One of the cornerstone goals of most financial plans for the successful entrepreneur is to eventually transfer some of the value of their life’s work and identity to the next generation without their wealth being unnecessarily eroded by the federal and/or state estate tax. Currently, this exemption sits at $11.58 million per individual or a combined $22m+ per couple, leaving only a small percentage of successful estates potential subject to this tax. Combined with the ability to gift $30,0000 (if splitting gifts in a married couple) to any number of defined beneficiaries each year without applying against the lifetime exemption, clients often forget the changing tides of the estate tax exemption may force them into a vastly differently situation down the line during times of legislative change. Beyond that, there are a significant amount of successful business owners who are, and will continue to be, subject to federal estate tax down the line based on current asset values, even if they do not have the liquidity to cover this exposure.

Let’s look at a few key ingredients for this potential financial disaster:

  1. In 2026, the law is scheduled to “sunset” to pre-tax cut levels (~$5m per individual + inflation) unless – and this is key – we see a change in executive or Congressional authority and new tax reform passes changing these exemptions earlier.
  2. States often have their own estate tax exemptions or other arduous and expensive wealth transfer provisions – with 12 states in 2019 retaining an estate tax and another 6 assessing inheritance or other forms of transfer tax.
  3. Federal estate tax rates are at 40%. When combined with potential state estate taxes and/or income tax on a decedent’s qualified or otherwise taxable assets – gross tax exposure can significantly hurt an estate’s liquidity.

So, given at least temporarily higher exemptions, what are the primary goals of estate tax planning as it stands today.

  1. How do I transfer assets out of my name, preferably at a discounted valuation – and into trust or other vehicle which isn’t subject to estate tax?
  2. In doing so, how do I ensure those assets appreciate outside of my estate?

These two central issues are where estate freeze techniques come in. Whether using grantor retained annuity trusts (“GRATs”), Charitable Lead Annuity Trusts (“CLATs”), sales to defective trusts (“IDGTs”) or other strategies designed to freeze future appreciation into trusts outside of the estate – there are a few unique keys to owners of businesses and/or private enterprise.

  1. Consider an owner ramping up for a future strategic sale in which they expect stronger than usual EBITDA multiples given industry trends and/or availability of a future buyer. Despite these higher projected sale values on paper, the company doesn’t yet justify those valuations. A gift and/or strategic sale – perhaps of nonvoting, minority interests in the business to trust – would combine the benefits of an overall lower valuation plus potential lack of control/marketability discounts into a lower assessed value of the gift. Once the business had a liquidity event, the embedded growth from the sale would already be in trust, making it the perfect use of leverage.
  2. GRATs in particular are incredibly valuable – even for the business owner not ready to relinquish large amounts of control or ownership – as they are designed simply to transfer growth on the underlying asset to a trust outside of the estate – while allowing the grantor to receive the initial investment back in the formal of an annuity payment. In theory, assuming the business asset is sustaining a higher growth rate than the IRS 7520 rate (equivalent to 120% of the federal midterm rate), the transaction will succeed in transferring growth potentially without any usage of the lifetime exemption.
  3. Sales to IDGTs can provide even more leverage given the notes used are typically interest only (whereas GRATs pay the grantor back principal as payments can only increase by 20% each year) The ability to backload the payment on the promissory note in an IDGT can transfer large amounts of capital for a relatively small gift.
  4. Regardless, taking advantage of increased exemptions; the ability to discount or have lower valuables pre-sales process; and the low interest rate environment (which means low 7520 rates) makes proactive planning to the business owners and entrepreneurs extremely valuable.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. Brix Partners is not a subsidiary or affiliate of MML Investors Services, LLC, or its affiliated companies. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. CRN202203-261457

First featured on Forbesbooks.com