Cartoon of arm labeled "government" taking bag of money from man

Estate Taxes and Your Lifetime Exemption: Use it or Lose it?

Author

Bruce Brugler

Date

February 2019

Wealthy families with a desire to transfer significant wealth to future generations should act swiftly as there is real risk that their ability to do so will be materially reduced in the future.

There has never been a greater opportunity to transfer wealth to future generations than there is today. The 2018 tax reform legislation doubled the amount that an individual can transfer in their lifetime, allowing a married couple to transfer $22.8 million free of gift or estate taxes in 2019. With some creative planning and/or by gifting assets that will appreciate in value, the actual amount that could be transferred using this exemption might be far more than this amount.

Appropriately, many families have taken advantage of this opportunity by accelerating inter-generational giving. Families in highly taxed states (whose effective tax rates went up significantly in 2018) have also increased their use of structures that move assets to jurisdictions with far friendlier tax environments (see here for an earlier post I’d written on this). However, many families with a desire to transfer wealth have yet to act - we strongly urge them to consider doing so as it may become much more costly in the future.

What are the risks of waiting? The first is simple: the increase of the lifetime exemption is only a temporary one and is scheduled to expire in 2025, reverting to where it was (plus an inflation adjustment). The IRS has already issued guidance that wealth transfer that is made prior to the expiration of the increased limit cannot be “clawed back” even if the existing exemption at the time of death is less than what was in effect when the transfer was made.

Beyond that, the increased exemption is a highly political issue that is susceptible to a change in political power and will. It’s entirely possible that a new administration and/or congress could lead to legislation that reduces the exemption well prior to 2025. With a hotly contested presidential election in 2020 there is a real possibility that the timeframe to use the increased exemption will be shorter than advertised.

There is real risk that both the lifetime exemption will be significantly reduced and estate tax significantly higher in the near future. Listed below are the current proposals of several candidates with a realistic shot at winning the White House in 2020:

Elizabeth Warren: Reduce the lifetime exemption to $3.5 million and increase the estate tax from 40% to 55% on the amount over this exemption. Also impose annual wealth tax of 2% of wealth over $50 million and 3% over $1 billion.

Bernie Sanders: Reduce lifetime exemption to $3.5 million, increase estate tax to a minimum of 45% and maximum of 77%.

Cory Booker: Reduce lifetime exemption to $3.5 million, increase estate tax to a minimum of 45% and maximum of 65%, repeal stepped-up basis (making effective tax rate far higher).

Regardless of one’s political beliefs it is impossible to ignore the real possibility that the estate tax laws will be similar to the proposals above in as little as two years.

Let’s use a simple example for a family with a net worth of $50 million.

  • Under current law (and not using strategies to lever gifting above the stated limits) upon their death $22.8 million would pass free of tax and the remainder taxed at 40%. Their descendants would thus receive $39.1 million after estate taxes of $10.9 million.
  • Assuming a $3.5 million exemption ($7 million per couple) and 55% rate, their descendants would receive only $26.3 million after estate taxes of $23.7 million, a reduction of wealth transfer of some 33%.

Given this, families with significant wealth should consider acting soon to preserve their wealth:

  • Accelerate wealth transfer to ensure it is completed before the lifetime exemption drops. Note that there are many ways to transfer wealth to future generations without giving up control of the underlying assets, a major consideration for many who want to move wealth but fear losing control.
  • Consider moving assets to tax-friendly jurisdictions. For residents of highly taxed states like California (13.3% highest marginal rate), moving assets to states like Delaware may allow the deferral or elimination of state taxes.
  • Alter your estate plan to favor charity over estate taxes. Families with limited desire to transfer wealth typically still prefer to determine the ultimate use of their hard-earned wealth rather than to simply pay additional taxes. By directing estate assets to charity they avoid estate taxes ensure that their assets are directed to purposes that they support. Using private foundations or donor advised funds to keep charitable assets in the control of their family is actually a manner of wealth transfer in itself.

Bruce Brugler is a Managing Director of Tiedemann Advisors LLC. Tiedemann Advisors is an investment advisor. Investors should consult with their financial, tax and legal advisors before investing in any investments or trust arrangements. The information presented herein is intended as an illustration of the services offered by Tiedemann and such services may not be suitable for all individuals. The information is not intended to be, nor should it be construed or used as, investment, tax, accounting, legal or financial advice. Any information that may be considered advice concerning a federal tax issue is not intended to be used, and cannot be used, for the purposes of (i) avoiding penalties imposed under the United States Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter discussed herein. This is for information purposes only and is not a solicitation to buy or sell any specific investment. For more information go to www.tiedemannadvisors.com

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