifts can be surprisingly large. For example, if a married couple has three adult children, each of whom is married, the couple could give away $180,000 per year ($15,000 × 2 × 2 × 3) without using any estate/gift tax exemption. Making such gifts over an extended period can result in substantial estate tax savings.

5. Don't Forget About State Estate Taxes
The well-publicized increase in the federal exemption has misled many taxpayers who live in states that impose a state-level estate tax into believing that they have no estate tax exposure. However, Illinois imposes an estate tax on any estate valued in excess of $4 million (including the face value of life insurance, if the decedent had any incidents of ownership therein).

This tax can be surprisingly high. For example, a single individual who dies with an estate valued at $11.7 million would owe no federal estate tax but would owe $1.2 million in Illinois estate tax. Fortunately, there are several techniques that can reduce state estate tax exposure considerably.

Contact a member of Much's Estate Planning & Wealth Transfer group to discuss estate tax planning for you and your family.