Gifting is an important estate planning tool to downstream assets. As it is likely that estate tax exemptions will be sharply reduced, now is a brilliant planning opportunity. Historically, gifting has been of modest benefit to families with larger estates due to the $1 million maximum lifetime gifting limit, which later increased to $5 million, and increased again to its current $12.93m level. The increased gifting credit is due to expire at the end of 2025; less than 2 years off and Biden’s agenda has taken aim at the exemption and has proposals to reduce the estate tax exemption to something in the $3.5m to $6m range.
The estate and gift tax rules (both federal and state) levy a large tax on transferring assets when alive or at death (currently 40%, historically at 55% separate from applicable state death taxes). There is a base amount that can be transferred annually when alive (currently $17,000 per year) and a larger historical sum commonly known as the “lifetime credit” which can be applied while alive or at death.
Gifting has been an estate planning staple as a steady, simple means to transfer assets to the younger generations. While neither the annual or lifetime credits were dramatic, gifting over time could amount to a significant sum, and more importantly, could transfer not just the asset, but its future appreciation downstream. Most families do not give cash or other assets directly to children, but instead use entities to hold assets and give non-voting interests to children, grandchildren, and/or trusts, so they may enjoy control, access, protect the assets from claims, while also decreasing eventual estate taxes.
To get more utility from gifting, leverage techniques are common. A simple, yet effective approach, is to gift assets most likely to appreciate. The credit consumed is based on the value of asset on the date gifted, not its future value. For instance, the author was involved in the gift of a closely held business interest, then appraised at $2 million, to a trust benefitting children/grandchildren. One year later the business was sold to a larger competitor for $24 million. The full $24 million is outside the taxable estate, yet still controlled, managed, and accessible by the family.
Entities are often used to make gifts, not just for retention of control, but also for tax discounting purposes. Transfer taxes are based on the gifted asset’s fair market value, which can be artificially reduced by crafting control limitations. Rather than owning an asset individually, a family may own assets in limited liability companies (LLCs) or limited partnerships (LPs) and retain the one share that votes. The remaining 99 shares, which have no vote and very limited rights, have reduced fair market value. Discounts vary based on the liquidity of the underlying asset and range from 20% to 50%. Presuming a common 35% discount, gifts of LLC/LP units effectively allow one to give away $24,000 annually and $20m for the current lifetime credit.
With general unrest due to inflation and economic unrest, values of some businesses and other assets, get gain an additional advantage as the valuation of many assets is currently depressed allowing more to be given away.
The credit can be further leveraged with sales techniques, such as an intentionally defective trust (IDIT) to dramatically increase the net effect of a gift. A trust is created to be a gifting vehicle which is primed with a gift of some of the non-voting shares of the LLC/LP and the remaining majority of the LLC/LP non-voting shares are sold to the trust in return for a low interest note. The assets appreciate in the trust, benefitting the younger generation, which is outside the family taxable estate. For example, a business was valued at $100m early in 2023, but is currently worth $70 million. However, the business is poised to be sold in two years for substantially more. The senior family members keep all management control then give a 25% non-management equity portion to the IDIT (value $17.5m, but after LLC discount, tax value of gift is 35% less – $11.38m – using the majority of the available lifetime credit). The remaining 75% of the LLC units are sold to the trust in return for a note bearing interest at the lowest acceptable IRS rate (currently 5%). As the business generates a 7% return, servicing the note is not an issue. The business sells in two years for $115m. The note value of $34m is still part of the estate (the interest and/or principal payments the senior family members can use for living on) and we have achieved moving over $81m out of the estate, plus its future appreciation, using the lifetime credit of just one person.
As it is difficult to predict the precise tax course the current administration will take, but it is conservative to use the generous gifting credit while it is available. For those who have planning vehicles in place, a discussion with the advisory team is indicated to take advantage of the unusually large credit and consider leverage techniques. This will need to be well coordinated for those who live in states with a separate state gift tax (i.e. Connecticut). For most families, the day to day management of assets will be exactly the same and they can maintain all control, access and management. For families who have not yet employed planning techniques or gifts, there is no better time than the present.
