Create tax savings with giving and estate planning strategies


Estate planning is an excellent way for people to ensure their assets go to the intended recipient(s) upon their passing. There are many giving strategies that can help wealthier clients minimize estate or transfer taxes.

But when first bringing up the topic of estate planning with a client, the initial subject to discuss usually is the estate tax.

The estate tax is a federal-level tax imposed on a taxable estate at the death of a US citizen or resident when their taxable estate is transferred. There also are several states that have a state-level estate tax or an inheritance tax.

An estate tax is levied against the decedent’s estate, while an inheritance tax is levied against the heir, which means the heir pays rather than the estate. There are six states that have an inheritance tax and 13 states that have an estate tax (Maryland has both).

The second tax that usually comes up when discussing estate planning is the gift tax. This is imposed during a US citizen or resident’s lifetime when transferring gifts that exceed the exemption limits. Both the estate and gift tax share the same exclusion during a person’s lifetime.

Encourage Gift Tax & Estate Tax Exclusions

Both of these taxes have a basic exclusion, which is the amount allowed in each individual’s lifetime to be transferred without owing tax. They are tied together, meaning the estate and gift tax amounts use the same exemption amount. Currently, the exemption amount is $10 million adjusted annually for inflation.

In 2026, the exemption amount is scheduled to drop back down to $5 million (adjusted annually for inflation). For 2022, the exemption is $12.06 million. The credit then is the amount of credit applied against the first $12.06 million of assets.

In addition, there is the annual exclusion, which is the yearly amount of gifts that each taxpayer can give to an individual without being required to file a gift tax return or reduce their lifetime exemption amounts. This amount is $16,000 for 2022. It is adjusted annually for inflation and rounded up or down to the nearest $1,000.

Married individuals can elect to “gift-split,” meaning they can give up to $32,000 to the same person and it will be treated as if each spouse gave $16,000. In order to qualify for the annual exclusion, gifts must be a “present interest” gift, where the recipient has the right to the money now.

What does not qualify for the annual exclusion is future interest gifts. An example of a future interest could be an annual exclusion gift to a trust that the beneficiary will have future access to. For example, this could be when a grandfather gives $16,000 to a trust each year with his adult grandchild as a beneficiary, with the trust distributing percentages when she reaches certain milestones, such as 27, 33 and 40 years of age.

Take Advantage of the Generation-Skipping Transfer Exemption

As years pass, a large amount of assets can be shifted out of a taxable estate using annual exclusion gifts. That’s why a popular strategy is to set up trusts for grandchildren that are funded with annual exclusion gifts through the years.

This has the additional benefit of avoiding the generation-skipping transfer tax, which is a tax imposed on transfers of property to grandchildren and descendants from later generations.

There also is the generation-skipping transfer tax exemption (GST). The amount for this exemption is tied to the amounts for the estate and gift tax exemption. While allocations of the regular gift and estate tax exemption are required, GST allocations are optional.

Amounts not used during life may be applied to transfers of wealth upon death. After death, the full amount of assets given is added up, and transfers over the exemption are subject to a 40% tax.

Set Up Trusts for Estate Planning

Another strategy firms can suggest to wealthy clients is to use a trust, which is subject to personal income tax rates with compressed brackets. For 2022, trusts are subject to the top tax rate of 37% after $13,450 of income. Often, trust income is taxable when the income is not distributed to beneficiaries or the grantor.

Some trust income can be distributed to beneficiaries while other income accumulates. Depending on the type of trust, the grantor (donor/funder) may have income tax instead of the trust. Typically, trust income that is distributed out to beneficiaries is not taxed at the trust level; rather, only income that is left to accumulate inside the trust is taxed at the trust level.

Private Foundations

The classic charitable giving model for wealthy families is having a private foundation. This is when an individual or household creates a charitable organization under IRC 170 without becoming a public charity.

There must be a stated charitable purpose for the foundation, and the person then contributes a large amount of money—typically over $2 million—to the foundation, which is usually invested.

The foundation is legally a separate entity controlled by the funder/donor, and it must meet all compliance requirements for charitable organizations. Keep in mind that investments are subject to the 1.39% excise tax on investments, and there must be a distribution of at least 5% of charitable assets annually.

The income tax deduction for a private foundation is limited to 30% of AGI for cash contributions or 20% for securities/appreciated assets. This is a good giving strategy for individuals who want to have a direct impact and be very involved in the charitable causes they support.

When first bringing up the topic of estate planning with a client, the initial subject to discuss usually is the estate tax.

Donor-Advised Funds

Meanwhile, a donor-advised fund is typically the easiest strategy to implement for most individuals. The donor partners with an existing organization and donates to it. Over the years, the donor can advise on where and when to distribute the contributions, and there is no requirement to distribute a certain amount of funds each year—or ever.

Cash contributions to donor-advised funds are limited to 60% of AGI. Gifts of securities are limited to 30% of AGI. Excess contributions can be carried over five years to offset income. The compliance and filing requirements are managed by the existing organization.

This is a good option for individuals who want to give larger amounts but do not want to be involved on an ongoing basis or be responsible for all compliance requirements.

Charitable Lead Annuity Trust

Next, there is the charitable lead annuity trust (CLAT), where the donor establishes an irrevocable trust to invest funds in. The trust might be for a set term of years, one life or two lives or be created upon death. The trust may be a grantor trust (meaning the donor/grantor is not treated as being separate from the trust) or a non-grantor trust (meaning the trust is treated as a fully separate entity).

The trust will distribute a set amount equal to at least 5% of the funding amount each year to a named charity or charities, with the remainder of the assets going to beneficiaries at the termination of the trust.

There are two ways to get a charitable deduction with a CLAT:

  • An income tax charitable deduction, limited to 30% of the taxpayer’s AGI for the year of the contribution. (It must be structured as a grantor trust in order to have an income tax deduction, and it may result in further income tax liabilities down the road.)
  • An estate tax deduction, limited to the ascertainable present interest to the charitable beneficiaries. (This often is created upon death.)

CLAT Deductions

Finally, there is what is called a CLAT deduction. This deduction is equal to the ascertainable amount of the donation to charity. It may be determined by the number of years of the trust term or by the life expectancy of the donor(s).

The number of years and the set amount the fund will distribute each year are called the “present value” of the full donation amount. In lower interest environments, a CLAT is a good option for a charitable deduction while shifting assets to a lower generation.

Essentially, if an investment is put in trust for a term of 20 years with a payout of 5%, the growth of the investment historically will exceed the 5% of the funding amount yearly, leading to appreciation of the investment over time.

A CLAT is a good option for someone who wants to give for a long period of time to a specific charity while providing for their heirs. They typically are done when there is a taxable estate or large income amounts to offset over five years. But there are significant compliance requirements with CLATs—the trust must have an annual accounting and file multiple forms, including federal form 5227.

Other Methods of Estate Planning

While the above methods cover many of the most advanced forms of giving, there are other methods to reduce a taxable estate. Direct payments of educational or medical payments are not considered gifts, and medical trusts (HEETs) can be set up to pay direct medical costs for grandchildren.

For education, 529 accounts can be set up and contributed to. These have no federal tax deduction but might have state tax benefits. Coverdell ESA contributions can also be made.

When it comes to estate planning and giving, firms should bring up a plethora of possible strategies that can create significant tax savings for their wealthy clients.

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