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Brad Lard's practice primarily involves estate and trust planning and administration, with an emphasis on the related income, estate, gift and generation-skipping transfer tax issues. In addition, Brad is actively engaged in representing individual and corporate fiduciaries (executors and trustees) in administrating and litigating estate and trust matters. View articles by Brad

On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (the “2017 Act”) which, among other items, made several changes to the federal wealth transfer tax system with respect to transfers occurring during calendar years 2018 through 2025.

Background

Prior to enactment of the 2017 Act, the first $5 million (as adjusted for inflation in years after 2011) of transferred property could be exempted from gift, estate and generation-skipping transfer (GST) tax. For estates of individuals dying and making gifts in 2017, the applicable inflation-adjusted exemption amount was approximately $5.5 million (or $11 million for a married couple).

New Law

Under the 2017 Act, this basic exemption amount was doubled from $5 million to $10 million, which, after being indexed for inflation, is now $11,180,000 for 2018 (or $22,360,000 per married couple). However, the increased exemption amounts are scheduled to “sunset” or revert on January 1, 2026, to the 2017 levels, as adjusted for inflation.

Considerations for Action

What should individuals do in response to these changes in the estate, gift and GST tax law? The following is a summary of some of the initial issues to consider in light of the 2017 Act:

Review your current will and estate plan.

The substantially increased estate tax exemption amount may permit the wills of married couples to be simplified. For the past 30+ years, the wills of many clients have included tax-planning provisions creating a so-called “bypass trust” or “family trust” to protect the estate tax exemption of the first spouse to die of a married couple. While there are many non-tax reasons to continue to use such a trust, the increased $11,180,000 estate exemption may enable some married couples to eliminate such a trust and allow assets to be given outright to the surviving spouse.

In addition, many wills and other estate planning documents are designed to minimize estate taxes through the use of formula provisions that are dependent on the estate tax exemption amount, the GST tax exemption amount, or both. Because of the changes under the 2017 Act, these formula provisions may produce serious unintended consequences for a person dying between 2018 and 2025, including the possibility of materially altering the intended beneficiaries receiving property under a person’s will.

For example, assume that a person’s will makes a gift equal to “the largest amount that can pass free of federal estate tax” to his or her children, with the remainder of property given to such person’s spouse, and that person has less than $11,180,000 million of assets passing through his or her will. If this person dies while the 2017 Act is in effect, the children may receive 100% of this person’s property and the surviving spouse may receive no property. Other examples would include wills that have similar formula provisions to make charitable gifts or generation-skipping gifts for grandchildren.

We think it is very important that you consider these recent changes in the tax law in connection with your current estate plan and encourage you to review these matters as one of your 2018 New Year’s resolutions. At a minimum, you should be aware of the possible impact of the 2017 Act on your estate plan and should consider what changes, if any, should be made to your will and other estate planning documents.

Make current gifts for family members.

For individuals who want to make gifts to family members, gifts may be made during 2018 that utilize an individual’s unused $11,180,000 gift tax exemption amount, or $22,360,000 gift tax exemption amount per married couple (taking into account prior gifts). Such a gift may be made outright or in trust, and unused GST exemption may be allocated to a gift into a long-term trust to protect it from future estate and GST taxes. You may also want to leverage these gifts using your gift and GST tax exemption amounts through other estate planning strategies, such as sales of assets to grantor trusts, intra-family loans, grantor retained annuity trusts (GRATs), and split-interest charitable trusts.

Family Business Interests, Charitable Remainder Trusts and Life Insurance: Q & A with Capital Strategies GroupBradley’s Family Owned Business team asked our friends at Capital Strategies Group, Inc. to share a case illustrating how high-net-worth families involved in family businesses are using life insurance in creative ways that go beyond the standard uses for term or whole life policies. Here’s a Q & A with Preston Sartelle, Director of Business Development at Capital Strategies Group, Inc., that shows how a large block of life insurance can enhance the results and yields of business succession and estate plans for families.

Capital Strategies: We recently had the pleasure of working with a family of first-generation wealth looking to exit their business in a way that met several goals. First, they wanted to pay as little income tax as possible, which was problematic due to the extremely low basis in their company stock. Second, they wanted to provide a significant benefit to charity, and third, they wanted to maximize wealth to the second generation. After considering various options, the family settled on a Charitable Remainder Trust (CRT) combined with a life insurance policy insuring a family member from the first generation.

Bradley: It is likely helpful to offer a basic explanation of the workings of a CRT in this situation. There are, of course, several types of CRTs, each with complicating nuances, but the basic steps are relatively simple:

  1. The owner (donor) transfers the business interest to a CRT that is structured to pay the donor a specified amount during life, or for a certain term of years, with the remainder going to one or more designated charities or to a private foundation.
  2. The donor will be entitled to an immediate income tax deduction for the present value of the remainder interest given to charity, subject to the standard limitations on charitable deductions.
  3. The CRT is a tax-exempt entity and can sell the business interest without incurring capital gains tax at the trust level, thereby allowing the sales proceeds to be reinvested by the trust undiminished by taxes.
  4. During the donor’s life (or for the term of years), the CRT will distribute to the donor either a set dollar amount or a set percentage of the trust’s value determined annually—an income stream that the donor would not otherwise have if the interest was held until death. Each distribution is reportable by the donor as taxable income to the extent of any income that would have otherwise been recognized by the trust. In other words, any capital gains triggered by the sale are deferred over the course of the distributions to the donor, providing a tremendous advantage to selling the interest outright with all gain reported in the year of the sale.
  5. At the donor’s death (or at the end of the term of years), the charity or private foundation receives all remaining assets held by the CRT.

Bradley: What are some of the non-tax benefits of combining the CRT with an insurance policy?

Capital Strategies: The CRT can provide a boon to the next generation where the donor allocates the CRT distributions to a life insurance contract on the life of the donor. Often the amount of death benefit purchased with the CRT distributions far exceeds what the donor’s heirs stand to inherit from the business net of estate taxes.

As a quick example, consider a 70-year-old donor who owns $5 million worth of zero basis stock in the family business—a roughly $1.2 million capital gains tax liability if sold today. If the stock is retained by the donor and transferred to children at death after growing at 5 percent for 15 years, the children would inherit roughly $6 million net of estate taxes assuming the donor’s estate tax exemption had been otherwise used.

Instead, the donor could transfer the stock to a CRT, providing an income tax deduction for the present value of the remainder interest. The CRT could then sell the stock and pay the donor a 5 percent annuity for life, all or a portion of which the donor could use to purchase a life insurance contract. So, let’s assume a roughly $190,000 annual distribution to the donor, net of capital gains and income taxes – the actual amount will of course depend on actual CRT earnings.

Bradley: What are some other factors to consider?

Capital Strategies: The amount of insurance that could be purchased with the CRT distributions will depend on several factors, not the least of which is the donor’s health. If the donor is a standard, non-smoker underwriting risk, a universal life policy to the age of 100 with a lifetime premium schedule of $190,000 would result in approximately $6.85 million of death benefit proceeds to the next generation net of income and estate taxes—the amount the heirs stood to receive previously plus a 14 percent bonus. And, of course, the charity receives the residue of the trust, the amount of which will depend on the trustee’s investment experience during the CRT term. Earning a return equal to the 5 percent annuity rate will leave the charity the original $5 million principal.

Takeaway

CRTs can afford donors an efficient exit from an otherwise precarious tax position and make both the charity and the family better for it. Working with advisors such as Capital Strategies, Bradley’s team can recommend several ways life insurance, when structured intentionally and correctly, can elevate a client’s business or estate plan.

Diving into Family Philanthropy (Segment IV): Family Philanthropy – Where to Begin?In our previous posts on family philanthropy, we addressed the benefits of family philanthropy, choosing the right giving vehicle, and investing for impact. In this final post in our four-part series, we discuss how to get started with your family philanthropy. While there is no right or wrong way to “do” family philanthropy, we find it helps to begin with a clear idea of your goals and objectives. We’ve designed the questions below to help you start thinking about what you might like to accomplish for your community and your family through your philanthropy.

1. What do you want to achieve with your family’s philanthropy?

  • Is there a particular cause or issue area that ignites your passion to give?
  • Do you want to be able to deploy your charitable dollars wherever the need is greatest as needs change over time?
  • Are you seeking a mechanism to make annual giving to the charities you already support easier?

2. What value do you place on philanthropy?

  • Does philanthropy play an important role in your life now?
  • How much time would you like to spend engaging in philanthropic pursuits?
  • Do you anticipate that your charitable giving will increase, decrease or stay the same over time?

3. How do you want to involve your family?  

  • How much control do you want other family members to have over where money is donated?
  • Are you interested in using your philanthropy as a way to teach future generations about stewardship and leadership?
  • Which family members do you want to include?

4. How much control do you want to retain?

  • Do you want to have the final say on where funds are distributed?
  • Do you want future generations to have the flexibility to change the way the funds are used?
  • Do you want to ensure that your wishes are carried out in perpetuity?

5. What amount of administrative responsibility do you wish to maintain?

  • Do you like the idea of handling the details associated with regulatory compliance, due diligence and grantmaking?
  • Do you anticipate hiring staff or others to help with administration?
  • Would you be willing to give up some control in order to decrease the number of administrative tasks you are responsible for handling?

6. How will you fund your philanthropy?

  • Are you planning to use an ownership interest in your family-owned business?
  • Are you anticipating a liquidity event?
  • Will you use an asset that you ultimately want to leave to your children?
  • Will the assets used to fund your philanthropy change from year to year?

These are just a few of the common questions we explore with our clients. In our experience, each family’s path to meaningful family philanthropy is different. If you want to brainstorm ways to take your family’s giving to new heights, we are available to discuss these and other topics related to charitable giving at your convenience.