Estate Tax Tips for Wealthy Clients

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Only a tiny number of estates owed any estate tax at all in 2012, due to an individual exemption of $5 million — up from $675,000 just 12 years earlier. But that doesn’t mean the IRS ignored the returns.

Taxpayers filed 9,404 returns in 2012 for estates worth less than $5 million, that year’s individual exemption. The IRS audited 1,362 of those returns — a 14.5% audit rate — and recommended collecting an average additional tax of $85,718 per return.

But bigger estates drew more scrutiny. For estates worth between $5 million and $10 million, the IRS audited 58.6% of returns and determined that heirs still owed an average of $105,388 per return, in addition to taxes already paid.

And while there were just 937 returns that year for estates worth more than $10 million, the IRS actually conducted 1,087 audits, going over returns repeatedly — and, on average, asked heirs for an
additional $819,243 per return.

The lesson: The higher a client’s net worth, the more important it is to create an estate plan that can withstand careful scrutiny. For wealthy clients, a solid estate plan can offer tax benefits via strategies that work to reduce estate value, shelter estate value and shift future appreciation — between now and the second spouse’s death — out of the estate.

Attorneys are estate plans’ final architects, of course, but a financial planner’s recommendations can offer both attorney and client valuable input — and help estate and asset management plans work in concert.

“An attorney thinks about tax planning first, which is their job,” says Brian Power, principal at Gateway Advisory in West Westfield, N.J. “But estate plans need to happen within the context of someone’s overall financial plan.”


No matter what other strategies an estate plan employs, preserving the portability of the estate-tax exemption — also called the deceased spousal unused exclusion — is often the simplest way to garner significant tax benefits. The exclusion amount for 2015 is $5.43 million, and even though clients whose estates will amount to less than this will probably not owe estate taxes, many still need to file tax returns in order to preserve that portability — a move that’s particularly important if the estate is expected to grow substantially.

“If a spouse dies without using the full deduction, the surviving spouse can use what’s left over in addition to her own,” says Samuel Donaldson, a professor of law at Georgia State University College of Law in Atlanta.

A client who gives $1 million apiece to his two children has $3.43 million of leftover deduction, which his wife can use in addition to her own $5.43 million deduction at her death, for a total exclusion of $8.86 million.

There are two conditions attached to the portability election. The surviving spouse cannot remarry and still use the previous spouse’s unused deduction and (ahem) the first spouse’s estate must file an estate tax return.

Planners must also recognize that many states have their own estate taxes, with much lower exemptions than that for federal estate tax. “We have clients around the country, and we need to be mindful of their state laws,” says Elliot Herman, a partner at PRW Wealth Management in Quincy, Mass.


Charitable giving is a popular way to reduce an estate to below the exclusion amount; such gifts can also create a legacy and help a cause that’s close to a client’s heart.

Clients often want to make a significant impact in their areas of interest, says Terri Munro, a senior financial planner at BT Wealth Management in Atlanta. “They don’t want to just give $500 to anyone who calls,” she says. “They prefer to endow a chair at the symphony instead, for instance, if they’re interested in classical music.”

It can be easy to overstep the line between minimizing taxes and giving away more than the donor can afford, advisors caution. Older people are often more able to see which assets they need and which they probably don’t, says Lawrence Gingrow, PRW Wealth Management’s director of advanced planning. A cash-flow analysis can help clarify the picture, he adds.

Charitable remainder trusts and family limited partnerships can allow a client to donate highly appreciated assets and draw lifetime income from those assets while still removing them from the estate, he points out.
Advisors can also help clients decide between donor-advised funds and family foundations, which offer different sets of advantages.

“Family foundations offer you more control than a donor-advised fund,” Munro says. “A donor-advised fund doesn’t let you give to an individual — only to another 501(c)3, and then without strings attached. A family foundation also makes it easier to give internationally.”

And foundations offer another way to leave a legacy. Let members of younger generations direct a family foundation now, in cooperation with the older client, then continue on their own after the original donor has died, says Austin Frye, an LPL advisor in Miami. “A $5 million or $10 million foundation can last indefinitely,” he says. “The more someone has, the more likely they are to form a charitable foundation.”

But donor-advised funds have some advantages on the tax side, Munro points out. Taxpayers can deduct up to 50% of their adjusted gross income based on contributions to public charities, but only up to 30% of AGI based on contributions to private foundations, or 20% for contributions of appreciated property.


To whittle down the estate and avoid a big tax hit later, say advisors, clients should also consider using the annual individual gift exclusion. “You can give $14,000, or $28,000 per couple, to kids, grandkids, nieces, nephews — whoever you like,” says Charles Bennett Sachs, principal at Private Wealth Counsel in Miami.

“That adds up if you move that money every year.”

Writing a check to pay medical bills or tuition is something clients can do in addition to annual cash gifts, without owing any additional gift tax. The only stipulation is that the donor must give the money directly to a medical provider or school, on the patient or student’s behalf.

It’s often an enjoyable way to give. “They get to watch the gift be used while they’re still around, and my clients really love that,” Power says.

Another issue to consider: variations in the recipients’ tax brackets. If clients give assets instead of cash while they’re still alive, they must remember that “when you give something, they inherit your basis in it,” says Reid Hartsfield, vice president and financial planning strategist at BB&T Wealth Management in Jacksonville, Fla. “Consider giving low-basis assets if the recipient is in a low tax bracket.” Higher-basis assets, of course, can be a better fit for recipients in higher tax brackets.


One way to reduce the value of an estate is a family limited partnership, which wraps assets in a partnership and divides partnership shares among family members. The advantage for heirs is that the value of the whole does not equal the sum of its parts.

“You can’t sell shares, because the partnership agreement says you can’t, and you have no real control, particularly if the donor is the general partner. So the IRS might value your share at half what they would otherwise be worth,” says LPL’s Frye. “Other than charity, this is the No. 1 vehicle that wealthy families choose. It could turn a $10 million exemption into $16 million or $17 million in value.”

Such a partnership can hold shares in a family business, but could also hold cash and other assets, including real estate and nontraditional investments. The more liquid the assets, the less discount the IRS is likely to allow.

A family limited partnership worked for one client family with wealth in real estate, Munro says. “When the mom passed away, the patriarch disclaimed some amount into a family limited partnership. It’s tax efficient, and the general partner still has control over the assets.

“A family limited partnership is also a flow-through entity,” she adds — “so you can use this strategy to shift income from the donor to the children or grandchildren, which can be good if the donor is in a higher tax bracket.”

Advisors may also want to consider some more sophisticated strategies, such as one favored by PRW’s Gingrow and Herman, called “private split dollar.” How it works: A client makes a gift to an irrevocable grantor trust using the lifetime exemption, which is $5.43 million in 2015. The trust then purchases life insurance — with a death benefit of $20 million, for example — and the premium payments are split between the client and the trust. The trust pays a small portion of the annual payments, and the client advances the rest of the premium.

Because the trust allocates only a small amount to premiums, most of the $5.43 million gift is invested.
At the end of a designated period — perhaps 20 years — the trust, which ought to have grown considerably, repays the client for the advanced premiums. “The client has essentially made loans to himself or herself,” Herman says. “The trust has a fully funded $20 million life insurance policy and, after repaying the client for premiums advanced, should still have a sizable asset base to continue investing. It’s a way to create exceptional leverage from the initial gift to the trust.”

If the lifetime exemption continues to be indexed for inflation, the client would gain additional exemptions over the 20-year period, and so may be able to forgive at least some of the loan to the trust without triggering gift tax. That keeps even more investable assets in the trust.

“This is a great strategy, but is only practical for the right kind of client,” Herman says. The ideal candidate has very high net worth — enough to make the initial gift, pay the trust’s income taxes, and advance the majority of premiums on a large policy for 20 years.

No matter which strategies fit a client, the time to start working on them is now, Sachs says. And no matter the tax goals, he and other planners caution against letting tax strategy take precedence over a client’s wishes.

“There is no formula for doing this,” Hartsfield says. “Situations are all different. Sometimes we let taxes rule the day when the client’s intentions are more important. The goals of the client should be No. 1.”

This story has been updated after publication to correct an error.

Ingrid Case, a Financial Planning contributing writer in Minneapolis, is a former editor at Bloomberg News and author of Your Own Two Feet (and How to Stand on Them): Surviving and Thriving After Graduation.

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