In case you were wondering, Ultra High Net Worth (UHNW) individuals are busier than ever when it comes to planning for estate and income taxes. The new tax laws have presented some opportunities that may not exist in a few years, and those who are extremely wealthy (and smart) intend to get their fair share now. Chris Erblich, whose law firm is ranked at Tier 1 for their Trusts and Estates practice by US News and World Reports, notes several actions UHNW clients have been taking in light of the Tax Cuts and Job Act:
1) Establishing Trusts
As we may have suspected, UHNW individuals are still planning for estate and gift taxes. They are afraid the new higher estate tax exemption limit is going to be short lived, and they are doing everything they can do to safeguard their wealth with trusts.
There are several types of trust that serve different purposes. An Intentionally Defective Irrevocable Trust (IDIT or IDGT) is especially powerful because assets are protected from creditors, and out of your estate. Assets can be transferred into the trust via a ‘sale’, i.e. the trust will pay back the grantor with interest. And because it is a ‘sale’, no gift tax is triggered.
However, the individual is still responsible to pay income taxes on the gains. This is good news because it further reduces their taxable estate. Also, assets build up within the trust unfettered; meaning no income tax repercussions for heirs. It’s like gifting extra wealth, without incurring gift taxes.
2) Keeping or Getting Life Insurance
UHNW individuals are covering any risks with a life insurance policy that delivers a tax-free death benefit. For example, what if they get divorced(and lose half the assets)? Or one spouse dies first (and assets go to the kids)? Or estate tax laws change again? The life insurance policy ensures that these potential losses don’t bankrupt the estate.
3) Changing the Rules
UHNW individuals are asking themselves new questions because their kids are now going to come into significantly more money. For example, “what if the kids and grandkids just decide not to work at all, and squander the money?” New safeguards are being put into place with contingencies, including using ‘no contest’ clauses (in states where they are allowed) to help enforce the trustees’ authority regarding the distribution of funds.
For better or for worse, clients don’t want to have to deal with a bunch of what they consider to be red tape. For example, they don’t want to have Crummey letters sent out (to take advantage of annual gift exemptions). Because the lifetime gift and estate tax exemption is so much higher than before, the ultra wealthy are just doing away with administrative tasks that are going to have a marginal impact.
5) Planning for State Inheritance Taxes
We often forget that some states have a significant inheritance tax, in addition to the federal estate taxes that are levied. Maryland is an interesting example; it has a high state estate tax but no gift tax. In states like Maryland, clients are making gifts now so that they can avoid the estate taxes later. They won’t have to ever pay a gift tax, and the money will no longer be in their estate when it comes time to pay estate taxes.
6) Covering their ‘Basis’
Did you know that assets in an irrevocable trust don’t get a step up in basis when you die? This is because it is not in your estate, and no longer in your name. Your heirs will eventually have to sell the assets, and eventually pay capital gains on all the profits.
For example, let’s say you had a property in your name that was worth $2 million at the end of your life, and you paid $200,000 for it. If your heirs sell it for $2 million, they will pay zero taxes. On the other hand, if the property was in a trust, your heirs would pay taxes on $1.8 million! For assets that have significantly increased in value, a step up in cost basis could mean massive tax savings.
To minimize capital gains taxes for their heirs, clients are taking a look at the assets in their trusts. If they are highly appreciated, they are swapping them out for less appreciated assets.
7) Planning for an Increase in Income taxes
The new limit on the deduction that can be taken for state and local tax payments will hike up the tax bill for UHNW individuals. To prevent this, clients are modifying trusts by moving them to states where income taxes are not charged, such as Nevada or Delaware. They may use NINGS, INGS or WINGS [incomplete non-grantor trusts] for this purpose. Assets are included in the estate for tax purposes, but the trustee can be located in a state that doesn’t charge income taxes.
Some individuals are choosing to use more than one non-grantor trust to save on income taxes. This is because, for tax purposes, the grantor and the trust are recognized as separate entities. Each non-grantor trust will receive the 10K deduction, multiplying the tax benefit.
8) Creating Trust Companies
UHNW individuals are creating their own private family trust companies, and picking one of those favorable tax states in which to incorporate them (for example, states without income taxes, good ‘no contest’ provisions, and favorable privacy and asset protection laws). They will save on income and estate taxes, and have greater protection for their assets. An added bonus; basis point fees paid to money managers are tax deductible if the money manager is one of their employees.
They are not moving houses; they are moving their trustees. UHNW individuals are setting up trustees in states that will never be subject to estate taxes, such as South Dakota, Nevada, Wyoming, etc,. They may even have multiple trustees, but the one who manages the the administrative tasks is strategically located in a favorable state.
10) Calling Family Meetings
And finally, many UHNW individuals are bringing everyone in the family together to discuss the future of the family’s wealth, the purpose of wealth, and bringing up issues that had long been swept under the rug. This discussion can be the most rewarding of all.
If you would like to discuss whether one of the wealth preservation strategies outlined above is a good fit for you or your affluent clients, give us a call at any time. It is our goal to make a measurable difference in your financial life.
Note: The statements above should not be considered financial, legal or tax advice, but ideas for careful consideration with trusted financial advisors and lawyers. For tax or legal advice, please consult with an accountant or an attorney.
About Axia Global
J. Michael Roney, founder of Axia Global, has worked alongside the best financial and legal professionals in the field to craft profitable solutions for even the most complex wealth preservation and estate planning cases. Together, the team at Axia Global has nearly a century of combined experience in the financial services sector.