Year-end tax guide: Estate planning

2015 Year-end tax guide“Estate planning” is a misnomer. Transferring your wealth to loved ones in a tax-efficient manner is a lifelong process that is usually more about giving during your lifetime. Estate planning is an ongoing process. You should ensure your plan fits with both any changes to the law and your own circumstances. Planning starts with understanding the basic rules. Transfer taxes comprise two tax bases: the unified gift and estate tax, and a generation-skipping transfer (GST) tax.

Estate and gift tax adjustments (click to view chart)

Q: How are the estate and gift taxes “unified”?
You have one combined lifetime exemption that can be used either by your estate at death or during your life with giving. Once your lifetime exemption is depleted, your wealth will generally be subject to a 40% tax, regardless of whether it’s imposed when you transfer assets while alive or when your estate transfers them when you’ve passed.

Q: Why are low interest rates so good for estate planning?
Many transfer tax strategies, such as grantor-retained annuity trusts (GRATs) and intentionally defective grantor trusts (IDGTs), discussed later, hinge on the ability of assets to appreciate faster than the IRS-prescribed interest rates. An appreciating market and historically low rates create the perfect atmosphere for estate planning.

Q: Is my same-sex spouse eligible for the marital deduction?
The IRS will treat any same-sex couple as married for federal tax purposes if the couple was legally married in any of the 50 states, the District of Columbia, a U.S. territory or a foreign country. The IRS does not recognize domestic partnerships, civil unions or other similar formal relationships as marriages for federal tax purposes.

Estate and gift taxes
The estate and gift taxes have been reunified with a lifetime exemption that reached $5.43 million in 2015 and a top rate of 40%. The estate and gift tax allow unlimited marital deductions for transfers between spouses. Your estate generally can deduct the value of all assets passed to your spouse at death if your spouse is a U.S. citizen, and no gift tax is due if you gave the assets while alive. There is also no limit on estate and gift tax charitable deductions. If you bequeath your entire estate to charity or give it all to charity while you are alive, no estate or gift tax will be due.

The exemption is now also fully portable between spouses after death. To use a predeceased spouse’s unused estate tax exemption amount, the executor must file an estate tax return that computes the unused estate tax exemption amount and makes an election on the return that allows the surviving spouse to use the predeceased spouse’s unused estate tax exemption amount.

You also have an annual gift tax exclusion that is indexed for inflation in $1,000 increments but remained at $14,000 per recipient in 2015.

GST taxes
The GST tax is an additional tax applied to transfers of assets to grandchildren or other family members that skip a generation (including nonrelatives at least 37½ years younger than the donor). You are entitled to a GST exemption of $5.43 million in 2015. Your estate may benefit in the long run if you deplete this exemption while you’re alive. But remember, you’ll also need to use your gift and estate tax exemptions to make these transfers completely tax-free.

The benefits of giving
Giving while you are alive remains one of the best strategies. It should start with leveraging the $14,000 annual gift tax exclusion. You can double this exclusion to $28,000 by electing to split gifts with your spouse. So even if you want to give to just four individuals, you and your spouse could give a total of $112,000 this year with no gift tax consequences. If you have more people you’d like to benefit, you can remove even more money from your estate every year. You can also save your lifetime gift and estate exemption by making taxable gifts during your lifetime. See our tax planning tip for when this makes sense.

Choose your gifts wisely. Give property with the greatest potential to appreciate. Don’t give property that has declined in value. Instead, sell the property so that you can take the tax loss and give the sale proceeds. When deciding which assets to give, keep in mind the step-up in basis at death. If the loved ones to whom you give property are unlikely to sell it before you die, you need to analyze the situation. If it stays in your estate, the property gets an automatic step-up in basis to fair market value at the time of your death. This could generate significant income tax savings for your heirs upon later sale, but must be balanced against the fact that the property could appreciate during your life and add to your estate at death.

You can also avoid gift taxes by paying tuition and medical expenses for a loved one. As long as you make payments directly to the provider, you can pay these expenses gift tax-free without exhausting your annual exclusion.

Planning tip: Make taxable gifts
Much estate planning is focused on leveraging your lifetime exemptions, but making taxable gifts can have significant benefits. For one, the amount of gift tax paid is removed from the estate. The gift tax is “tax exclusive” because you don’t pay tax on the gift tax itself, while the estate tax is “tax inclusive.” This means that giving wealth while living results in less tax than passing it at death.

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Planning makes perfect
If you have a sizable estate, your planning should go well beyond basic giving. There are a variety of sophisticated planning techniques that can help transfer significant assets to loved ones in a tax-efficient manner, including family limited partnerships (FLPs), GRATs, qualified terminable interest property trusts (QTIPs), irrevocable life insurance trusts (ILITs), IDGTs, Crummey trusts, dynasty trusts and personal residence trusts.

You can talk to a Grant Thornton professional to understand which of these tools could work well in your situations, but check our planning tips for examples of the benefits.

Planning tip: Family limited partnership
An FLP is an excellent vehicle for passing business interests and investment assets to heirs at steep transfer tax discounts. When you pass an interest in an FLP onto a family member, the value of the partnership interest used to calculate the transfer tax implications may be discounted significantly because the underlying assets are subject to restrictions for marketability and control.

However, you can’t set up an FLP just for tax planning purposes, and the IRS has had success challenging FLPs in which the donor retains the actual or implied right to enjoy the FLP assets or when the donor retains the right to control the FLP.

You must have valid business reasons for setting up an FLP, but fortunately, there are many nontax benefits to FLPs, including the ability to consolidate and protect assets, centralize management and costs, arbitrate family disputes, facilitate retention of family assets, increase investment opportunities and provide business education to your family.

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Planning tip: Zero out your GRAT to save more
GRATs allow you to remove assets from your taxable estate at a reduced value for gift tax purposes while you receive payments from the trust. The income you receive from the trust is an annuity based on the value of the assets on the date the trust is formed. At the end of the term, the principal passes to your beneficiaries.

It’s possible to plan the trust term and payouts so there is no taxable gift. This is called “zeroing out” the GRAT and happens when the GRAT is structured so that the value of the annuity interest at the time the GRAT is created equals the value of the assets transferred to the GRAT. So the remainder’s value for gift tax purposes is zero or close to zero. Assuming the GRAT appreciates faster than the rate used to determine the remainder value, you’ve passed on assets tax-free.

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Planning tip: ‘Freeze’ asset values with IDGT
An IDGT is similar to a GRAT in that it offers you the ability to pass on assets to loved ones tax-free if the assets appreciate faster than IRS-prescribed interest rates. To use an IDGT, you structure a grantor trust so the assets will pass to your beneficiaries. You can sell an asset to a trust in exchange for a note. This will not be considered a gift if you use the interest rates prescribed by the IRS to determine that the value of the note equals the asset sold. If the assets appreciate faster than the interest rate, the trust will have significant assets to pass on to your heirs tax-free. The IDGT must generally make a down payment on the assets of at least 10%, and when you contribute this “seed money” to the trust, it will be subject to transfer taxes.

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David Walser T +1 602 474 3410

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