If the parent was feeling especially generous, he might decide to forgive some of the interest each year using his annual exclusion (currently $17,000 per year, described further in this article).
Similarly, if you or members of your family have high interest rate loans currently outstanding, and the borrower is in a lower generation, refinancing the note in a lower interest rate environment would be a relatively painless way of reducing your estate and passing some money to the borrower. The lower rate would mean less interest would be required to be paid back before the end of the note’s term. As long as there is some consideration for refinancing (i.e., it is not just a gift from the lender to the borrower, but there is some reason to refinance – a longer loan term, or perhaps a partial prepayment), this strategy should not result in gift tax or use of exemption. As rates rise, this strategy becomes less appealing; however, opportunities to refinance and/or restructure today’s intra-family loans if and when rates fall again should be considered on a regular basis.
Finally, the simplest estate planning strategy around is still available and very effective. The annual gift tax exclusion has increased over the years in $1,000 increments from $10,000 to $17,000. This means that you can give away $17,000 each, to as many individuals (outright, or in a properly structured trust) as you choose, without incurring gift tax. If you plan to transfer wealth to grandchildren or more remote descendants, contact your estate planning attorney about GST tax implications.
Planning with Your Dynasty Trust
In 2012, 2020, and 2021, facing potential reductions in the lifetime exemption from transfer tax, many clients took advantage of their lifetime gift and GST tax exemptions by transferring assets to a dynasty or spousal access trust designed to benefit multiple generations without payment of transfer tax at each level. Those dynasty trusts, once “seasoned” with assets that have been in trust for some time, present excellent planning opportunities. Many of these trusts were structured as grantor trusts, meaning that the trust gets to pass along its income tax bill to the client who funded it. The grantor/client and the trust are treated as the same for income tax purposes. This is nice for the trust beneficiaries (frequently the client’s children and grandchildren), because money is not taken out of the trust account and mailed to the IRS each year – instead mom or dad writes a check to the IRS from a personal account, and the trust account continues to grow tax free. So, for each year that the trust has taxable income and mom or dad pays its income tax bill, children and grandchildren are enriched in a manner that is not currently subject to gift tax. In case mom and dad have second thoughts about this generous structure, some clients included a provision in the trust agreement allowing them to “turn off” the grantor trust status and decide when to shift the income tax burden to the next generation.
If you funded a trust in 2012 or over the past few years, this is not a “set it and forget it” wealth transfer strategy. First, because the exemptions doubled in 2018 and are indexed annually for inflation, the amount you can transfer tax free will continue to increase. Each year, to the extent aligned with your values and overall wealth plan, you should “max out” your trust – for example, in 2012, you could give $5.12 million transfer tax free. In 2023, the amount has increased to $12.92 million – transferring the balance of the exemption to the trust now moves those assets, as well as any appreciation between the date of transfer and your death, out of your estate.
Second, many of these trusts included a provision allowing the donor to reacquire trust property and substitute property of equal value. Assuming the trust was funded with property that was expected to appreciate, you should keep an eye on the growth of the trust assets and consider swapping out the assets and substituting cash to lock in gains. If your trust account is at BBH, your relationship manager and, if BBH is named as a trustee, trust officer are keeping close watch on the trust account for such opportunities.
Finally, even if you have maxed out your trust, you can enhance it in other ways. One great strategy is to lend assets to the trust for a few years. Why would you loan assets to a trust if the trust is just going to have to pay the assets right back to you, plus interest? Because as discussed earlier, to the extent the trust assets grow at a faster rate than the IRS interest rates for intra-family loans, the trust has increased in value in a manner not currently subject to gift or estate tax. Even better, there is no income tax on loans between the grantor and a grantor trust because, as noted, they are the same for income tax purposes. On the other hand, if the loan is not between a grantor and a grantor trust (for example, the eight-year loan between parent and child discussed earlier), the lender (parent) would pay income tax on the interest payments (even if interest is forgiven and not paid).
If you did not fund a grantor dynasty or spousal access trust in 2012 or the past couple of years and still have exemption remaining, it is not too late; however, we encourage you to consider acting soon. Under the current tax code, the transfer tax exemptions will continue to increase with inflation until January 1, 2026, when they are scheduled to revert to 2017 levels ($5.49 million, adjusted for inflation, vs. the current $12.92 million).
Shifting Gears: From Lifetime to Testamentary Planning
In the course of structuring new wealth transfer plans and enhancing existing plans, we heard many clients note that their wills and other testamentary documents had not been revised in years, and in some cases did not reflect their current wishes. However, in the rush to create and fund new trust agreements, clients put wills and other testamentary documents aside to be focused on at a later date, given the time-sensitive nature of using up the increased exemption amount. So, just as you are breathing a sigh of relief and feeling as though you have finally accomplished your wealth planning goals, remember to also look back at your existing testamentary documents and, if necessary, update them to reflect any recent gifts.
If, for example, you used some of your exemption to purchase a home for one child in 2012, but your will currently provides that your assets pass equally to all of your children at your death, you may want to insert an “equalization clause” providing that your other children be made whole in light of the gift made to the first child during life. Planning during life is so connected with testamentary planning that anyone who engaged in significant gifting in the past several years should take a look at her will and the interplay between that document and the planning accomplished so far.
If you are not sure whether your estate plan should be revised this year, your BBH wealth planner and relationship manager would be happy to take an initial look and provide some suggestions. Above all, it is important to assess your estate planning objectives and work closely with your BBH team, accountant, and estate planning attorney before moving forward with any of these strategies. Fortunately, especially for those of us who have made a career of the practice, it seems as though despite (or because of) the flood of transfer tax transactions implemented in 2012, 2020, and 2021, in addition to the 2018 increase in the transfer tax exemption amounts, estate planning will live to see another day!
Brown Brothers Harriman & Co. and its affiliates do not provide tax, legal or investment advice, and this communication cannot be used to avoid tax penalties. This material is intended for general information purposes only and does not take into account the particular investment objectives, financial situation or needs of individual clients. Clients should consult with their legal or tax advisor before taking any action relating to the subject matter of this material.