Insights and Resources

Estate Planning and Potential Tax Changes: What you Should Know

Death and taxes are both certain, and under several tax changes currently in the pipeline, the odds that taxes are going to be higher when people pass away are going up. 

The reason for the changes is twofold. The more immediate consideration comes from the Biden Administration’s proposed tax changes, which are currently held up in the reconciliation process in Congress. The secondary concern is in a sunset provision of the Taxpayer Relief Act of 2012, which will significantly decrease the federal estate tax exemption to $6.5 or $7 million per person, down from the current $11.7 million, in 2026. 

While the latter concern is certain unless Congress extends the exemption, the former continues to be in flux. But even though the changes remain in limbo and only time will tell whether they are implemented, it is in the interest of high-net-worth individuals to act sooner rather than later to be smart about their money and explore different avenues that may allow it to be taxed at a lower rate. 

Doing so will help protect the value built up over a lifetime, and help ensure that your heirs will have the resources they need in the future. Here are a few suggestions that we make for our clients. 

Get up to speed on your plan

Many people think of estate planning as one-and-done. They build a plan, write their will, assign a beneficiary, sign it, and it sits in the safe until needed. 

That works, but it’s not ideal. Estate plans are typically built to maximize returns under the tax code that is in place when it is signed and written. It is a smart habit to get into to periodically review individual plans every ten or so years to see whether they are still reflective of the tax code and whether they use best practices given your level of income and business interests. As careers progress and endeavors expand, tax applications often shift as well. 

The review should include each of the most important estate documents, including your will, beneficiaries, powers of attorney, and trusts. If any of those documents sound new, then it may be a good time to speak with an estate planning attorney. 

What is your charitable donation plan?

Transferring some or part of an estate to charity is one of the most common paths that high-net-worth individuals take in estate planning, and is one that ensures a lasting legacy and a tangible difference made for a good cause. 

Charitable donations are also a smart strategy to increase certain federal and state tax exceptions to an estate. One of the most popular vehicles to do this with is a charitable trust that disburses money over time after a person passes. Trusts, if set up in certain ways, can also yield income tax benefits for people who still remain employed. 

Donor-advised funds (DAF) and private family foundations are two other popular routes for estate planning, each of which has benefits and drawbacks. A DAF offers an income tax deduction and will reduce the tax rate on an estate and much control over donations, however can be used at the discretion of their overseers. Private family foundations offer similar, if not more control over funds, and similar tax and estate benefits, however, filings have to be recorded with the IRS. 

Don’t delay your generosity

If the Biden Administration does in fact raise the estate tax rate, one way to both potentially lower the rate of tax and be in the interest of beneficiaries is to simply start giving away money before death. 

The tax code allows individuals to give other individuals up to $15,000 annually, or $30,000 for married couples, completely tax-free. For a married couple giving the annual maximum to two children, the total adds up fast, amounting to $600,000 in a decade, and $1.2 million in two decades. 

Insurance can be your advantage

Most people think of life insurance as a way to maintain a standard of living after the death of someone whose income is dependent on. While that is certainly true and important, one of the original purposes of life insurance was very different - they were used as trusts, and their main purpose was to pay off estate taxes. 

It was mainly used for estate tax when exemptions were low - in the thousands of dollars range. If someone passed away, the insurance money would be used to subsidize the tax payments, and family would come out even or slightly better after all was said and done. Since that time, much has changed and we have moved away from trusts.

But with exemptions looking like they are on a downward trajectory under the Biden proposal and the TCJA sunset, it may be an opportune time to take a move from the old playbook and run with life insurance trusts. Doing so, like in the early days of life insurance, will protect the money from the taxable portion of an estate. 

Think about a freeze

Tax shielding tactics, known in the industry as “freeze techniques”, are one more way that high-net-worth individuals can shield estate assets from the tax collector after they pass. 

The strategy is exactly what it sounds like - it simply halts the growth of assets in an estate by transferring them to trusts set up in the name of beneficiaries, so that the money can be transferred on a low-tax basis. 

In such a trust those assets will continue to grow, however, they will do so under someone else’s name and therefore will not be taxed upon death. Guardrails can also be set that forbid the usage of funds prior to death, essentially following the same guidelines as any other trust. 

Much is left to be sorted out with regard to estate tax in the coming days, weeks, and months as Congress continues to grapple with the tax code in reconciliation. Should the bill be signed into law, the IRS will likely also go through a rulemaking process, meaning that concrete regulations could take even longer. 

The smartest thing to do is check-in with your estate tax professional, who can offer some certainty despite the uncertain times. 

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