Imagine, if you can, that you’re one of the richest people in the U.S., in the top 0.1 percent or so, with a net worth measured in the tens or hundreds of millions. Now picture your wealthy self sitting in a conference room. The tangle of Midtown Manhattan rises outside a window. Frosted glass hides you from a hallway. Sitting across a stone-and-wood table, your trusted advisers deliver the good news: You’ve received a very thoughtful gift from the U.S. government.
The new tax law, signed by President Trump in December 2017, gave a number of goodies to rich families like yours, starting with doubling the amount you can pass on to heirs without triggering the estate and gift tax. If you’re single, you get $11.2 million to dispense with, while married couples can play with $22.4 million.
So how are you and your advisers going to get to work making the most of the new tax rule? This is where it gets complicated. If you and your spouse can bequeath $22.4 million, you can create a dynasty trust that’s essentially a self-perpetuating cash machine that will take care of your descendants for a very long time. That means you have to make even bigger decisions about your family—perhaps including some not yet born. What will so much money do to them? Will they be entitled or empowered? What if they fight? What if they waste it? Those questions make the tax planners’ job part-bean counter, part-high-end social worker.
“I know that these are First World problems by most standards, but they’re still real problems,” says Paulina Mejia, a trust counsel who leads the New York office of Fiduciary Trust Company International. “And the more wealth you have, the more complicated it is.” Fiduciary Trust, which manages more than $77 billion, agreed to let Bloomberg Businessweek inside its New York headquarters for a rare peak at the process. Although client privacy was sacrosanct, the company’s leaders and planning experts opened up during hours of interviews.
While lowering most Americans’ tax bills, Trump’s enormously complex law directed most of its largesse to corporations and other businesses. That benefits rich investors and business owners who already used an array of tactics to legally avoid taxes. “This law made the system worse at taxing those at the top, and it opened up more opportunities for the wealthy to escape taxation,” says New York University law professor David Kamin.
Like other estate planners, Fiduciary Trust, which is owned by money management giant Franklin Resources Inc., creates elaborate structures to protect assets from tax collectors, creditors, and sometimes family members. And that means an adviser might dig into some sensitive matters: the daughter-in-law the client hates, the son who seems lost. Even basic planning can involve a half-dozen trusts or more. Fiduciary creates detailed flowcharts to explain it all to clients. Trusts can also attach strings to money, giving the benefactor power beyond the grave.
“Our clients are concerned about the impact of too much money on their families,” says Gail Cohen, the company’s general trust counsel and chair of its board. For a billionaire client concerned about motivating his family members, Cohen set up a trust that would fund their business ideas—but only after Fiduciary Trust checks out and approves their business plans. As a trustee, the company often acts as a neutral party. “Family members will have somebody other than another family member to be angry at,” she says.
Fiduciary clients are thinking out 50 years, or even 100. In most states, trusts must have an expiration date. But a few states, including Delaware and South Dakota, have eliminated that requirement. That allows for dynasty trusts that, in theory at least, can keep your heirs comfortable forever. And yes, you can set up trusts in a state even if you don’t live there and benefit from the local rules.
If you want your dynasty trust to last for generations, though, you need a lot of money. That’s why the new tax law, which doubled the exemption, is making them far more popular this year, Fiduciary and other firms say.
Still, getting too excited about tax-saving strategies can be risky. If you have millions, the doubling of the exemption is a huge chance to avoid the estate and gift tax’s rate of 40 percent—and you might want to take advantage of it soon, since it expires in 2026 and could end earlier if the political winds switch direction.
But you might feel like you’ve already given away too much, especially if you’re merely very rich, with a fortune in the tens of millions. “There’s a lot of angst about, Will I have enough?” says Jim Le Rose, an avuncular senior relationship manager at Fiduciary. Clients worry about recessions, stock market corrections, and paying for long-term care. One way around that is to pass your vacation homes on to your heirs, while keeping your stocks, bonds, and business investments handy for your own needs.
Again, the tax code is here to help. For a rich couple with a few homes, Fiduciary’s recommendation is to set up a qualified personal residence trust, or QPRT, a vehicle that can pass real estate to the next generation. Even after putting a house in a QPRT, a wealthy couple will still get to live in it rent-free for a set amount of time, usually a decade. A QPRT’s biggest perk, though, is that gifting a $3 million house doesn’t eat up $3 million of your $22 million estate tax exemption. The tax savings depend on how long you stay in the house and on interest rates. In the spring of 2018, when Fiduciary first discussed a QPRT with the couple, a $3 million home would have counted for only $2.2 million against the exemption.
Not all implications of the law are clear. Consider the case of one successful cardiologist. High-income service professionals, including doctors and lawyers, were supposed to be barred under the law from a new 20 percent break for owners of noncorporate businesses. Over the summer, before the IRS issued regulations for the provision, Fiduciary advisers raised the idea of dividing ownership of some of the doctor’s holdings—a parking lot, a retail storefront, and medical equipment—among his four children and putting them into trusts. Moved outside his direct control, these trusts could at least get the tax break. The trusts would put a crucial wall around that money—at a time when one child was getting a divorce and another was being sued. But will it work? IRS regulations issued in August didn’t definitively answer the question. The cardiologist decided to take the chance anyway.
Some Fiduciary clients, particularly those in New York and California, got unwelcome news about their tax bills this year. The new rules cap state and local tax, or SALT, deductions at $10,000, a pittance for folks with high incomes and property tax bills on multiple homes. Clients keep bringing up the obvious solution: move to a state such as Texas or Florida that’s kinder to rich taxpayers. Some clients are packing their bags. But Craig Richards, Fiduciary’s energetic director of tax services, asks them: Should you make a major life decision just to save a few bucks? Isn’t a perk of wealth getting to live wherever you want? Those questions apply to other tax-driven strategies. “There’s a cost-benefit analysis: Is the cost of doing that going to be more than what the tax savings are?” Richards says. “And also, how much complexity do people really want to live with just to save taxes?” Quite a bit, apparently. “There are some people who just don’t like paying taxes,” says Gerard Joyce, Fiduciary’s national head of trusts and estates.
Spend enough time in the offices of Fiduciary Trust, however, and there’s an undercurrent to the buzz of activity. If history is a guide, the majority of rich Americans would have automatically decided to throw an additional $11 million at their heirs. Yet many clients are doing nothing, for now at least. Says Mejia: “I’ve had a lot of clients say, ‘That just doesn’t seem right. At what point am I taking this too far?’”
©2018 Bloomberg L.P. All rights reserved. Used with permission.