Many ultra-high net worth clients used all of their available gift/estate and GST exemptions in 2020 or 2021. For an individual, the exemption increased by $120,000 in 2021, $360,000 in 2022 and is estimated to increase by $860,000 in in 2023. We can make assumptions for the increases in 2024 and 2025. What would it look like if we used the increases to fund additional life insurance.
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“Life insurance continues to play a vital role in legacy planning because of its unique value proposition – a source of income tax efficient liquidity, efficient wealth transfer on a multi-generational basis, a mortality hedge, a non-correlated asset class, and strong internal rates of return relative to the current stock market. Nonetheless, advisors should evaluate how higher rates and a volatile market may impact the performance of both new and existing life insurance funding approaches.”
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“The “step transaction” doctrine is alive and well. In the foot-race to beat potential tax law changes, families often miss the forest from the trees. The economic realities and entity formalities must be respected in the execution of a gift transaction….On November 10, 2021, the Tax Court rendered its decision in the case of Smaldino v. Commissioner, which involved a purported gift of LLC interests by Mr. Smaldino to his wife, followed by a purported gift of the same LLC interests, the very next day, from Mrs. Smaldino to a dynasty trust for the sole benefit of Mr. Smaldino’s children from a prior marriage. The Court found a series of ignored formalities, and that as a practical matter there was never a time when Mrs. Smaldino would have been able to effectively exercise any ownership rights with respect to the LLC interests “given” to her. The Court held that Mr. Smaldino never effectively transferred any LLC interest to Mrs. Smaldino, and consequently the dynasty trust received its entire LLC interest from Mr. Smaldino, creating a taxable event.”
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“While conventional estate plans focus on a “traditional” family notion of one husband, one wife, and their children, families today often involve far more complex relationships. Thus, modern-day families often present unique planning issues, such as the need to satisfy obligations under marital agreements, the goal to provide simultaneously for both the surviving spouse and children from prior relationships, and the desire to ensure “fair” treatment of children from prior relationships, all while minimizing potential conflicts between the spouse and those same children. The acquisition of life insurance, as well as other “tweaks” to the conventional core plan, can address these objectives.”
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“As part of their comprehensive legacy plan, clients who are charitably inclined, hold significant highly appreciated assets, and wish to create a lifestyle “annuity” should consider a CRT, especially if they can benefit from an income tax charitable deduction. Selling an appreciated asset inside a CRT may provide an economically superior result compared to selling the same asset in a client’s own hands, especially when done in conjunction with purchasing additional life insurance through an irrevocable life insurance trust (“ILIT”).”
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An interesting article in today’s NY Times authored by Paul Sullivan. He writes, “So the question for taxpayers now is: What happens once Mr. Biden can begin enacting changes in tax policy? The biggest long-term change involves the estate tax.” Sullivan goes on to discuss the possible loss of step-up in basis, “A Biden administration may move to change this for logical and revenue reasons. Imagine trying to determine the capital gains from AT&T stock that your grandmother bought in 1943 when record-keeping was done with a pencil and paper. Today, cost-basis information can be retrieved in seconds.” He goes on to discuss some of the inherent problems in this approach.
A different approach could be adjustment to current estate tax exemptions and rates. “With Democrats controlling the legislative and executive branches, there is concern that the exemption level could drop to $5 million or even $3.5 million…For the wealthiest in the country, the bigger concern is the rate itself. It’s now at 40%, but it was as high as 55% in 2001.”
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Paul Sullivan (Wealth Matters) writes today in the New York Times, “What needs to be analyzed for affluent individuals are the potential changes no candidate is talking about: lowering exemptions and raising rates for the estate and gift taxes and ending the valuation discount for closely held family businesses, a tax break that allows families to transfer a valuable asset for less than it is worth.”
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“In the absence of life insurance, options for fiduciaries to generate needed liquidity for estate taxes and expenses may be limited, creating additional hurdles for estate administration and post-mortem planning.”
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“Sample cases targeting trustees vividly illustrate unique fiduciary challenges in terms of trust administration and asset management, including for irrevocable life insurance trusts (“ILITs”). The growing complexity of life insurance products and the potential for increased gifts in the next several years can make ILIT administration far more complicated than anticipated, particularly for non-professional trustees.”
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“In legacy and life insurance planning, using ILITs to acquire life insurance was almost automatic. Now, with lower federal estate tax rates and higher exemptions, some clients may feel saddled with old ILITs that no longer match their goals or provide the intended tax benefits, even though retention of the life insurance makes financial and investment sense.”
To read the full report, click here.