Thanks to tax cuts made during the first Trump administration, Americans can give or hand down about $13 million in assets without paying federal estate tax. Only 0.2% of taxpayers have to worry about this tax, and they hire top-notch accountants and lawyers to pay as little as possible.
“This is a wealthy person’s playground problem,” Robert Strauss, partner at the law firm Weinstock Manion, told Business Insider.
Some of these tax avoidance techniques might be eyebrow-raising, yet they are perfectly legal. For instance, taxpayers can put homes and country homes in trusts that last decades and any appreciation in the property’s value doesn’t count toward their taxable estate. Life insurance, probably the least sexy area of financial planning, can be used to save tens of millions of dollars in taxes if bought from issuers in the Cayman Islands and Bermuda.
Currently, individuals and married couples can gift or bequeath $13.61 million and $27.22 million, respectively, before a 40% federal estate tax kicks in. That exemption is due to expire at the end of 2025, but it looks likely that it will be extended given the Republican Party’s total control of Washington.
Here are 12 little-known techniques that the richest taxpayers use to pay less to Uncle Sam:
Using trusts to give away homes and country houses
Qualified personal residence trusts, better known as “QPRTs,” effectively freeze the value of a real estate property for tax purposes. The homeowner puts the primary residence or vacation home in the trust and retains ownership for however many years they choose. When the trust ends, the property is transferred out of the taxable estate. The estate only has to pay gift tax on the value of the property when the trust was formed even if the home has appreciated by millions in value.
QPRTs have become more popular in the past year as interest rate hikes confer another tax benefit. It seems too good to be true, but there are a few strings attached.
Passing wealth to future generations with trusts that last up to 1,000 years
From the Wrigley family behind the titular chewing gum brand to Jeff Bezos’ mother, an Amazon investor, some of America’s wealthiest use generation-skipping trusts to avoid paying wealth transfer taxes and provide for future heirs.
These so-called dynasty trusts allow taxpayers to pass along wealth to generations that haven’t even been born yet and only be subject to the 40% generation-skipping tax once. Many states have eased trust limits to get the business of the wealthy, with Florida and Wyoming allowing dynasty trusts to last as long as 1,000 years, which spans about 40 generations.
The heirs don’t own the trust assets but rather have lifetime rights to the trust’s income and real estate. These trusts even protect assets from future creditors and shield them in the event of a divorce.
Giving to charity via trusts that also yield income
Charitable remainder trusts (CRTs) allow moneyed Americans to have their cake and eat it too.
Plenty of affluent taxpayers deduct charitable donations from their taxable income, but the ultra-rich can parlay their philanthropy into guaranteed income for life.
Taxpayers put assets in the trust, collect annual payments for as long as they live, and get a partial tax break. Only 10% of what remains in the CRT has to go to a designated charity to pass muster with the IRS.
These trusts can be funded with a wide range of assets, from yachts to property to closely held businesses, making them particularly useful for entrepreneurs looking to cash out and do good.
Holding life insurance policies via trusts to save on taxes and protect heirs from lawsuits
Rich founders with illiquid assets can take out life insurance policies to cover their estate taxes. They get the most bang for their buck if they put the life insurance policy inside a trust rather than owning it directly. The irrevocable life insurance trust (ILIT) collects the death benefit, pays the tax bill, and distributes whatever is left according to the insured individual’s wishes. Any payout is also protected from estate taxes, even if the insured’s estate and death benefit exceed the exemption.
There are other perks. If the insured wants to make sure that their heirs are protected from creditors or divorcing spouses, they can use ILITs to be doubly safe. While the law varies by state, trusts and life insurance both have strong legal protections.
Using charitable trusts that give the remainder to heirs
Also known as the Jackie O trust since it was used by the late First Lady, a charitable lead trust or CLT makes annual payments to a charity or multiple. Whatever is left when the trust expires goes to a remainder beneficiary picked by the grantor, typically their children.
If the assets within the trusts appreciate faster than an interest rate set by the IRS at the time of funding, the beneficiary can even end up with a bigger inheritance. CLTs can also be used to discreetly transfer wealth while being publicly philanthropic.
“I’ve seen lawyers use these to plan for mistresses, to plan for children that perhaps the spouse doesn’t know about,” lawyer Edward Renn told Business Insider.
Taking loans to pay estate taxes
Unlike QPRTs and CRTs, this technique is highly scrutinized by the IRS and comes with a lot of hoops to jump through.
Families that are asset-rich but cash-poor and facing an estate tax bill can either rush to sell those assets to make the nine-month deadline or take a loan.
The estate can make an upfront deduction on the interest of these Graegin loans, named after a 1988 Tax Court case. Further, if illiquid assets make up at least 35% of the estate’s value, families can defer estate tax for as long as 14 years, paying in installments with interest, and effectively taking a loan from the government.
Graegin loans are prime targets for auditors and have led to years-long legal battles, but the savings can be worth it for rich families.
Buying offshore life insurance policies
Private-placement life insurance, or PPLI, can be used to pass on assets from stocks to yachts to heirs without incurring any estate tax.
In short, an attorney sets up a trust for a wealthy client. The trust owns the life-insurance policy that’s created offshore. The assets in the trust are treated as premiums, and if structured correctly, the benefit and assets in the policy are bequeathed free of estate tax.
It’s only relevant to the ultra-wealthy, often requiring $5 million in upfront premiums as well as a small army of professionals to set up and administer, including trust and estate attorneys, asset managers, custodians, and tax advisors.
Transferring depressed assets during a market slump
The down market has one silver lining for high-net-worth individuals. It is an optimal time to create new trusts as people can transfer depressed assets, whether they are stocks or bitcoin, at a lower tax basis.
The long-favored grantor-retained annuity trusts (GRATs) can confer big tax savings during recessions. These trusts pay a fixed annuity during the trust term, which is usually two years, and any appreciation of the assets’ value is not subject to estate tax.
GRATs have picked up in popularity in the past year as the Federal Reserve has raised interest rates, which eat into the returns on these trusts.
Stashing assets in trusts for a spouse
The wealthy can save on taxes by putting their riches in trusts before the Trump tax cuts expire, but some don’t feel ready to give their fortunes to their kids yet.
Luckily, there is a compromise. Using a spousal lifetime-access trust, also known as a “SLAT,” married taxpayers can stash their fortunes in trusts that pay distributions to their spouses rather than giving assets to their kids. The beneficiary spouse can use this cash flow to fund the couple’s lifestyle. After this spouse dies, the trust passes to new beneficiaries, typically the couple’s children.
Buyer beware: divorce can mean losing those dollars forever. But millions in potential tax savings can be worth the gamble.
Using trusts that pay cash to spouses but keep the assets for the kids
When the wealthy remarry, they often have to balance the needs of their new spouse and their kids from a prior marriage. Trusts can be used to take care of the spouses, but the adult kids want their piece of the pie.
There is a way to make everyone happy. With a qualified terminable interest property trust, also known as a “QTIP,” married taxpayers can put their fortunes in trusts that pay distributions such as stock dividends to their spouses. The income-producing assets, however, are untouched, and when the beneficiary spouse dies, everything in the trust is transferred to new beneficiaries, who are typically the adult children of the spouse who funds the trust.
The main benefit of QTIPs is peace of mind. If the beneficiary spouse remarries, they still get the cash, but they can’t gift the assets to their new partner.
Transferring business assets to family-limited partnerships at big discounts
Sam Walton, the founder of Walmart, used a family limited partnership or “FLP” to save his kids and wife from paying any estate taxes on multibillion-dollar family fortune.
With an FLP, an individual — often a parent or two parents — pools their business assets, commonly real estate or stocks. As a general partner, the original individual can name their children as limited partners and give them interest in the partnership. The kids get cash distributions from revenue generated by the trust but do not have control over the actual assets. This control is appealing to parents who want to hold the purse strings.
Another sweetener: You can claim a discount on the assets transferred to the FLP and use even less of your estate-tax exemption. Though the IRS scrutinizes these discounts, they can be worth the gamble. The right lawyer can justify a discount of 45% or higher for less liquid assets, such as privately held businesses.
Giving stock to parents and inheriting it back when they die
Wealthy founders who built their businesses from the ground up face hefty capital gains taxes when they cash out. Instead of selling the shares outright, they can save on taxes by gifting their stock to their parents and waiting to sell the stock until they inherit it after their parents’ death. These “upstream transfers” take advantage of a tax loophole for inherited assets that boosts the cost basis to its fair market value at the time of inheritance.
This tactic can also be used to save on estate taxes by ultra-rich entrepreneurs who have already used their exemption but have less-wealthy parents who haven’t. They can stash the assets in a trust that benefits their parents until their passing and then their children. When the children inherit the assets, the federal estate tax doesn’t kick in as long as the grandparents’ estate does not exceed $27.22 million.
Lawyers warn that upstream planning comes with risks. Individuals can lose their assets for good if their parents decide to share the wealth with a new spouse or other children.
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