ESTATE PLANNING usually less than estate tax on the full asset.
These tools must be approached with caution and are best suited when estate liquidity is needed but lifetime gifting capacity is low.
Under Section 675( 4)( C) of the Internal Revenue Code, a client can also use an irrevocable trust that is treated as a completed gift for gift tax purposes but as a grantor trust for income tax purposes. This means that whatever is in the trust is excluded from the client’ s estate but the trust can include terms which allow the grantor to swap assets of equal value into it. Before the client dies, lowbasis assets can be swapped back into an estate to ensure that there’ s a step-up in basis, and that allows heirs to avoid a capital gains tax on assets whose value is highly appreciated. Take, for example, a client who owns $ 1 million in Treasury notes and $ 1 million of stock with a basis of $ 100,000 in an irrevocable trust. The client can swap the $ 1 million of Treasury bonds, which have a cost basis nearly equal to the fair market value, for the stock. At the client’ s death, the stock gets stepped up to a $ 1 million basis for income tax purposes.
This is a nuanced but potent way to reduce future income tax liability while keeping what’ s included in an estate tightly managed. The substitution powers— when properly drafted— mean highly appreciated assets are not included in an estate.
During a downturn, families can also form a family limited partnership or family limited liability companies and transfer assets into them.
When such assets are transferred, it’ s easier to defend valuation discounts since a grantor lacks control and marketability. Court decisions have supported significant discounts even for the fractional ownership of artwork( though it should be noted that artwork and collectibles are not discounted for the lack of owner control or marketability, but rather discounted on the basis of their illiquidity and on the basis of a bulk transfer, since the value assumes all of the artwork and collectibles were sold on the date the owner dies).
But care must be taken to avoid what’ s called a“ 2036 inclusion,” referring to that part of the Internal Revenue Code that says a grantor must include an asset in their estate if they are controlling and benefiting from it( for instance, living in a condo that they have tried to transfer out of their control for estate purposes).
Roth IRA conversions also allow clients to take advantage of lower asset values during downturns. When assets have depreciated, it takes less in taxes to convert them into Roths, and that reduces a client’ s taxable estate by the amount of additional income tax paid on the conversion— while converting tax-deferred cording to a person’ s income tax objectives. Non-grantor CLATs, meanwhile( in which the trust is the owner of the assets) can be structured according to a person’ s estate tax objectives. But both serve to maximize a family’ s benefit amid a market recovery.
If liquidity will be important to survivors such as widows when a client dies, then the client can take advantage of premium-financed life insurance placed inside a spousal lifetime access trust or an irrevocable life insurance trust, which will pay large death benefits without requiring large up-front gifts. Banks lend the premiums in these cases, which are
Depressed asset values and low interest rates open the door to a range of powerful strategies that can transfer substantial wealth to future generations at a reduced tax cost.
ordinary income that you must withdraw eventually into tax-free income that you do not have to withdraw during your lifetime.
For example, a $ 10 million IRA that drops to $ 6 million can be converted now from the IRA itself with only $ 2 million in taxes paid. If the resulting $ 4 million account rebounds to $ 10 million, you have access to $ 6 million in tax-free growth, as will the beneficiaries you designate to inherit that Roth, though the value of the Roth at the date of your death is still included in your estate.
Ultra-wealthy donors, meanwhile, often turn to charitable lead annuity trusts( CLATs), which allow them to lock in large charitable deductions for either income tax or estate tax purposes and pass residual growth to family at minimal or zero gift-tax rates( when structured to pay out at Section 7520 interest rates). This strategy is particularly potent when funding family foundations or donor-advised funds or when the client wants to meet multiyear philanthropic pledges during an economic contraction. Grantor CLATs can be structured ac- collateralized by the policies. The trusts then repay via a death benefit or some other future liquidity event. The result is a net estate reduction with minimal outof-pocket cost, as long as interest rates remain manageable.
Court rulings have upheld these sophisticated insurance structures when formalities are followed.
Plan Boldly, But Plan Carefully
Volatile markets favor the well-prepared. For ultra-wealthy clients, these economic cycles offer some of the most tax-efficient opportunities to transfer wealth, lock in appreciation and secure legacy plans. But the execution matters: The strategies outlined here demand precision, documentation and rigorous compliance with tax law and case precedent.
A seasoned estate planner, working with valuation experts, CPAs and fiduciaries, can ensure that downturns become defining moments in the family’ s generational wealth strategy— and not missed opportunities.
MATTHEW ERSKINE is a managing partner at law firm Erskine & Erskine.
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