Category: Gift Tax

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Business Succession Estate Planning Generation-Skipping Transfer (“GST”) Tax Gift Tax Income Tax

Estate Planning for the Business Owner Series, Part 2: Valuing the Business

Andrew J. Haas —

The value of an asset at the time of a transfer is the key component to the United States’ transfer tax system. Gratuitous transfers during lifetime are considered gifts, while transfers as a result of the death of the owner are included in the value of the decedent’s estate. Some assets are easy to value: marketable securities have a value based on the mean of the high and low on the public exchange on the applicable date where they are listed, while the value of cash is equal to the total amount transferred. Valuing an interest in a closely held business is much more complex. When an estate planner has initial discussions with a client and invariably asks how much their business is worth, the client may give you a number based entirely on speculation, or perhaps they are using “book value,” a multiple of the business’ EBITDA (i.e., earnings before interest, taxes, depreciation, and amortization), a value used in a recent loan application, or even the value used for equity as compensation (a “409A” value). None of these values are “adequate” for purposes of determining the value of the business at the time of a transfer for estate planning purposes, and none of these “values” can be used to substantiate the value of a transfer on a Federal Gift or Estate Tax Return.

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Business Succession Estate Planning Generation-Skipping Transfer (“GST”) Tax Gift Tax Income Tax

Estate Planning for the Business Owner, Part 1: The Business Owner as a New Client

Andrew J. Haas —

For most business owners, the business is the most valuable item on their balance sheet. From an estate planning perspective, the equity in the business is also often the best asset to use for lifetime transfers to pass value (and future appreciation) out of the taxable estate. Before an estate planner can effectively provide guidance on the planning opportunities for the business, he or she will need some background information about the business. This data gathering does not need to be all-encompassing, but a good estate planner will want to know as much information about the business as possible since it is often closely intertwined with the client. Some information can be gathered through the business owner’s other professionals, such as separate business legal counsel, internal executives, accountants, and financial advisers, and it is important to have an open communication among the estate planner and these professionals as early on in the process as possible.

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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.

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Estate Planning Gift Tax Trust Administration

Is CCA 202352018 the Death of Irrevocable Trust Decantings?

Kyle G. Durante —

For years, practitioners have freely used irrevocable trust decantings as a means to make various changes to irrevocable trusts without concern of giving rise to gift tax consequences. However, the Internal Revenue Service’s (“IRS”) Chief Counsel Advice Memorandum (CCA 202352018) (the “CCA”) may be the death to irrevocable trust decantings as we know them.

The term “irrevocable trust” is somewhat of a misnomer—there are mechanisms by which irrevocable trusts can be modified in certain respects. Generally, irrevocable trusts can be modified in one of two ways depending on applicable state law: (i) some states, such as New Jersey, Pennsylvania, and Connecticut, permit an irrevocable trust to be modified with the consent of the beneficiaries and the trustee (some states also require the consent of the settlor if he or she is then living), which is typically referred to as a “non-judicial modification;” and (ii) some states, such as New York, Delaware, and Florida, permit an irrevocable trust to be modified by a decanting, which is a process by which an authorized trustee exercises his or her independent discretion to pay over the property of the trust to a new trust that has different terms.

For years, practitioners have been concerned that using a non-judicial modification to make certain changes with the consent of the beneficiaries (such as removing a beneficiary, shifting beneficial interests, or diluting a beneficiary’s interest), may be deemed to be a taxable gift by the beneficiaries. However, this concern was not present with respect to decantings since a decanting is effectuated by the independent act of an authorized trustee, who does not have a beneficial interest in the trust, without the consent of the beneficiaries. That was, until the CCA.

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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 Estate Tax Gift Tax

Increasing the Available Gift and Estate Tax Exemption for a Surviving Spouse

James R. O’Neill —

In planning for the estate of a surviving spouse, the availability of the unused gift and estate tax exemption of his or her deceased spouse can be important, and particularly so with the impending reduction of the exemption. The federal gift and estate tax exemption, which was doubled pursuant to the 2017 Tax Cut and Jobs Act and presently stands at $12,920,000, is scheduled to be automatically reduced by approximately one-half on January 1, 2026.[1] The exemption is portable between spouses allowing for use by the surviving spouse of any unused exemption of the deceased spouse. This portability arises under IRC Section 2010(c)(5)(A), which provides that a deceased spousal unused exclusion (“DSUE”) amount becomes available for use with a surviving spouse’s subsequent transfers during life and at death, but only if the executor of the first-to-die’s estate timely files Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return (“Form 706”). The due date of a Form 706 required to elect portability is the date which is nine months after the decedent’s death, or the last day of the period covered by an extension, which may be obtained for six additional months. The so-called DSUE election is automatically made by timely filing a Form 706 unless the executor affirmatively opts out as permitted on the return. The portability election, once made, becomes irrevocable once the due date of the Form 706, including extensions granted, has expired.

An executor may file a Form 706 for the estate of any U.S. citizen or resident, but the executor is only required to file a Form 706 under IRC Section 6018(a) if the value of the gross estate, plus adjusted taxable gifts, exceeds the exemption amount for the year of death. Given the effort and expense of preparing a Form 706 when not otherwise required, particularly when the assets of the surviving spouse are not expected to exceed the current exemption amount, a Form 706 is often not filed when the first spouse dies, resulting in the deceased spouse’s unused exemption being unavailable to the surviving spouse. With the scheduled reduction of the exemption after 2025, it may, in many cases, be important to recover that unused exemption of the deceased spouse for use by the surviving spouse.

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Estate Planning Estate Tax Gift Tax Income Tax Litigation

A Promise Is a Promise: The Enforceability of Charitable Pledges under New York Law

Haley B. Bybee —

Charitable contributions are often utilized in estate planning to assist a client not only in supporting his or her favorite charities but also to reduce tax liabilities both during life and at death. However, before clients agree to make any charitable contributions, they should understand that the agreements between themselves and charitable organizations, such as pledge agreements, can be binding.

Historically, New York courts have favored enforcing charitable pledges as a matter of public policy and in doing so, courts have relied on three common law contract law theories: (1) unilateral contract, (2) bilateral contract, and (3) promissory estoppel.[1]

Courts have most frequently relied on the theory of unilateral contract to enforce charitable pledges.[2] Under that theory, a charitable pledge or promise to make a future gift constitutes a unilateral offer, and “when accepted by the donee charity by the incurring of liability or detriment . . . [the offer] ripens into a binding contractual obligation of the donor and [is] enforceable against him.”[3] There have been numerous cases in which a donor’s promise to make a charitable contribution has been enforced on this ground.

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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 —

James O'Neill's headshot photo

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.