Observations

Looking Out for Your Financial Future

13 - Aug 2020

My Favorite Tax Savings Structures, Part Two

Federal estate tax planning isn’t something that everyone needs to worry about, but that could change over the next few years. Because federal gift and estate taxes could eventually apply to a larger number of taxpayers than they do now, I’d like to share a favorite structure for reducing those tax liabilities. 

The Grantor Trust

Gift and estate taxes currently apply to the least number of taxpayers in U.S. history because of the very large amounts for the life-time exclusion that were recently introduced into law. The current amount of wealth that is excluded from taxation is $11,580,000 per person. Each spouse for a married couple has that same exclusion for a total amount of $23,160,000 for the couple. As you can see, not many people are currently facing any gift and estate tax.  

That situation could change with the whims of Congress. Just to give you an example, the exclusion amount when I first began my career was only $600,000. There is also the fact that the current $11,580,000 is scheduled to expire in 2025. Upon expiration, the amount will be just over half of the current amount. So, with nothing more than the passing of time, after 2025 the gift and estate tax will affect many more taxpayers.

I believe the single most valuable structure to use in estate planning is the Grantor Trust. This is a tax term of art that means a trust that is disregarded for income tax purposes and therefore taxable income of the trust is reported in the grantor’s tax return. I could not quickly find the date for the origin of the statute, but the associated regulations were written in 1956. So, there is a long history on the topic.  

At first glance, it may not be apparent how valuable it is to use a Grantor Trust. Here is the quick bottom line of the benefit: You can make a gift of securities into the trust today, for the benefit of your heirs, but the heirs do not receive the benefit until your death. Over all the years of your remaining lifetime, the value of the trust continues to grow for the heirs in a structure that is outside of your taxable estate. In short, all growth is transferred to your heirs with no estate tax.

There are many other benefits; these are just a few of my favorites:

  1. Even though a trust with a portfolio will generate taxable income such as interest, dividends, and capital gains, you are not required to use the trust funds to pay those taxes, making the structure more valuable for the heirs. 
  2. When you report the taxable income of the trust in your tax return, and then pay the tax due from a source other than the trust, the payment is not considered a further gift or transfer to the trust or to your heirs. This is true even though the economics are exactly the same as making a gift to your heirs for them to use to pay the taxes.
  3. The economics of this structure also reduce your remaining taxable estate faster because you are using your wherewithal to fund the payment of the trust’s (would-be) taxes due.
  4. Using the current tax rates, the maximum capital gains tax rate is 23.8% and the current estate tax rate is 40%. That difference of 16.2% is the reduction in taxes due for as long as you live.
  5. The structure is essentially just a separate account for a section of your investments to operate over the years, in the name of the trust, and no separate tax return is required.

The only downside of a Grantor Trust is that you have made an irrevocable gift and therefore those funds must stay in the trust. So be sure to make gifts that you can afford to do without. If you do not have a comfortable excess of wealth, then you really do not need federal gift and estate tax planning.

Please contact your Telarray Advisor for more details on tax planning, and to find out more about these and other ways to decrease your possible federal tax liabilities. 

M. Andrew Shaul

Author:

Andy Shaul began his career in financial planning at Arthur Andersen & Co. in 1986, where he specialized in estate and tax planning for individuals. He earned an early promotion to Manager, and to this day, many of his clients have been clients since that time. He left Andersen in 1993 to work with Cliff Paessler at the accounting firm of Dunavant, Dickey, Paessler & Shaul. He and Paessler founded Financial Strategy Group in 1999 to provide comprehensive financial planning services.

Shaul graduated from the University of Tennessee with a bachelor’s degree in business, and holds a Master of Science in Taxation from the University of Memphis. He is both a CPA and a Personal Financial Specialist (PFS).