Category: Exemption Capture Planning

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Estate Planning Estate Tax Exemption Capture Planning Generation-Skipping Transfer (“GST”) Tax Gift Tax

Don’t Wait until Next Year to Make Your Gift!

Sean R. Weissbart —

Sean Weissbart's headshot photo

Any estate planning attorney will tell you that certain years stick out in their professional lives more than others. Here are some recent examples:

  • 2010: The year that estates of billionaires—including, most famously, New York Yankees owner George Steinbrenner—were administered without paying a penny of federal estate tax.
  • 2012: The year the affluent made gifts to capture gift tax exemptions—then, at $5.12 million—before a scheduled reduction to $1 million.
  • 2020: An election year where wealthy individuals feared record-high exemptions scheduled to remain in effect for five more years might abruptly be slashed with little notice.

In the final months of these years, scores of individuals emerged hoping to take advantage of tax benefits before it became too late. To accommodate, members of the trusts and estate community worked around the clock to finalize trust agreements, engage valuation companies, and draft documents transferring stock in closely held companies to irrevocable trusts. But many clients were frustrated when they learned that optimizing these tax benefits usually requires more than writing a check and signing a trust agreement, and can take well more than a month to craft and effectuate.

We expect 2025 to be another year for the estate planning record books. Absent legislative action, the federal estate, gift, and generation-skipping transfer (“GST”) tax exemptions—currently at $13,610,000 per individual—will be reduced by approximately one-half. Undoubtedly, scores of individuals sitting on the sidelines waiting to see if the tax laws will actually change this time, will emerge in the waning months of 2025 asking trusts and estates practitioners to help them capture these tax benefits.

Continue reading “Don’t Wait until Next Year to Make Your Gift!”
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Estate Planning Estate Tax Exemption Capture Planning Generation-Skipping Transfer (“GST”) Tax Gift Tax

Take Note: Significant 2024 Gift/Estate Tax Exemption Inflation Increases

Kyle G. Durante —

The New Year brought inflation adjustments to the federal and some states’ gift/estate tax exemption amounts, thereby increasing the amount individuals can gift during life and at death free of federal and state gift and estate tax. Given the significant 2024 inflation adjustments, particularly with respect to the federal gift/estate and generation-skipping transfer (“GST”) tax exemption amounts, the New Year presents a prime estate planning opportunity not only for those individuals who have not previously engaged in significant gifting, but also for those individuals who previously made gifts to capture their exemptions and who now have additional exemption available.

The Federal Gift, Estate, and GST Tax Exemption Amounts

Under current federal law, the federal gift/estate tax exemption amount (i.e., the basic exclusion amount) is an amount equal to $10,000,000, adjusted for inflation since 2017. In 2023, the federal gift/estate tax exemption amount was $12,920,000, which increased to $13,610,000 with the 2024 inflation adjustment (a $690,000 increase).

In addition, the federal generation-skipping transfer (“GST”) tax exemption amount is an amount that mirrors the basic exclusion amount. Accordingly, the federal GST tax exemption amount also increased from $12,920,000 to $13,610,000 as of January 1, 2024.

These amounts will continue to increase for inflation each year until December 31, 2025. Under current federal law, the increase in the federal basic exclusion amount is scheduled to automatically sunset on December 31, 2025, from $10,000,000 plus an inflation adjustment, to $5,000,000 plus an inflation adjustment. As such, on January 1, 2026, the exemption amounts are scheduled to be automatically slashed by approximately one-half.

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Estate Planning Exemption Capture Planning Generation-Skipping Transfer (“GST”) Tax

Proposed Resurrection of the Common Law Rule against Perpetuities—At Least for GST Tax Purposes

Kyle G. Durante —

There is one common law rule that haunts most law students, and many legal practitioners: “no interest is good unless it must vest, if at all, not later than twenty-one years after some life in being at the creation of the interest.” This rule, known as the rule against perpetuities, has many applications, but, most importantly, it limits the duration that an irrevocable trust may remain in existence. This rule was initially adopted in an effort to limit dead-hand control over property by requiring property to vest in a beneficiary within a certain period of time.

Generally, at common law, an irrevocable trust could remain in existence for a period of time not exceeding 21 years after the death of all members of a particular class of persons who were alive at the time the perpetuities period began. For an irrevocable trust, generally, the perpetuities period will begin on the date the trust was created. While some states, such as New York,[1] continue to follow the common law rule, a number of states, such as New Jersey, Pennsylvania, Delaware, and South Dakota,[2] have completely abrogated the rule, while others have extended the period of time that an irrevocable trust may remain in existence, such as Connecticut (which applies an 800 year period in gross) and Florida (which applies a 1,000 year period in gross).

Continue reading “Proposed Resurrection of the Common Law Rule against Perpetuities—At Least for GST Tax Purposes”
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Estate Planning Estate Tax Exemption Capture Planning Gift Tax

IRC Section 2701 and Gifts of Carried Interests

James R. O’Neill —

The transfer in the course of estate planning of a fund manager’s carried interest early in the life of a fund (when the carried interest has a modest value) can be an attractive way in which to remove anticipated future appreciation from the manager’s estate at a nominal gift tax cost. However, any transfer of a carried interest could be subject to the special valuation rules of Internal Revenue Code (“IRC”) Section 2701 and result in an unexpected deemed gift and substantial gift tax liability. If the entire carried interest is transferred, the capital interest in the fund retained by the manager may be valued at zero for gift tax purposes under Section 2701, and the manager may be deemed to have made a gift of his entire interest in the fund, including his capital interest, rather than just the carried interest.

One way to achieve the desired estate planning result and avoid the applicability of Section 2701 is the sale of a derivative, based on the performance of the manager’s carried interest, rather than a transfer of the carried interest itself. Typically, the sale would be made to an intentionally defective grantor trust (also simply known as a “grantor trust”) for the benefit of family members. The use of a derivative contract to transfer the value of the carried interest does not require the actual transfer of the carried interest itself, thereby avoiding the applicability of Section 2701. Under this approach, the manager enters into a derivative contract with the trust agreeing to pay the trust at a future settlement date, usually set near the end of the fund’s life, the fair market value of the carried interest on the settlement date. For more aggressive planning, the payment may be set in the derivative contract as a multiple of the value of the carried interest on the settlement date. The derivative contract also can be structured so that the payment is required only after the carried interest has exceeded a certain total return, using a hurdle amount. For its part, the trust pays to the manager upon execution of the derivative contract the present value of the trust’s right to receive the future payment on the settlement date. That present value is determined by an appraisal of the trust’s future right (at current fair market value) upon execution of the derivative contract, which is generally significantly less than what the trust will actually receive upon the settlement date.

For example, if the present value of the trust’s right to receive the future payment based on the carried interest is appraised currently at $500,000, the trust pays the manager that amount upon execution of the derivative contract. If the value of that carried interest is five million dollars at the future settlement date, the manager pays to the trust that five million dollars on the settlement date at conclusion of the term of the derivative contract. A gift tax return is filed to report the sale to the trust (and a zero-dollar gift) of the appraised value of the derivative based on the carried interest to start the running of the statute of limitations for the Internal Revenue Service to audit the gift tax return. Given that the derivative was sold to the trust and there is no reportable gift value, there are no gift tax consequences associated with the sale.

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Estate Planning Estate Tax Exemption Capture Planning Gift Tax Income Tax

Irrevocable Trusts: Who Is the Taxpayer?

Kyle G. Durante —

In establishing and funding an irrevocable trust, a common question is who is responsible for the income tax liabilities associated with the trust? Many individuals assume that the trust is a separate and independent taxpayer, requiring the trustees to file income tax returns for the trust. However, that is not always the case.

Irrevocable trusts are either classified as “grantor trusts” or “non-grantor trusts.” When an irrevocable trust is classified as a grantor trust, the trust is treated as identical to the settlor or the donor, requiring the settlor to report all matters of income and deduction with respect to the trust on his or her own individual income tax returns. When an irrevocable trust is classified as a non-grantor trust, the trust is deemed to be a separate taxpayer, requiring the trustees to file annual income tax returns for the trust (known as fiduciary income tax returns) reporting all matters of income and deduction with respect to the trust.

Generally, whether an irrevocable trust will be classified as a grantor or non-grantor trust depends on certain powers that may have been retained by the settlor with respect to the trust, who are the beneficiaries of the trust, and certain provisions in the trust. For instance, if the settlor retained the power of substitution (also known as a swap power), if the trustees have the power to use trust income to pay premiums on a life insurance policy insuring the life of the settlor or if the settlor’s spouse is a permissible beneficiary of the income of the trust, the irrevocable trust will be deemed to be a grantor trust. As a general rule, although not always the case, an irrevocable life insurance trust (holding a life insurance policy insuring the life of the settlor) or a spousal lifetime access trust (“SLAT”) will almost always be deemed a grantor trust during the settlor’s lifetime.

At first blush, a grantor trust may be seen as a harmful result given that the settlor is transferring property to an irrevocable trust (of which the settlor is generally not a beneficiary and no longer has access to the property) but the settlor remains liable for the income tax bill. However, establishing an irrevocable trust as a grantor trust can have significant transfer tax benefits. By establishing a grantor trust, each year the settlor will report and pay any associated income tax liabilities with respect to the trust. Under current law, the payment of tax liabilities that would otherwise be paid by the trust is, in essence, a tax-free gift to the trust each year. As such, the payment of the trust’s tax liabilities by the settlor will permit the settlor to further deplete the assets in his or her own name (that will be subject to estate tax at his or her death) without using any of the settlor’s gift/estate tax exemption.

With respect to grantor trusts, of course, once the settlor dies, the trust will generally cease to be a grantor trust and convert to a non-grantor trust. It may also, however, be possible to convert the trust from a grantor trust to a non-grantor trust, and vice versa, during the settlor’s lifetime, if that would be desirable.

Irrevocable trusts are further subclassified under the Internal Revenue Code as either foreign or domestic trusts. As a general rule, domestic trusts are subject to U.S. income tax on their world-wide income, while foreign trusts are subject to U.S. income tax on only their U.S.-sourced income. The implications of each such classification and the tests to determine such classifications will be addressed in an upcoming cross-border estate planning series.

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