March 2024
- The estate tax exemption as of today is $13.6 million per individual, meaning estates valued over this amount are subject to estate tax. This amount is expected to be cut in half to about $7 million at the end of 2025.
- Using entities like Family Limited Partnerships(FLPs) or Limited Liability Companies (LLCs) for estate planning can lead to discounted valuations of transferred assets, potentially reducing estate taxes.
- The strategy of holding onto high-appreciation assets to benefit from a step-up in basis at death is discussed, highlighting the trade-off between avoiding capital gains tax and potential estate taxes.
- Real estate presents unique challenges in estate planning, including issues with leverage (loans), depreciation recapture, and property tax reassessment.
- Brian and Chris stress the importance of careful planning and timing when gifting assets to ensure that the chosen strategies align with the individuals' overall financial goals and estate planning objectives.
Watch previous episodes here:
Ep. 76 March Economic Highs & Lows: Should Investors Worry?
Ep. 75 8 Ways to Reduce Your Taxes in 2024
Hello, everybody. And thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host Chris Galeski, joined by wealth planner Brian Standing. Brian, thank you for joining us.
You're welcome.
Death and taxes. It's that time of year. March of 2024.
It's kind of always that time of year.
Yeah. It's the only two things that are certain in life, I guess.
You made me get dressed up and put on an actual jacket for today because I... I couldn't sit next to you, and I did not look professional. I did, too. We're here to talk about estate planning. Basic concepts. Those. You should be thinking about it. But the main reason is, is because in about 21 months, the estate planning rules or laws or limits are set to change.
And people shouldn't just wake up 20 months from now and say, I want to make some decision.
This is true. I think spoiler alert also, the IRS wants to collect money. The government needs money. And this is one way to do it. Right? Right. Is to tax people when they pass away. Right. I'm not going to take a position on that. You're welcome to have yours. But that's the world we live in.
But, you know, we're going to get into some estate planning concepts. Who should be thinking about it? Decisions that used to be made that you should be making things to consider. But the reason why you're here is a couple of reasons. Number one, you've been a practicing estate planning attorney for a long time, and we've had a very close relationship as our firms and giving advice for clients.
But you are also a wealth planner here, an employee at Morton. So you're able to kind of sit along the same side of the table with us as advisors and the clients, be able to look at the overall values of estates, see how they're projecting long term, understand what the impacts would be of giving a piece of their estate away into an irrevocable trust or a different entity would affect somebody.
So that way you can go work with their estate planning attorney or if they don't have one, your law firm, Via Law can can take advantage of that and execute for those clients.
Yeah, that's exactly right. I think one of the really rewarding parts of the wealth planning role and Morton is that the estate tax planning conversation it really starts in a much more personal environment. We're not throwing a bunch of like alphabet soup of strategies on the wall and saying like, you could do this or you could do this because who knows?
It generally starts when you're talking with your wealth advisor and you're talking about values around money. You don't just give your kids millions of dollars. Well, most people don't. They structure it thoughtfully. And so it's in that context where you're talking about values around money. What does our estate look like? Do we care about taxes? Do we care about, you know, the next generation after that or a charitable endeavors or who knows, you know, And in that conversation, we can sort of determine right up front whether estate tax planning even makes any sense, because we can talk about the concepts, maybe some of the drawbacks or risks that you run and before you're ever sitting in an attorney's office again, no offense to great estate attorneys, you now know what you're going into and you're not in the attorney's office, starting with like values around money, right? You're ready to, like, get down to business.
Yeah. Especially if you're paying hundreds of dollars, if not thousands of dollars an hour for those conversations. Should be thoughtful. So today we're not talking necessarily about who needs an estate plan because everyone has one, whether they had it drafted by a state attorney or not. There are rules that are in place. All right. Today, we're going to focus more on who should be thinking about having an estate tax planning conversation or what are the things to consider... what should be thinking about?
And that's the conversation for today.
It is.
So let's start there. Who should be thinking about having an estate tax plan?
So currently, admittedly a small portion, hopefully many of your listeners have aspirations to become in this group of people who need estate tax planning. But as you mentioned at the start, we have exemptions right now which say that if you're over a certain net worth when you pass away, this is worldwide assets. If you are a resident here, then you pay estate tax.
That number is 13.6 million per person. Right. So we're over 27 million for a couple.
So if so, if my estate is worth 14 million and it's 13.6, right. So that $400,000 that's over, that 13.6, that 400,000 is going to be subject to some estate.
Yes. Some 40% tax, something like that.
That's all. Just 40%.
Just 40%. You know, and California does not have an estate tax, to be clear. We have a lot of other taxes. Yeah, but we don't have that one.
And so people that have an estate as either as an individual or a married couple, that's north of 13.6 or 27.2 million, they should be thinking about having an estate tax planning conversation.
They should. But now we bring in this, you know, quote, deadline, which is what's going to happen at the end of 2025. So a little less than two years. And that is that the amount that you can have will be effectively cut in half. And because this number changes with inflation, it's not exactly clear what that would be.
But let's say it would be 14 million. Then it will go down to seven per person starting January one of 2026. And there are quite a few more families who are between, you know, 14 and 27, then 27 plus. So that does capture a much larger group of individuals who need to be thoughtful about planning, because right now today, they're not taxable and that's great.
And if they do nothing and of course, we hope they do live two more years, all of a sudden their estate is taxable when this law expires, you know, subject to an extension. And I don't know if you're interested or people will be interested in any comments on whether it will be extended.
I mean, look, it is in an election year and the estate tax laws have changed somewhere in the neighborhood of seven or eight times over the last 20 years, I believe. So it's a number that changes a lot. Yeah. And it's going to be in the headlines likely more over the next 20 months.
Exactly right. And I mean, just as a we can just briefly note that the only way it gets extended because it automatically reverts back, this is built into the law is if a new law is passed and it's generally part of the budget for technical reasons, you don't need more than 60 votes in the Senate, which is filibuster proof if it's part of the budget.
So as long as you can justify it as a budget thing, you can force it into the 50 votes only rule. So that's why these things only last nine years, because it has to be neutral after ten years to go in the budget. So then it reverts back before the end. So all that being said, the only way we get a new law and an extension of a higher exemption is if they voted in, which is very likely to be only if you find Republican House, Republican Senate, Republican president.
Right. And so I think people should be planning that that, you know, just in case those for people who want fewer taxes, that those stars don't align. Right. And at least be prepared for what you would want to do in the event of the exemption going back down. And so that might lead us in that to take your role here into, well, what is what does that even mean?
And in running the financial planning analysis and the projections to see can you afford to remove assets from your estate? Because if you remove them, you might have some control or decision making, but you lose assets to income and other things and we'll get into that. But the current estate tax rules, let's call it 13.6 million per person, that's set to revert back or get cut in half in about 20 months, December of 2025. If you're leaving assets to a spouse, you can leave unlimited.
Estate taxes apply when assets are left to beneficiaries at death who are not a spouse, a US citizen spouse and not charity. Not charity. Right. And so basically, if you're leaving it to children, other beneficiaries over the limit, that's when estate taxes come in. Now, eventually with the spouse, they'll get estate taxes when he or she passes away.
It's just a delay. Yeah, right. You just tell the IRS like, no, we're not going to pay you now. We'll pay you later. So so that's important just to have the context, which maybe we'll probably get back into when we talk about who needs to do estate tax planning. It really depends on your estate plan. Right within the assets, too.
Right. So the the important thing I think that we should mention about this deadline is just the way the estate and gift taxation rules work. Just so we have a foundation before going on. Right. So the way to think about this 13.6 million or 7 million or whatever it is, it's a transfer exemption.
It's just the amount you can give to anyone else that will not be subject to tax. And the reason for that, that it's a transfer exemption is that if you keep it, it obviously is taxed when you're gone.
It's part of your estate.
Yeah. And so if you tried to give it away while you're living, they have to keep track of that because everyone would just give things away while they're alive and there would never be estate tax. Yeah. So that's why there is a gift tax exemption as well. Was a gift tax on the exemption. So just I mean, to make it easy, you give 2 million to your kids, a million each to buy a house.
There's no tax to pay, but you file a return and you tell the IRS, hey, IRS, I use 2 million of my 13.6. I've got 11.6 left now. And when the exemption goes down to seven, you start with seven, you've used two, you're at five. So that's the sort of game theory behind using this is that when it reverts back to seven, for example, if you haven't used more than seven, you haven't really utilized, you haven't...
really taken...
advantage of the extended exemption. Right. Just to be clear. So we kind of have the ground rules. I'm like, what? What are we even talking about with this gifting estate tax stuff?
Understood. And by being able to give it away, it can go into a structure and then it passes to the next generation estate tax free. Tell us a little bit more about that.
Yeah, so there's just... I guess it's nice to sort of round out all of our taxes. And again, because they're transfer taxes, what they're trying to do is get money at every generation. Right? So every time someone dies, they take a little piece by piece, depending on your definition of those words. Right. And so that means that there's an estate tax
if you die. It means there's a gift tax if you try to give it away before you die. It also means that if you were to give assets to the next generation, straight to grandchildren, there's like a third potential taxation, you know, rule that comes into play called a generation skipping tax that says, wait a minute, not only are it's not going to get taxed when you die, now we miss the kids’ generation, so we're going to simulate that tax, too.
So it's 40% and then 40 more percent on top of that. And then finally, the gift goes to the grandchildren. Now there's an exemption 13.6 million. But just conceptually speaking, what we're trying to do is if we're doing estate tax planning, reduced assets that will be subject to taxes at death and keep assets out of the next generation's estate as well so they can grow their own 13.6 or whatever it is, without inherited assets being added to it.
Right. With special trust structures and things like that.
And so because the complexity of our tax code and the estate tax keeps me employed.
But that's why it's important to be able to be able to do two things right, identify what it is you're trying to accomplish, the values that you have around money, understand the projections where you are at life and what you need in order to get the most life out of your wealth. And then you can go into making some decisions.
So what are some before we get into strategies and other concepts, what are some other things that we should understand when we're looking at making some of these gifts? I mean, what are we really doing?
Clients come in and they they'll say something like, Well, I'll just put the buildings in my kids names. Yeah. So cool. You know, we'll file a gift tax return and they'll own it. Yeah. They said, Okay, well, do you need the income? And they said, we are not going to keep living off the income to be in their names.
Yeah. And the IRS says, okay, well you haven't done anything right.
You're still benefiting from the income, you haven't really given this away. And so it's not really a gift.
Yes. They're very much a substance over form thing with the IRS. Right. Has the substance of whatever the, you know, economic entity is. Has that changed? And so if you are giving something away but you're still getting the income, the IRS says you haven't really given it away.
Unless maybe you give up control even then...
Yeah. So there are multiple things that need to be given up. Initially it is the income itself. Now again, this is on a gift of assets. You know, there are other strategies maybe we can touch on and then in future episodes dive a little deeper. Right? But conceptually speaking, a gift is a gift. When you give away an asset, you give away its economic benefits, right?
You don't get to have those anymore. That's part of the gift.
Seem fair.
Yeah, that's right. So that's one issue. The second issue is, well, I, I don't need the income, but I really want to be doling out the money to my kids right. Well, that's not different enough from having that money go into your bank account and just giving them money when you want to put it in this new trust.
But you're in charge and you decide if and when the kids get money. The IRS says that you've retained still too much control, you know, So you have to consider both of those giving up the income and giving up the right to control where the income goes, at least in order to change it. Right. So you can set the rules upfront.
It's all discretionary. My trustee decides if and when my kids receive distributions, you're just not going to be that distribution trustee, that person in charge of when they get it could be a friend. They'll probably listen to you. If you take your call.
Sometimes you see friends, you know, work together in this and you hear complex structures like Family Limited partnerships and LLCs and different types of structures. And we're not going to get into the strategy behind those. And this happens, but...
But they typically use those structures so that way they they get a discounted value. So if they put $10 million into a family limited partnership that they're a small owner in and they don't have as much control or they they give up more control over time for estate tax gifting purposes, that entity is not valued at $10 million.
It's maybe diluted seven and a half or eight or even potentially six and a half, something like that. So the reason why those structures exist and you're adding in layers of complexity is to be able to discount the overall value of your estate so you can give more assets away.
Yeah, yeah, this is an important concept. The structure itself isn't the strategy, it's sort of leverage, is it, or sort of like turbo charge is the strategy. Right. So what you want to do is either with your gifting or if you own something at death, you want to own potentially a discount of all interest. Yeah, right.
So that it's not valued as high for estate tax purposes and these...
Are these strategies that are meant to be deployed for people that are going to be subject to estate taxes. So net worth north of call it, $27 million.
You technically... you wouldn't want this if you're not subject to estate tax, right? Because you want the highest valuation possible. You want a new basic cost when you pass away so that you can sell without capital gain. So that's a separate concept. So conceptually speaking, the idea here is, well, if I give an interest in, let's say this $10 million building, but instead it's some kind of limited interest, a nonvoting LLC interest or a limited partner interest and you give away, you know, 5 million of that.
It's not worth 5 million, as you said, because they can't vote, they don't have control, they can't...
Go get it, raise their hand and say, give me all the money. Right, Right. Yeah.
And so you intentionally create the structures for the purpose of future gifting, future sales or just passing away owning a discount with interest through this entity type.
So a lot of people like to give away real estate, like what are the pitfalls and risks like with gifting and real estate itself?
Yeah. So this is the one where we have the, the most sort of diligence required upfront because we find that a lot of people, especially in California, their net worth is tied up with real estate. All right. It makes sense if they've held it a long time. And they also believe that it is an asset that will continue to appreciate sort of in dollar terms.
Right. So from an estate tax standpoint, that's a good asset to give because you want to give things away that will go up in value because one of the other things maybe foundationally that I'll just mention is the discount obviously allows you to give something away right away at a lower value. The second sort of fundamental benefit of gifting now versus later is future appreciation, right?
If you gift $1,000,000 now and you live another 30 years, that's going to be much larger. If you kept that million and passed away, it's still in your estate.
And so you used a million of your estate exemption, but it grew to ten or 15. And your beneficiaries are benefiting from that gift and the appreciation.
So even if the estate exemption does not change, if you feel comfortable giving things away, sooner is better than later just for the appreciation after the gift, you know. So back to the real estate question. For those reasons, that's a good asset to give away. For a lot of other reasons, it becomes a struggle. Number one, leverage. People have loans.
Well, those loans say that you are the borrower. If you don't own that property anymore, the loan is due. They're going to find out. So we're not going to play the game of like keep paying the mortgage. You're going to have to go get new insurance because now an irrevocable trust owns the building. Tenants is going to check with the lender.
You're not going to hide this, right? So unless you're planning to get potentially refinancing with an irrevocable trust, which won't be at good rates and is sometimes challenging to begin with, you might have to shift debt around to have encumbrance free property to give in right in the first place. So we always want to know that the second problem is there sometimes and I've seen this many times taxes to pay on a gift because you have a building that you've depreciated, you've basically gotten value out of it by saving taxes, depreciating this, and then you've leveraged it, you've taken out more cash tax free.
If you give that property away and you owe that debt, it counts as a sale. So you're taxed on the amount of your debt above that basis. But not to get too technical today, the point is it limits us.
And then finally in California, property tax reassessment.
This is the part that the people don't quite understand, but it's also a needle in the side. And it's also another reason why that that third generation of inheriting that piece of real estate sells it and takes the cash to do something else.
And again, these are detailed rules with, you know, entities and LLC, things like that. The point is that it used to be a little more friendly to transfers between parents and children. Those rules have been changed, you know, few years back. If you remember, that was a Prop 19 staffing. Yeah. So what it requires is one extra level of analysis.
If we transfer this building, how much can we transfer without a new property tax basis? If there is a new property tax basis, how much is it going to be? Who pays it? Is it triple net? Maybe the tenant pays it. I mean, where it's going to dump them, Right? A huge tax on them, but it's just another element.
And so when people get into this, they start to throw up their hands like, I don't even want to deal with this, but it's worth it if we put in the time. And it just means that real estate is challenging, too.
Well, we've seen examples where somebody owned an apartment building and they're collecting the rents and it's generating nice cash flow for them. But then when it transferred to that next generation and the property tax went up, the net income was not nearly as attractive because of that appreciation over the years. Maybe they, you know, bought an apartment building for two and a half million dollars many years ago.
It's worth 22 today. That's a big difference in property tax that you're going to pay. But we've talked about an awful lot of things.
So before we kind of wrap it up and kind of summarize some of the key points that we've made, is there any other any other key points that you thought would be beneficial?
I think we touched on it briefly, and so I want to mention that the flip side of the gifting is the basis issue that we mentioned.
The cost basis and not the property tax basis.
If you sold it, would you have a capital gain? Yep. And the reason for that and the reason why estate tax planning might and of course does have personal elements there is that sometimes the property that goes up the most in value isn't the best one to gift because the kids are not keeping that one.
It's like they don't like that property. Maybe they could exchange it for example. But let's say that's for whatever reason that the.
The best way to overpay for your future real estate to save taxes today is to do a 1031 exchange. I love.
So if they know they're selling that one, well, maybe you do estate tax planning with other things to get the basis step up at death on one of those, especially if you have two spouses and one passes away first, you wouldn't want to gift that low basis real estate you don't want. You hold it.
There's no estate tax. When one person dies, you get a new basis. Survivor can sell it. No capital gain, do some other planning with it. It's just something to think about. So it's kind of like a double edged sword right now. You get the estate tax benefits. When you give something away, you don't get a new basis.
So you seem to be thoughtful about that.
It's very similar to when one spouse passes away and you've got some assets and some real estate, when you're funding a marital trust, don't just take the real estate, don't just take the home. Right. Don't give up all the assets. Right. We have to be thoughtful. So, you know, let's return back. We should be thinking about estate tax planning.
So this is exactly where one would start, right? Because there's in my mind, there's like, this flowchart, there's like, this threshold of, like, are you taxable, first of all, or might you be after the estate laws change? Let's say it's yes. Who are you leaving assets to? Right. We have to look at the estate plan. If you have a foundation and most of it's going there.
I have a client in net worth has grown quite a bit substantially and they're likely to be subject to estate taxes in the future. But the majority of their estate is going to a charity when they're gone. We do not need to rush to make decisions.
So you're taxable. You want to leave things to, let's say, your children and future generations, not to charitable beneficiaries. Yeah, you care about estate tax. There are clients who say “it is what it is.” So we have to have not only the estate but the desire to actually reduce the tax.
So then finally, we're at a stage where it's like, okay, does it make sense? Let's talk about what it would take from a standpoint of effort and details that we need, what you're giving up, a willingness to have some complexity in your life after these strategies. And if you get through all these steps, then it's like, okay, I'm a good candidate for some of these crazy acronyms that we'll get into.
Well, I'm looking forward to the future episodes where we get to talk about all those fun things.
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