Four Tips for High Net Worth Individuals Desiring to Utilize Record-High Lifetime Exemptions
The historically high lifetime exemption amount for gift, estate and generation-skipping transfer taxes increased from $11,400,000 to $11,580,000 per person this year due to inflation indexing. Individuals who had used up their lifetime exemption as of last year may choose to make “topping up” gifts of $180,000. Those of considerable means who have not yet made gifts to utilize their lifetime exemption may wish to at least begin to think about lifetime gift strategies. Some will find this to be a good time to devote to planning. In addition, a silver lining to the current economic volatility is that valuations may be depressed such that you can give more now at lower values.
By making gifts now, a person can “lock in” exemption that may shrink in 2026 or sooner. Treasury Regulations issued last year confirm that gifts made on or before December 31, 2025 will not be “clawed back” into a person’s taxable estate at death, regardless of whether the lifetime exemption amount subsequently decreases. Absent new legislation, the lifetime exemption will revert to the prior $5,000,000 level, adjusted for inflation, on January 1, 2026.
Set forth below are four tips for high net worth individuals desiring to capitalize on the record-high lifetime exemptions in what may be a “use it or lose it” scenario.
1. Make Gifts in Trust
By making gifts to your loved ones in trust you can retain some degree of control over the gifted assets and allow for flexibility to adapt to changed circumstances. An independent Trust Protector can be authorized to add or remove beneficiaries, for example. A beneficiary can be granted the power to change the disposition of trust assets remaining at the beneficiary’s death (within any constraints provided by the grantor) or to redirect assets to charity during life.
The trust structure can offer beneficiaries some protection from creditors, including by way of keeping assets clearly separate from a divorcing spouse. Trusts also enable potential avoidance of estate and generation-skipping transfer taxes when the assets pass to the next generation.
If you make gifts to a grantor-type trust, you remain responsible for the payment of income taxes associated with the gifted assets, unless or until you choose to “turn off” the grantor trust status. The payment of income tax on behalf of the trust enables you to make further tax-free “gifts” to the trust (of the income tax) without utilizing additional lifetime gift tax exemption.
Another benefit of using grantor trusts is that you are permitted to substitute assets of equivalent value in exchange for the trust assets without recognition of gain, which enhances flexibility and can be a useful tool in terms of managing income tax basis (e.g., substituting any low basis trust assets for high basis assets before death).
2. Give Assets that Will Remain in the Family
With lifetime gifts, you forego a step-up in basis of appreciated assets that would otherwise occur upon your death, which step-up would reduce or eliminate capital gains exposure on a subsequent sale of those assets. This is not of consequence, however, if the transferred assets are not intended to be sold and will instead remain in the family. For this reason, it may make sense to give assets such as a family vacation property that your children have expressed interest in retaining, or shares of a business that is intended to remain family-owned.
Even if the gifted assets may one day be sold, the foregone basis step-up is of less consequence, in present value terms, if sale would take place many years after your death and the date for payment of estate tax.
By transferring a portion of certain family assets during life, you can ensure that your estate includes less than a 100% interest in those assets at your death, which is advantageous from a valuation perspective. When fractional interests are valued, they are typically eligible for generous discounts for lack of control and lack of marketability.
Lifetime gifts have the additional advantage of being valued on a per beneficiary basis, rather than based on the grantor’s aggregate ownership. The following numerical examples helps to illustrate: (a) you die owning a family vacation residence with fair market value of $4,000,000, passing to your four children (taxable estate includes $4,000,000) versus (b) you give each of your four children a 25% tenants-in-common interest in the residence (each valued at $850,000, or $3,400,000 total, using a conservative 15% discount).
3. Consider Selling Assets to a Grantor Trust for a Promissory Note, which May be Forgiven
One wealth transfer strategy is selling assets to a grantor trust (“intentionally defective grantor trust” or “IDGT”) in exchange for a promissory note. In the usual case, the grantor sells an asset at its fair market value to the trust in exchange for a note, typically with a nine to thirty year term, which note is either self-amortizing or, if the cash flow is not sufficient to amortize, interest only and a balloon payment of principal due at the end of the term. Assets that are either depressed in value or are expected to appreciate substantially should be selected for this purpose. The goal is to remove future asset appreciation, above the mandated interest rate, from the grantor’s estate.
A seed gift to the IDGT is generally recommended (minimum 10% of the purchase price), which uses some lifetime gift and GST tax exemption in order to give the transaction commercial viability. Given the record-high exemption amount, a twist on the typical sale to an IDGT planning is that additional lifetime exemption can be used to forgive a portion or all of the promissory note if it later looks like the exemption amount will decrease.
Given the particularly low current interest rates, sales to grantor trusts are a well-timed strategy even without the forgiveness of indebtedness gift component.
4. Don’t Make Gifts Beyond Your Comfort Zone
In order to “lock in” the increased lifetime exemption, you must use the entire $11,580,000 amount per person. If you were to make a gift of $6,000,000, for example, and the exemption amount subsequently decreases to that amount, you would be deemed to have used all of your exemption. Put differently, use of exemption is, unfortunately, not treated as coming “off the top” of the current amount. Before making gifts of great magnitude, however, it is best to consider carefully your cash flow needs and how the gift could impact you going forward.
We can insert safety values to help ensure that if your estate tax planning goes really well (i.e., you have substantially depleted your estate), you can, say, still draw a salary from your business for your services (while you are still working), stop paying the income taxes associated with gifted assets, and the like. But the best approach from the outset is to take care to refrain from making gifts that might jeopardize your lifestyle, not least in light of the unusual circumstances we currently face. Tax savings is merely a part of a larger discussion to be had around wealth transfer strategies.
You should revisit your estate plan, in general, from time to time, to consider how changes in law, the economy and your personal circumstances may impact your estate plan.