THE LETHAL TAX

Wherever you find significant wealth you find significant taxes. At death you find a wealth-destroying tax: the Estate Tax. Presently, when the tax applies, it exacts 40% of your net worth, payable within 9 months of your passing. Current legislative proposals aim to apply the tax to more of your wealth and increase the tax rate to as high as 65%. You cannot take your wealth with you when you die and the government won’t let you leave it behind either.

The nature of the Estate Tax is quite different from other taxes, such as the Income Tax. The Estate Tax is imposed because of something that happened to you, something you avoided at all costs – dying. On the other hand, the Income Tax is imposed, in almost all cases, because of something you did – generate income.

Income Tax comes because you accrue a new benefit and it can be paid from the benefit received, preserving the original value. Tax on rental income is paid from the rent receipts. Gains from the sale of appreciated stock is paid from the appreciation. Estate Tax, however, carves out a portion of all the property, both the original value and the appreciation. It strikes with unbiased precision and the expensive bill must be paid quickly. As a result, in order to generate sufficient liquidity to pay the tax, businesses, investments, and real estate are often sold by your heirs at fire-sale values.

The title to a recently proposed Estate Tax reform bill, “For The 99.5% Act,” describes precisely who Congress targets with the Estate Tax: the ultra-high net worth individual. The Estate Tax is lethal to this individual and it cannot be ignored. You must acknowledge it, understand it, and address it. Fortunately, your options are quite simple. The Estate Tax is imposed on the transfer of property owned at death. Therefore, you address it in one, or both, of two methods: (i) limit what you own at death or (/i) carefully select who you give it to.

Although the Estate Tax is imposed on all of your assets, it allows you to deduct the amounts you give to charity and the amounts you give your spouse. Transfers to charities are never taxed. If you transfer all of your wealth to charity you pay zero tax. Transfers to a spouse are not taxed at your death but, instead, at the death of your spouse. In essence, gifts to a spouse delay the tax, they do not reduce it.

Consequently, most planning reduces Estate Tax by limiting what you own at death. The simplest form of this planning is spending. For the ultra-high net worth, the true targets of the Estate Tax, their wealth is too great to spend away. Alternatives are necessary.

The oldest, easiest, and most obvious alternative to reduce your Estate Tax was gifting assets during life. It was so obvious and easy that Congress quickly reacted by imposing the Gift Tax in 1924 and overhauling it in 1932. Because it imposes a tax on the transfer of property during life, planning options had to evolve.

One common evolution is to take advantage of the difference between the legal value of something and the value your heirs receive. When the legal value is lower than what the heirs receive (the difference is referred to herein as the “Delta”), you can transfer the Delta without incurring Estate or Gift Tax.

Sometimes this happens by taking advantage of time. You transfer assets early-on at present value and incur the tax at that time. The appreciation in the assets that occurs between the transfer and when the heirs inherit – the Delta – is free of Estate and Gift Tax.

Another method uses the time-value of money to lower the value of the assets transferred. When you transfer assets to a trust that provides your heirs with inheritance at the end of a term of years, the value of that gift is less because the heirs must wait for the inheritance. The Delta is the difference between the present-value of the future gift and the value of the gifted assets today. This Delta transfers Estate and Gift Tax free.

A different evolution uses legal realities to reduce the value of an asset at the time of transfer. For example, the owner of all of a $30M commercial building has all the rights to the building. But the owner of 50% of the same building must share those rights with the other owner(s). Because the rights are shared, you must involve others in deciding to lease the building, make improvements, or sell, to name a few. Because others share these rights, it is more difficult to sell the 50% interest and because the interest is more difficult to sell, it warrants a lower price or value. You transfer 50% of the real estate to a trust for your children for a value much lower than $15M (50% of $30M) and that difference is the Delta, which transfers free of Estate and Gift Tax.

Another strategy uses specially designed trusts to limit the assets you own for Estate Tax purposes but still treat you as the owner for Income Tax purposes. Initially, this seems unattractive but it is one of the most effective wealth-transfer strategies. Because you are personally responsible for the Income Tax, you can pay the tax from your personal assets, further reducing what you own that is subject to Estate Tax, meanwhile the trust’s assets, which you do not own when the Estate Tax is calculated, will grow Income Tax free.

Nearly all planning utilizes several of these tactics but, unfortunately, many of them are under attack in the For The 99.5% Act and could be eliminated. Some will be “grandfathered in” should you implement the strategy before enactment. While last year saw an enormous amount of planning because of one expected change to Estate Tax, this year should see ten to a hundred-fold as much planning because multiple changes are now proposed. It is a grievous error to delay planning.

These are strategies the ultra-high net worth individual will implement whether or not the For The 99.5% Act passes, therefore the question isn’t “Should I act?” but “When?” The time is now.

ABOUT WEALTHGATE TRUST

Wealthgate Trust is a client-founded, Nevada-based, multi-family boutique trust company. Born from the founder’s own experiences searching for an ideal trustee solution for his family, Wealthgate Trust partners with ultra high net worth families and their advisory team to create, implement, and administer bespoke trust strategies.

Wealthgate Trust is licensed and regulated by the Nevada Financial Insurance Division (NFID), and audited separately by the NFID and two national CPA firms.

ABOUT THE AUTHOR

Aaron is a Wealth Strategist assisting Wealthgate Trust families and their advisors in developing and implementing bespoke estate planning strategies. He’s an attorney licensed to practice in California and Nevada, with over a decade of trust and tax planning experience, and presents on a variety of topics including wealth preservation and private trust companies.

Aaron previously served as the primary tax planning counsel for Lobb & Plewe LLP. He has represented several major trust companies and sits on the board of the Coalition for American Retirement. Aaron earned his JD from the University of Nevada, Las Vegas.