Wealth Transfer Planning for Uncertain Times

As of 2022, the federal lifetime gift and estate tax exemption is now $12,060,000 per person. If you are married, that means $24,120,000 can pass from you and your spouse to non-charitable beneficiaries without being subject to a 40% tax. The elevated lifetime exemption amount, combined with the recently increased annual exclusion amount of $16,000 per person, per year, brings us to a great opportunity for wealth transfer. So how do we capitalize on this opportunity, knowing that these amounts continue to be targeted in legislative proposals, and if the law isn’t changed, the exemption will decrease to $5,000,000 per person adjusted for inflation on January 1, 2026?

Option 1: Sale to a Grantor Trust

Applicable federal rates (AFR) tell us the minimum amount of interest that one can charge for private loans without having gift tax implications. The declared rate for February 2022 is 1.40% annually for a mid-term loan of three to nine years. It’s an attractive rate for a borrower, and we can leverage the low interest rate to provide flexibility in the context of wealth transfer. As an example:

Bob and Eleanor are married, financially secure, and want to transfer $1,000,000 for the benefit of their daughter, Samantha.

Instead of using $1,000,000 of lifetime exemption immediately, they conclude to sell an asset worth $1,000,000 to an existing trust for Samantha’s benefit that holds other assets. The assets already in the trust are valuable, so the team involved in the transaction agree that the existing trust would be considered a qualified buyer.

The trust is designed so that Bob and Eleanor pay the taxes on behalf of the trust, so no taxes are paid on any gains at the time of the sale. A promissory note documenting the purchase is designed for 9 years.

At a 1.40% AFR, the annual interest on the loan is $14,000.

The following options exist within the trust:

The trust can pay back the loan plus interest according to the terms of the sale. This will preserve Bob and Eleanor’s gift and estate tax exemption.

Bob and Eleanor can forgive all of the loan, or portions of the loan over time. If they forgive more than the annual exclusion limits, they will use some of their estate and gift tax exemption amount.

Typically, Bob and Eleanor can substitute assets of equivalent value for assets in the trust. This can be very valuable if they believe an asset is likely to appreciate significantly and getting it outside of their taxable estate would be beneficial.

In years where paying for all of the taxes on behalf of the trust is overly burdensome, the trustee could reimburse Bob or Eleanor for taxes paid on behalf of the trust.

After the sale is complete, Bob or Eleanor (whichever one of them is the grantor) can chose to stop paying taxes on behalf of the trust. They will have to forego the ability to substitute assets of equivalent value in the future.

The example in this case is scalable, so an individual with a $5,000,000, or $20,000,000 asset to sell could use the same concepts. This strategy is more complex than a straightforward gift, so we strongly recommend engaging a qualified attorney and accountant when exploring this idea.

Option 2: Silent Trusts

Most states have specific rules about how and when a trustee must notify beneficiaries about a trust, including Michigan, Ohio, and Florida. Suppose that you want to set aside wealth for your heirs but are concerned about them seeing the trust values. Consider the silent trust option:

Bob and Eleanor are married, financially secure, and believe now is the right time to transfer $1,000,000 to a trust for their daughter, Samantha.

Ensuring that Samantha remains motivated to accomplish her life goals, and that their wishes are followed regarding the trust assets, are key objectives. If possible, they do not want Samantha to know about this gift yet.

They have a person that they trust to serve as a designated representative. This is an advocate for Samantha that is designated within the trust to receive notices and hold the trustee accountable.

Under the Delaware Trust Act of 2015, Delaware trusts permit the grantor to restrict or eliminate telling the beneficiary “for a reasonable period of time.”

As a bonus, if the trust is designed to pay its own taxes, and the beneficiaries are not Delaware residents, then accumulated income within the trust will not be subject to Delaware income tax.

For some individuals, wealth transfer planning may be the right financial answer today, but the wrong psychological answer for the beneficiary. The silent trust option should be considered as a way to bridge the gap in these cases.

Conclusion

For those that are thinking of wealth transfer, consider this article as a way to spark questions and conversation. Should you gift assets to a child or grandchild outright, or should the transfer occur in trust? How about selling the assets to a trust instead of gifting them to a trust? How will the child or grandchild react when they learn about the money being transferred?

Every situation is unique, so these questions and more should all be addressed to ensure a good result. Of course, if you have questions, please reach out to us at Greenleaf Trust and we will be excited to work with your team and guide you along the way.