Estate Planning When the Estate Is Large

Lifetime gifts

Two separate allowances govern gifts, and they are easy to confuse. The annual gift tax exclusion is the amount you can give any one person in a year without filing a gift tax return or using anything up. The lifetime gift and estate tax exemption is the much larger amount you can transfer over your lifetime and at death before federal transfer tax applies. Gifts above the annual exclusion draw down the lifetime exemption; they do not usually create a tax bill.

Giving during life rather than at death moves the asset out of your estate now, so whatever it earns from that point forward grows outside the estate and is generally beyond what the estate tax reaches when you die. Timing is the whole advantage, and the price of it is control. A completed gift is gone. You do not vote it, spend it, or take it back. A family that gives an asset it cannot really spare, because a deadline was approaching, is the one that regrets it.

The California question

Gifting cuts the other way for many families here, and the reason is basis. California has no estate tax of its own, so a family below the federal exemption faces no state or federal estate tax either way. Meanwhile, property properly held as community property by a married couple receives a step-up in basis on both halves at the first death, which resets the built-in gain on those assets. Whether an asset qualifies depends on how it is titled and characterized, which the attorney and the CPA determine.

Give a low-basis asset during life and you remove future appreciation from an estate that may never owe estate tax, and you give up a step-up that would have erased the capital gain for whoever inherits it. Below the exemption that trade is usually a poor one. Well above it, the estate tax on decades of appreciation can outweigh the lost step-up several times over. Where a family sits relative to the exemption decides which of those is true for them.

Trusts for a spouse

A spousal lifetime access trust, or SLAT, is a gift to a trust that benefits your spouse. The assets leave your estate, and if a business fails or life turns, they remain reachable, through your spouse.

The appeal is that a family can move a large sum out of the estate without moving it out of reach, which is what makes a gift of that size affordable. The drawback runs through the same door. Two events close it. Divorce ends your access, because the beneficiary is now someone you are no longer married to. Your spouse’s death generally ends it too, because your access ran through them. There are partial answers, and they belong in the document rather than in hindsight: an attorney can define “spouse” deliberately in the trust itself, and some families pair the trust with life insurance on the beneficiary spouse so that the door closing is not also the money vanishing. A third risk catches business owners: whoever serves as trustee votes the business interests you put in.

GRATs, sales to a trust, and family loans

Three well-worn techniques look different and rest on the same idea. Each is a wager that an asset will grow faster than a low rate the government publishes monthly, and everything above that rate belongs to the next generation.

The clearest is the GRAT, a grantor retained annuity trust. Walk it with round numbers. You put a million dollars of stock into the trust for two years. The trust pays you back the million plus the published rate, call it a hundred thousand over the term, in two annuity payments. If the stock is worth $1.4 million at the end, roughly the $300,000 above what came back to you can pass to your heirs without using gift tax exemption, assuming the trust was structured and the assets valued so that the initial gift was near zero. If the stock falls instead, the trust returns what it has and you are back where you started, out little more than legal fees. Because a failed GRAT costs little, families with concentrated positions often run two-year GRATs one after another, keeping the ones that work. Its costs: you generally have to outlive the term, or much of the value comes back into your estate, what passes to the children faces estate tax again at their deaths, and the annuity returning to you has to go somewhere.

The installment sale to a grantor trust moves more at once. You seed a trust with a gift, then sell it a larger asset in exchange for a note at the published rate. Because the trust is treated as you for income tax purposes, the sale is generally not a taxable event under long-standing IRS guidance, though the point has never been fully settled in the courts. What the asset earns above the note’s rate stays in the trust. The costs: the seed gift uses exemption, the note has to be serviced from the trust’s own cash flow, and a disappointing asset still owes the note.

The everyday version is a loan to a family member at that same rate. They borrow, invest, and keep whatever exceeds the interest. It has to be a real loan, documented and repaid on schedule, or the IRS treats it as the gift it resembles.

How long a trust can last

How long a trust may last is set by the law of the state it is created under, and states differ widely. California limits the term; several states allow far longer or have removed the limit entirely.

A trust created in one of those states, with generation-skipping transfer tax exemption allocated to it correctly, can pass from one generation to the next without a transfer tax at each step. The costs are the ones that come with anything built to last: administration in another state, and terms your descendants live under without having chosen them. Changing a trust’s governing law afterward is sometimes possible and often difficult, so the state gets chosen before signing.

Charitable lead trusts

For a family that has used its exemption and still expects a taxable estate, charitable structures are one of the remaining routes.

A testamentary charitable lead trust pays a charity a set amount each year for a term, and whatever remains above the published rate passes to the heirs. Sized correctly, the charitable deduction can offset much or all of the estate tax. The cost is that the charity is paid first, for years, and the heirs receive later and less certainly. It fits a family that intended to give anyway, and it depends on an attorney doing the sizing against the rate in force.

Where this lands

Each of these gives up something to get something, and none of them is free. There are others we have not covered, and an experienced estate attorney will know which of them fit a particular family. Below the exemption, the step-up in basis is usually worth more than any transfer technique, which is worth knowing before anything is signed. Above it, the longer an appreciating asset stays in your name, the more of its future the estate tax can reach.