Just like in the classic board game Monopoly, managing real-life wealth requires strategic moves. As you go along, you might acquire assets, take risks, and experience setbacks and windfalls. There are unexpected twists and turns (and possibly long, boring stretches).
And while you may not pass on your Monopoly properties to your family and loved ones (hey, never say never!), the same strategic mindset is useful when you have a goal to protect your assets and pass on your wealth to the next generation.
Let’s delve into seven expert tactics for ensuring your hard-earned assets don’t get eaten up by taxes when passing them on to your loved ones to secure your family’s financial future.
Implementing these seven effective estate planning strategies can maximize the inheritance you leave behind while minimizing the tax burden on you and your heirs.
1. Make gifts using the annual exclusion
The IRS allows individuals to give a certain amount to an unlimited number of recipients annually without incurring gift tax. This is referred to as the annual exclusion amount.
In 2023, the annual exclusion amount per donee is $17,000. This means that every year, a married couple can gift $34,000 tax-free to each of their children, grandchildren, or whomever else they choose.
2. Sell property to an Intentionally Defective Grantor Trust
An Intentionally Defective Grantor Trust (IDGT) freezes certain assets for estate tax purposes. It’s a trust whose assets are not included in the grantor’s estate for estate tax purposes but whose income is taxable to the grantor.
Suppose you believe that a particular asset—typically, an income-producing asset like a ranch, business, or set of mineral interests—will appreciate significantly. You give the IDGT a promissory note in exchange for the property. The trust then pays you interest on this note.
The property’s income and appreciation beyond the interest rate are excluded from your estate and pass on to your beneficiaries tax-free. Due to your income tax liability, more wealth is effectively transferred to the beneficiaries. Since you pay the income tax, it also decreases your taxable estate.
3. Use installment sales of businesses
An installment sale allows you to spread out the gain from the sale of a business over several years, deferring the capital gains tax and enabling the gain to potentially be taxed at more favorable long-term capital gains rates.
For example, let’s say you sell the family business to your child. Instead of receiving the sale price upfront, you receive a promissory note requiring your child to make payments over a ten-year period. This can be advantageous for both parties because, not only does this enable your child to use the business’s future earnings to make the payments, but it also reduces your capital gains tax liability.
4. Establish a Family LLC or Family Limited Partnership
A Family Limited Liability Company (Family LLC) or Family Limited Partnership (FLP) facilitates the consolidation of family assets and the transfer of assets to younger generations at discounted values, resulting in substantial gift and estate tax savings.
For example, let’s say you transfer your real estate portfolio into an(FLP. Then, you systematically gift your kids or grandkids limited partnership interests. Due to limitations on these interests (such as lack of marketability or control), they may be valued at a discount for gift tax purposes, allowing you to transmit more value within the annual or lifetime exemptions.
There are several pitfalls that can arise in the execution of this strategy, so it’s important to work with an attorney and maintain proper records as you do so.
5. Establish a Grantor Retained Annuity Trust
A Grantor Retained Annuity Trust (GRAT) allows you to pass on to beneficiaries assets that are anticipated to appreciate in value at a minimal gift tax cost. You transfer assets to the GRAT and retain an annuity for a predetermined duration. If their growth exceeds a certain IRS-assumed rate, the excess growth is distributed tax-free to the beneficiaries.
For example, you could transfer anticipated value-appreciating assets into a GRAT with a five-year term. If the equities appreciate more than the set IRS interest rate (otherwise known as the “7520 rate”) during that time, the excess appreciation is goes to the beneficiaries tax-free.
6. Establish a Charitable Lead Trust
A Charitable Lead Trust (CLT) provides a steady stream of income to a charity for a specified number of years. The remaining assets are distributed to non-charitable beneficiaries, typically children or descendants, at the end of the term.
In this scenario, you transfer property to a CLT, which then pays a ten-year annuity to a charity. Whatever remains in the CLT after a decade is transferred to your beneficiaries. This strategy may result in significant estate and gift tax savings, especially if the assets appreciate in value.
7. Use your full lifetime gift and estate tax exemption
Use it or lose it! In addition to the annual exclusion, there is a lifetime gift tax exemption and an estate tax exemption. This allows you to transfer substantial funds during your lifetime or upon your death without incurring federal gift or estate tax.
In 2023, the federal exemption is $12.92 million for individuals and $25.8 million for married couples (that’s a lot of Monopoly houses!). Therefore, you could potentially gift or leave to heirs millions of dollars without incurring any federal gift or estate tax.
Many families currently use substantial portions of this in the short term as part of their estate tax saving strategy. This is because the current law is sunsetting at the end of 2025, at which point experts say the exemption amounts will likely be halved.
Contact our Texas estate planning attorneys for further guidance
If you have any other questions about how to minimize your tax burden as you pass on your wealth to your loved ones, it can be a big help to reach out to a talented team of attorneys like those at the law firm of Shann M. Chaudhry Esq., Attorney at Law PLLC.