Estate Tax Changes – The Clock is Ticking for a Lower (or Non-existent) Tax Bill

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Let this blog entry serve as the call to arms in getting you or your client’s estate planning needs addressed ahead of a massive decrease in the taxable estate threshold at the end of 2025. Simply put, act promptly to save on money that will be paid to the Federal Government as a result of changing tax laws in the near future.

The Tax Cuts and Jobs Act (“TCJA”) significantly increased the amount of wealth one could have in their estate tax free. As of the time of this blog post, the lifetime exemption is $13.61 million per taxpayer. This means that upon you and your spouse’s death, you are not taxed on your estate until the value of your estate reaches $27.22 million, less any significant gifts that have been made over your lifetime. The provisions of the TCJA are set to sunset, i.e. expire, on December 31, 2025. At this point, thresholds will revert back to $5 million per taxpayer, adjusted for inflation (which would yield a threshold of around $7 million, give or take). In other words, the thresholds will reduce to roughly half of their previous levels, effectively bringing significantly more people into a taxable estate situation.

The reason this is so important is because estate tax rates are very high; 40% at the max currently, and they reach this top rate quickly. Everything $1 million over the estate tax thresholds is taxed at 40%. As an example, a married individual with an estate currently worth $20 million does not have a taxable estate; however, once the tax laws change, assuming the thresholds revert to $7 million, this individual’s $20 million estate has now become taxable to the tune of $6 million. $5 million of this $6 million is taxed at 40%. This individual suddenly has a $2 million+ tax bill, and on top of that, their estate may not even be liquid, requiring the heirs to liquidate assets to pay the bill. Obviously, this can turn a family situation upside down, creating turmoil and upsetting the longevity of the family’s enterprise and wealth.

There are ways to act now to reduce or eliminate your family’s taxable estate exposure. The first is to consult with an estate planning professional, either a qualified attorney or CPA. These professionals can assist you in planning the necessary measures to undertake to prepare for these changes ahead of time. The use of closely held entities and trusts can be very useful here, even if you have very simple assets such as cash and publicly traded stock. These steps can be time consuming, which is why I recommend getting the conversation started now.

Where business valuation professionals can assist is with the gifting process. Gifting minority interests in closely held entities to your heirs is an extremely popular and effective way to reduce your estate and transfer wealth to your heirs either tax free, or at the very least at significantly decreased amounts. Logistically the way this is accomplished is through discounted values of minority interests in your companies. Typically, when held by you alone or by you and your spouse, ownership in family companies has a higher value than the value in the hands of your heirs. The way this is accomplished is by strategically gifting minority interests in the company. Because fair market value considers hypothetical buyers and sellers of an ownership interest, the minority interest is considered in the hands of an outside buyer. Acquirer’s of closely held companies seldom pay full pro rata value for minority interests and will apply substantial discounts to the ownership. This is because purchasers are decidedly less interested in non-controlling ownership and want to have more, if not all, influence over how the company is run, how often distributions are made, and the overall strategy of the company. Our job as valuators is to determine the value of the company and then to quantify the likely discounts that are applied to the subject interest. Doing this as an estate planning strategy results in taxpayers reducing the value of their estate at a discounted value. It is by and large one of the most effective and popular ways to reduce a family tax burden in light of changing estate tax thresholds, and it remains the biggest portion of the valuation work that we perform.

Gifts of minority interests in closely held entities need to be valued by credentialed professionals, as the value of these entities is not readily apparent like a publicly traded company. A formal appraisal needs to be performed and given to the IRS as part of a gift tax return when this is done. These reports serve to address the IRS’s requirements for what is called “adequate disclosure.” This means that unless adequate disclosure is met, the IRS can re-open a gift tax return for audit if the fair market value of the gift has not been properly supported by an appropriate business appraisal by a credentialed professional. Our reports serve as the first line of defense for IRS questions about the value of the gift, and therefore need to be as thorough as possible, in addition to meeting basic valuation reporting standards.

With the sunset of the TCJA, estate planning is going to boom during the next 18 months, and it is as good a time as ever to consult with the proper professionals. At the very least, consult with a CPA to get your arms around what you have. Preparing a personal financial statement can be a worthwhile practice to get this process going. If you have questions about this process or where to start, please contact our office for a consultation around your specific situation. We stand ready to assist you in accomplishing your goals for the future..