The Georgia run-offs are over, and with Democrats scheduled to take control of both houses of Congress and the presidency on Jan. 20, you should revisit your tax plan now.
If you make more than $400,000 annually (or if you have a sizeable estate), there could be some big changes coming your way this year.
Individuals in higher tax brackets are likely to see increases in capital gains taxes, income taxes, and estate taxes, as well as a reduction in the estate and gift tax exemption.
The key to saving is to act now—before any changes go into effect. These strategies can help minimize your tax liability.
Use a spousal limited access trust (or SLAT)
Of all of the proposed changes, the most significant is the reduction of the estate and gift tax exemption from $11 million to $5 million. This decrease can be avoided by transferring wealth now.
One option is the spousal limited access trust (or SLAT).
To use a SLAT, one or both spouses creates a trust for the benefit of the other spouse. Because the trust is funded by gift while both spouses are alive, this approach lets you take advantage of the current estate and gift tax exemption, avoiding any decreases in the exemption amount.
Be careful though. The SLAT is best used by individuals in extremely solid marriages. Also, if two identical trusts are created, the IRS can use something called the reciprocal trust doctrine to “uncross” the trusts, making the funds in each ineligible for the estate and gift tax exemption. If both spouses are going to create SLATs, it’s important the trusts are meaningfully different.
Sell part or all of your business
Another way to shield some of your assets is to sell your business to an intentionally defective grantor trust. Under this strategy, income-producing assets are sold to a trust in exchange for a promissory note. Because the trust now owns the business, the business is not subject to the estate tax (although the amount on the promissory note is).
Be smart about charitable contributions
Setting up a lifetime charitable remainder trust allows you to give to charity after death, receive a tax exemption now, and benefit from earnings on the gifted amount for the duration of the grantor’s life—the charitable giving equivalent of having your cake and eating it too.
Here’s how it works: a grantor donates one million dollars to a charitable remainder trust and receives an income tax deduction in return. For the rest of the grantor’s life, any earnings produced by the trust are distributed to the grantor as income, and when the grantor dies, the remainder is donated to the charity.
This option shelters donated funds from the estate tax, reduces taxable income in the year assets are gifted to the trust, and also provides the grantor with a lifetime annuity. It’s a win-win-win.
Fund a 529
Looking for another way to minimize capital gains and estate taxes? Fund a Section 529 college savings plan for your children or grandchildren.
Normally, people put $15K per year per child into a 529, but there’s a loophole that allows individuals to give five years’ worth of gifts at once (although they can’t then donate for the next four years).
This means that a married couple could put in $150K total for each child or grandchild. Although the donations themselves are not tax deductible, all earnings on a 529 are tax-free as long as the proceeds are used for post-secondary education expenses.
So what should you do? What will happen, and when will it all go into effect?
The short answer is that nobody knows exactly what will be passed—or when. But with a Democratic majority in both the Senate and House, the likelihood of future increases is high, particularly for individuals in higher tax brackets. Ultimately, the moves that you make now will depend on both your specific financial situation and your risk tolerance.
Understanding the options available to you (as well as how your tax liabilities might change this year) should position you to make informed decisions about your wealth planning strategy. If you’re not sure, the time to talk to an accountant was yesterday!
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Ted Byer is a member of Smolin Lupin & Co.