The possibility of paying up to 40% in estate taxes has many people contacting their estate planning attorneys to figure out how to avoid losing much of their estate to taxes. According to a recent article titled “An Alternative to Gifting For Estate Planning Exemptions” from Financial Advisor, there are a number of strategies to use, including using life insurance to pay estate tax.
These include using Spousal Limited Access Trusts (SLATs) so couples can gift significant assets to each other and still have access to the assets during their lifetime. Another is by making gifts to heirs who would otherwise receive them after their family member passes. However, the choices aren’t always desirable.
Gifting large amounts like $14 million is a lot of money to gift during one’s lifetime. If the asset gifted is securities, capital gains taxes may need to be paid. Suppose a taxpayer makes a $10 million gift of securities in 2024. They have passed $3.5 million and saved $1.4 million in estate taxes. However, if the transferees’ income tax basis in the $10 million of gifted securities is $4 million, and if the combined net capital gains tax rate, plus net investment income tax and state income tax is on the $6 million in appreciation, the built-in capital gains tax on the gifted securities would be $1.4 million.
Every gift of securities or business interest carries a certain amount of capital gains tax liability to be considered. If the taxpayer holds the assets until they die, the heirs get a step-up in basis, which they won’t get with a gift.
It’s impossible to know whether or not these tax exemption thresholds will be extended, which is why many taxpayers are confused about what to do. If a large transfer is made, then the tax exemptions remain high. Has the taxpayer put themselves in an unworkable situation?
An alternative to consider is life insurance. If a couple can purchase life insurance, they can purchase a second-to-die life insurance policy owned inside an irrevocable life insurance trust. If the premium is covered under the “Crummey powers,” which allow the money to not count against the estate and gift tax exemption, the proceeds of the second-to-die life insurance policy will be income and estate tax-free.
Will the numbers work? To see if it is a good option, each couple or individual will need to do a careful analysis of the premium cost, the expected time they will pay policies and the impact of gifting.
While each circumstance is different, discuss this with your estate planning attorney, accountant, and financial advisor. Giving up full access and control of assets may not be necessary to avoid the estate tax. Alternatives should be considered before making any significant estate planning moves.
Reference: Financial Advisor (July 24, 2024) “An Alternative to Gifting For Estate Planning Exemptions”
