Preservation | Family Wealth Protection & Planning

Income tax basis planning

1. Obtaining a basis step-up for irrevocable trust assets.

All existing irrevocable trusts should be reviewed. Many of these trusts should be modified to cause the income tax basis to be adjusted to fair market value (often referred to as a basis “step-up”) at the beneficiary’s death. By doing so, you can reduce the capital gains taxes that will eventually be due when the assets are sold. This can be accomplished by giving the current beneficiary a formula general power of appointment that is only effective to the extent it will not cause a federal or state estate tax.

Irrevocable “grantor” trusts should be reviewed to determine whether the low basis assets in the trust can be swapped for cash or high basis assets currently owned by the grantor.

2. Put investment assets in a single member LLC.

The best tax planning is to put all of a married couple's assets in the name of the first person to die. Then all of these assets can receive a step-up in basis at death to avoid future capital gains tax. In most cases it will be difficult to know which spouse will die first, and moving real estate or assets in a brokerage account can often take weeks to be effective. Putting assets in a limited liability company owned solely by a spouse’s revocable trust allows these assets to be quickly moved to the other spouse’s revocable trust if there is an accident or a spouse falls into poor health quickly.

3. Use your parent's unused estate tax exemption to reduce your capital gains taxes.

If an individual has a parent with a net worth less than $11.4 million, then consider using that parent's extra exemption to reduce the child's future capital gains taxes. The child can gift or sell low basis assets to an irrevocable trust for the benefit of the parents and the child's other heirs. Minimal assets, if any, ever need to be distributed to the parents. With proper planning, the assets will receive a basis step-up at the first parent’s death and continue in trust for the child’s other intended beneficiaries.

4. Amend revocable trusts that do not include basis step-up flexibility.

Most revocable trusts were drafted to avoid estate taxes when a spouse or child dies. Encourage clients to amend revocable trusts to give the trustees the power to purposely subject appreciated trust assets to estate tax for a basis increase. This can be accomplished with no estate taxes ever being paid. This is a planning idea every individual should consider.

Estate tax planning

5. Sell or give away more assets.

Families with a net worth such that they are likely to pay federal estate taxes should consider how best to utilize the additional $5,690,000 each parent was given in 2018. The simplest answer may be to give additional assets to irrevocable trusts that are already in existence. However, if the parents’ cash flow may not be able to handle the gift, then selling assets in return for a low interest promissory note can still accomplish many of the same things as a gift, but with the added flexibility of having access to the assets sold, through a principal prepayment. The short-term, mid-term and long-term AFRs for November 2018 are 2.7 percent, 3.04 percent and 3.22 percent. Sales require interest payments to be made back to the seller, which increase the seller’s taxable estate, but the flexibility of retaining access to the assets sold can make sales more palatable to clients than gifts.

Clients and advisors often ask whether existing promissory notes should now be forgiven. In most cases, there will be additional estate taxes saved with gifts of assets likely to appreciate more than the interest rate under these notes. Additionally, giving away assets through a partnership, as explained below, can achieve much greater estate tax savings than simply forgiving a promissory note.

6. Create a family limited partnership to reduce estate and gift taxes.

Before selling or giving away assets, individuals should consider the benefits of forming a family limited partnership (FLP) and transferring the limited partnership interest instead of the underlying assets currently owned. FLPs were on the IRS’ radar before President Trump was elected. The IRS even issued proposed regulations aimed at shutting down this planning opportunity. These regulations are now dead, and discount planning is still a great opportunity for families who expect to be paying estate taxes. Typical discounts for marketable security limited partnerships are in the 30 percent range, so giving away $1 million through an FLP can save $120,000 in estate taxes ($1 million x 30 percent x 40 percent) compared to giving away the marketable securities directly.

7. Allow GST exempt trusts to grow income tax-free.

Many irrevocable trusts have been divided because there was insufficient GST exemption available when the trust was created. If these GST exempt and non-exempt trusts are otherwise identical, then language can be added to the trusts that would cause the non­ exempt trust to be required to pay all of the income taxes of the GST exempt trust, allowing the exempt trust to grow income tax free indefinitely.

For clients whose estates are large enough that trusts will likely be divided for GST purposes at his or her death, this language should be added to their revocable trusts now to allow for this planning after the trusts are created at the client’s death. This planning also allows the non-GST exempt trust to sell assets to the exempt trust for a note to freeze the value of the trust for GST tax purposes, moving the future income and appreciation to the GST exempt trust that will never have to pay GST or estate taxes.