Wealth Management

When the Target Is Moving, Flexibility Is Key

By Shelly Meerovitch, Tara Thompson Popernik January 11, 2017
When the Target Is Moving, Flexibility Is Key

With the US tax code and regulations in flux, maintaining flexibility will be crucial to estate planning. One tax-efficient wealth strategy that preserves flexibility is the intentionally defective grantor trust (IDGT).

Wading Into the Unknown

Many high-net-worth families and their planners feel like the ground is shifting beneath them. During his presidential campaign, Donald Trump promised to reduce the top income-tax rate to 33% from 39.6%. His team also floated the idea of eliminating the federal estate tax. These proposals would provide windfalls to high-net-worth individuals or their heirs—if they are passed by Congress.

Other changes to the tax code may not be as favorable. Just last August, the Treasury Department proposed regulations limiting taxpayers’ ability to discount the value of gifts to family members of interests in a closely held or family owned business.

The rationale for applying discounts of 20% and 30% to the transfer of closely held assets is that the shares don’t provide control and aren’t marketable. The discounts also amplified the value of the gift and maximized the efficacy of the transfers. Limiting the applicability of discounts would result in increased estate taxes for owners of family businesses and could upset their legacy plans; many estate planners had advised rushing to make gifts ahead of the rule change.

Covering All the Bases

When faced with uncertainty, it’s generally best to keep your options open. One strategy to consider is an IDGT. The ongoing payment of income taxes by the grantor on behalf of the IDGT can ultimately result in estate-tax savings larger than valuation discounts and can be adjusted as needed, if tax laws or tax rates change.

The grantor’s payment of an IDGT’s income tax is a gift-tax-free transfer of wealth that can be repeated year after year for the life of the donor. Assets in the trust grow tax free, because the income they generate is included in the donor’s income for income tax purposes. Thus, both the funding gift and the income tax payments reduce the grantor’s taxable estate.

Our modeling shows that after 10 years, $10 million contributed to a IDGT could generate more family wealth (about $3.6 million) than discounting a $10 million gift by 30%—and would likely result in a lower estate-tax liability.

Discounts are useful for instant results, but they’re permanent transfers that may not prove to be necessary, if the estate tax is eliminated. An IDGT strategy is much more flexible. If income-tax rates change or the estate tax is eliminated, it’s possible to make adjustments that stop donor tax payments on trust income.

The views expressed herein do not constitute and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.

When the Target Is Moving, Flexibility Is Key
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