Transfer Tax Planning Basics

Transfer tax planning focuses on gift, estate, and generation-skipping transfer (“GST”) taxes, which are collectively referred to as “transfer taxes.”  The base transfer tax exemption amount is $10,000,000 ($12,920,000 million for 2023, as indexed for inflation).  Under current law, the base transfer tax exemption amount is set to reduce to $5,000,000 (as indexed for inflation) on January 1, 2026.  This impending tax law change presents a “use it or lose it” situation between now and 2026 with regard to the $5,000,000 of increased exemption.

You may give away, free of transfer tax, either $10,000,000 (as indexed for inflation) during life, on your death, or a combination thereof.  Anything in excess of this amount will be subject to transfer tax, which is currently a flat 40% rate.  You may give away an unlimited amount to your spouse under the estate tax marital deduction, with any estate tax essentially being deferred until the surviving spouse’s death.  A similar unlimited deduction is also available for amounts passing to charity.

For transfer tax purposes, an asset is valued at its “fair market value,” which is the price the asset would change hands between a willing buyer and willing seller.   Certain types of assets, such as non-controlling or minority interests in a limited partnership or limited liability company, are eligible for valuation discounts.  For example, a transfer of a non-controlling, minority interest in a business may be eligible for discounts for lack of control and lack of marketability because a minority owner typically cannot freely transfer such an interest, demand distributions, cause a dissolution and a return of the owner’s capital, or otherwise control business decisions. 

Two transfer tax planning techniques are (1) a gift to an irrevocable grantor trust and (2) a sale to an irrevocable grantor trust.  A gift of an asset during the donor’s life removes the asset—and, importantly, its future appreciation— from the donor’s estate and will therefore not be subject to estate tax on the donor’s death.  A sale of an asset to an irrevocable grantor trust allows the grantor to remove the appreciation of the transferred asset from the grantor’s estate at a minimal transfer tax cost. 

The mechanics of a typical sale to a grantor trust are as follows:  First, the donor creates an irrevocable grantor trust with an initial gift of at least 10% of the value of the asset the donor wishes to sell to the trust.  Next, the donor sells the asset to the grantor trust and receives a promissory note from the trust in exchange. 

A sale to a grantor trust offers several benefits.  By receiving a promissory note, the grantor does not part with the value of the underlying asset.  However, the grantor has transferred the asset and, importantly, all of its future appreciation out of his or her taxable estate in exchange for a note, the value of which is fixed.  In other words, the grantor has “frozen” the value of the asset for estate tax purposes by transferring an appreciating asset out of his or her estate in exchange for a note.  In addition, the sale provides the grantor with cash flow through the debt service payments.  The grantor also has the flexibility to forgive the note, resulting in a taxable gift equal to the balance of the note and utilization of the grantor’s transfer tax exemption. 

To achieve the tax benefits, the purchasing trust should be a grantor trust.  With a grantor trust, the grantor is treated as the owner of the trust assets for federal income tax purposes, but for all other purposes, such as state law and federal estate tax, the trust is a distinct entity and the legal owner of the trust assets.  As a result of this deemed ownership, any trust income must be reported on the income tax return of the grantor, who will pay the resulting income tax.  This permits the grantor trust to grow income-tax free while the grantor is alive, yet the grantor’s payment of the income tax is not considered a taxable gift.  Finally, because the grantor is the owner of the assets of the trust, the sale to the grantor trust and the interest payments on the note are ignored for federal income tax purposes. 

If you have any transfer tax planning questions, please contact Chris Weeg or the estate planning department’s attorneys of Comiter, Singer, Baseman & Braun, LLP at (561) 626-2101.