Swimming Upstream: Saving Taxes by Giving Back to Mom and Dad

July 26, 2018
Senior Wealth Planners discuss upstream gifting, an increasingly popular estate planning technique following the recent tax legislation that involves making gifts up the family tree, rather than downstream.

Since the passage of the Tax Cuts and Jobs Act of 2017, a rare estate planning technique has become increasingly attractive to families who own appreciated assets. Called “upstream gifting” by some, the technique involves making gifts of appreciated assets up the family tree to parents or grandparents, rather than more typical downstream gifts to children or grandchildren. An important benefit of making upstream gifts is that at the older recipient’s death, the appreciated assets will receive a step-up in income tax basis. Those who receive the appreciated assets from the older generation should then be able to sell the assets promptly with no capital gains tax due.

Upstream gifting was virtually unheard of when the federal estate tax exemption amount was a modest $600,000, as it was in the late 1980s and into the 1990s. Because the estate tax rate was 55% during that period, the prevailing strategy for wealthy individuals was to transfer assets down to younger generations as quickly as possible so that any appreciation could occur in the younger generation’s hands, rather than in the wealthy individual’s estate.

In recent years, however, the exemption amount has increased significantly, reaching $11.18 million in 2018. This means that a married couple can transfer $22.36 million free of federal gift or estate tax – and so can their parents.

For example: If a wealthy daughter has a father who is not expected to make use of his entire $11.18 million exclusion amount, the daughter could transfer low-basis assets to the father or to a trust for his benefit that is subject to estate tax. At the father’s death, his estate will not actually owe any estate tax as long as he has enough exemption remaining. However, because the gifted assets are includible in the father’s estate, the income tax basis should be stepped up to the fair market value as of the date of his death.

The upstream transfer can be structured as a gift, as a sale to a carefully drafted trust or as part of a more complex strategy such as a grantor retained annuity trust. At first blush, an observer may wonder why the daughter would use her exemption amount to gift assets upstream to her father, rather than downstream to her children. The answer is that the family expects to receive a step-up in tax basis at the father’s death, which is likely to occur sooner than the daughter’s death. If the assets are highly appreciated, the tax benefit of the upstream gift can be dramatic, particularly if the family had wanted to sell the assets but felt constrained by the built-in capital gain.

It is important to note that the gifted assets will not receive basis step-up if the father dies within one year of the gift and the assets revert back to the daughter at that time. However, many practitioners believe that step-up will be allowed if the assets pass to a trust for the daughter, rather than outright, or if the assets pass to a third party, such as the daughter’s children.

Of course, there are risks that should be considered. The father could happily accept the assets but then decide to pass them on to someone else, such as a new spouse, a friend or another family member whom he believes to be in greater need than the wealthy daughter. Similarly, the father might have creditors who could try to seize the property in satisfaction of their claims.

Both of these risks can be mitigated if the daughter makes the gift to a trust for the father’s benefit, rather than to the father outright. However, the trust agreement would need to contain special provisions designed to trigger estate inclusion – a result that was keenly avoided in the past. Trying to obtain estate inclusion will be a new exercise for many practitioners.

Finally, there is a risk the tax laws will change midstream. Currently, the exemption amount is set to increase incrementally every year until 2026, at which time it is scheduled to revert back to $5 million (plus inflation). However, it is entirely possible that Congress could decide to change the exemption amount before that date, particularly if a different political party is in control. If the exemption amount is unexpectedly reduced after the upstream gift has been made, the older generation may have to pay estate taxes on the gifted assets after all. For this reason, upstream gifts are best suited for clients who have a true desire to provide for their parents, regardless of any tax benefits.

Please contact your BBH wealth planner or relationship manager if you would like to further explore this technique.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2020. All rights reserved.  PB-03789-2020-07-13

This browser is not fully supported by our public website and may not display or function as expected for this reason. Please note, the Infuse Portal and BBH client applications fully support the IE 11 browser.

Important Information for Non-U.S. Residents

You are required to read the following important information, which, in conjunction with the Terms and Conditions, governs your use of this website. Your use of this website and its contents constitute your acceptance of this information and those Terms and Conditions. If you do not agree with this information and the Terms and Conditions, you should immediately cease use of this website. The contents of this website have not been prepared for the benefit of investors outside of the United States. This website is not intended as a solicitation of the purchase or sale of any security or other financial instrument or any investment management services for any investor who resides in a jurisdiction other than the United States1. As a general matter, Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) is not licensed or registered to solicit prospective investors and offer investment advisory services in jurisdictions outside of the United States. The information on this website is not intended to be distributed to, directed at or used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Persons in respect of whom such prohibitions apply must not access the website.  Under certain circumstances, BBH may provide services to investors located outside of the United States in accordance with applicable law. The conditions under which such services may be provided will be analyzed on a case-by-case basis by BBH. BBH will only accept investors from such jurisdictions or countries where it has made a determination that such an arrangement or relationship is permissible under the laws of that jurisdiction or country. The existence of this website is not intended to be a substitute for the type of analysis described above and is not intended as a solicitation of or recommendation to any prospective investor, including those located outside of the United States. Certain BBH products or services may not be available in certain jurisdictions. By choosing to access this website from any location other than the United States, you accept full responsibility for compliance with all local laws. The website contains content that has been obtained from sources that BBH believes to be reliable as of the date presented; however, BBH cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content contained herein is current as of the date of issuance and is subject to change without notice. The website’s content does not constitute investment advice and should not be used as the basis for any investment decision. There is no guarantee that any investment objectives, expectations, targets described in this website or the  performance or profitability of any investment will be achieved. You understand that investing in securities and other financial instruments involves risks that may affect the value of the securities and may result in losses, including the potential loss of the principal invested, and you assume and are able to bear all such risks.  In no event shall BBH or any other affiliated party be liable for any direct, incidental, special, consequential, indirect, lost profits, loss of business or data, or punitive damages arising out of your use of this website. By clicking accept, you confirm that you accept  to the above Important Information along with Terms and Conditions.

1BBH sponsors UCITS Funds registered in Luxembourg, in certain jurisdictions. For information on those funds, please see bbhluxembourgfunds.com

captcha image

Type in the word seen on the picture

I am a current investor in another jurisdiction