Estate Planning Opportunities to Seize in 2023

If the past is any indication, our lives will get more frenetic as the year progresses, and many wealth planning strategies will be pushed aside until being reinvigorated late in the year.

However, the first quarter – before things pick up and implementation becomes more challenging – is a great time to pause, think through personal finance issues, assess income tax positions and asset values, and start examining some estate planning strategies.

For that reason, our Private Wealth Services group is providing this summary of 2023’s estate and gift tax exemption amounts, as well as some estate planning opportunities for you to seize (and hopefully sooner, rather than later).

Increased Gifting Limits

This year, the IRS has adjusted the estate and gift tax exemptions to $12.92 million, an increase of $860,000 over the 2022 exemptions. Accordingly, federal wealth transfer taxes will not be assessed on cumulative taxable gifts of up to $12.92 million per person.  

In addition, the annual gift tax exclusion amount has been increased to $17,000 per US recipient.

Background on Trust Planning

The top federal gift and estate tax rate is 40%. At a conceptual level, the federal gift tax is imposed on taxable gifts exceeding an individual’s gift tax exemption ($12.92 million in 2023, adjusted for inflation). The federal estate tax is imposed on all estate includible assets in excess of an individual’s remaining estate tax exemption (roughly, the same $12.92 million in 2023 minus the value of lifetime gifts). 

Many states also have separate estate and gift tax regimes. For example, New York imposes an estate tax with an exemption of $6.58 million for 2023. 

Making gifts of appreciating assets to trusts is “Estate Planning 101”. While there are a multitude of tax and non-tax advantages that arise from making lifetime gifts to trusts, here are a few basic reasons for planning with trusts.

“Freezing” Asset Values Prior to Appreciation

Most estate planning trusts are structured as “estate exclusive,” meaning that that gifts to these trusts are “complete” for gift and estate tax purposes, and the assets in those trusts are generally not includible in anyone’s estate. Generally speaking, a properly drafted trust is not subject to estate tax at the death of the trust creator, the trustee or the beneficiaries. 

This basic feature can allow you to grow assets outside of your estate by making gifts of appreciating assets to a trust. The “cost” of making these gifts is consuming some or all of your $12.92 million exemption. However, because the exemption amount is limited to inflation-based adjustments (and smart investors generally beat inflation), the compounded growth of the assets in the trust can be vast. These trusts are also often structured as “grantor trusts,” meaning the creator of the trust bears the cost of the trust’s income tax liabilities over years (or at least until this tax treatment is changed). This can further deplete your otherwise estate includible assets and allow an estate exclusive trust to grow on an internally income-tax free basis. Studies and experience have shown that it is possible to reduce the value of a client’s estate dramatically (or almost entirely) using this basic technique alone.

Economically, the effect of making large gifts to a trust is, therefore, to “freeze” the value of the trust at the time of the gift for gift and estate tax purposes. Assuming you use your full 2023 exemption of $12.92 million by making a gift to a trust, all future appreciation is transferred to the trust (and, therefore, its beneficiaries) free of gift and estate tax. 

Of course, we have a variety of tools at our disposal to customize a trust and maximize tax efficiency. For example, various mechanisms exist to retain certain controls over the trust and make gifts subject to substantial discounts. These tools have many intricacies, but the important takeaway is that trusts can be extremely flexible and effective, given proper planning.

Exemption Sunset

The current $12.92 million exemption may seem lofty, but if new legislation is not passed by congress, the exemption will be reduced significantly in 2026. While the exact value of the 2026 exemption will depend on inflation and is not yet clear, many professionals believe the exemption will be around $6.8 million at that time. 

If you can make current gifts in the full amount of your exemption (or at least in an amount greater that the roughly $6.8 million that will likely remain available in 2026), you would effectively “lock in” the additional exemption available today, even if you pass away after 2026. If you have the means available, this planning alone could produce millions of dollars in tax savings.  

State Tax Planning

As noted, certain states have separate estate tax regimes. However, those states may not have gift tax regimes. For example, New York imposes an estate tax but no gift tax. Gifts made more than three years prior to death are completely removed from your New York estate. Considering New York’s marginal estate tax rate is 16% on estate includible assets, making lifetime gifts can be an extremely effective strategy.

Creditor Considerations

Trusts created for legitimate estate planning purposes are generally not accessible to creditors. This means that if the trust creator runs into unforeseen troubles with a creditor, assets that were previously gifted would be protected. The same is true for beneficiaries, whose potential ex-spouses and creditors would not be able to access the trust assets.

2023 Planning Opportunities

This year, keep in mind that a high interest rate environment presents unique planning opportunities and pitfalls. Certain trust formats and transactions may make more (or less) sense in the current interest rate environment. Additionally, asset values and expected growth are key considerations in the current economic climate.

With that in mind, here are five brief points for you to consider this year: 

Get the Basics Done

If you have not yet done your estate planning, it is often best to start with basics. You should make sure your core documents (i.e., will, revocable trust, health care documents and powers of attorney) are complete and current. Beneficiary designations for retirement accounts should be reviewed, as there have been many changes in this area over the last few years.

Consider basic wealth transfer planning, which often involves creating an insurance trust. Life insurance often has insubstantial or limited current gift tax value and does not produce current cash flow, but if the proceeds were to be paid, a large windfall would result. Although life insurance proceeds are not subject to income taxes, they may be subject to estate taxes. Ensuring these assets are held in an appropriate trust can be a crucial first step in limiting estate tax exposure. 

Don’t Overlook Business Planning

For clients who have sacrificed for years to develop their businesses, thinking through succession issues and other business planning elements is fundamental. It is often desirable to make gifts of real estate or other business interests to trusts. Another often overlooked aspect of estate planning is making sure “buy-sell” arrangements are in place for your business to ensure that a plan exists to address how the ownership interests will be handled on retirement, at death, upon exit, if one of the owners were to encounter financial headwinds, and in a variety of other circumstances.

Maximizing Other Tax-Free Gifting Strategies

In addition, you should consider maximizing the use of annual exclusions and other tax-free gifting strategies (such as making direct tuition payments and payments for medical care). This can be done with outright gifts or, in many cases, using trust vehicles for minors or others for whom significant gifts would be inadvisable.

Consumed Your Entire Estate Tax Exemption?

If you have made prior gifts to consume your entire exemption amount before 2023, the increased exemption now presents an opportunity to make additional gifts of $860,000 per donor. Consideration should be given to utilizing prior trusts, which should be reviewed to ensure the provisions are still desirable. If circumstances have changed, consider options to “decant” or otherwise modify previously existing trusts.

Selling Assets to Trusts

If you have a larger estate beyond the current exemptions, you should also consider selling assets to trusts for cash or a promissory note. The tax and economics of these transactions are too technical to cover here, but simply put, this can be an extremely effective tool in pushing asset appreciation into trusts once gift exemption limits have been reached. Additionally, it is important to periodically review income tax basis planning opportunities and income tax treatment of grantor trusts, which are extremely important and often overlooked considerations.

This summary is provided for informational purposes only. If you would like to discuss your estate planning strategy, please contact Jason A. Lederman, Esq. at jlederman@steinadlerlaw.com.